'Past performance' disclaimer does not lead to good investment decisions

New research shows that the 'Past performance does not guarantee future results’ disclaimer does not lead to good investment decisions.

The standard disclaimer ‘Past performance does not guarantee future results’ is familiar to anyone with a passing interest in investing.

But it is also counter-intuitive: investing aside, past performance is often highly useful in decision-making in many areas of life: a restaurant serving good food will be returned to, and a good plumber will be called back to fix a leak. 

New research from the University of Leeds suggests that the standard investment disclaimer is not efficient at improving investment decisions and should be reworded.

In experiments, around 1600 US investors had to choose between investing in two mutual funds over a simulated 60-month period and given information about the funds’ past performance and the management fees charged by the funds.

The aim was to understand how investors could be encouraged to base investment decisions on management fees, and not past performance.

Historical stock market data has shown that fees are the only long-term reliable predictor of future mutual fund returns, because fees are a guaranteed recurring cost. Extensive research has repeatedly confirmed that stock market prices are unpredictable – even the most skilled investor cannot consistently and reliably pick stock market winners.

In Leeds research, participants persistently chased past performance by choosing the fund that had the highest returns in each previous month. Those with no experience in financial markets did worse by chasing past performance more aggressively than more experienced investors.

The use of the standard disclaimer was found to have little impact on their decision-making: most participants did not change their investment decisions when it was shown, in comparison to no disclaimer being used.

In fact, the disclaimer backfired for participants with no previous stock market experience, who instead chose to base their decisions on high management fees. The researchers suggest that this was on the mistaken belief that higher management fees would equate to quality.

Dr Leonardo Cohen, who led the research, said: “Investing in mutual funds is notoriously difficult as there are thousands of funds available. Investors typically try to chase past performance by putting their money into funds which have recently outperformed their peers.

But this is a poor strategy – research on decades of mutual fund performance has consistently shown that past performance cannot be used to reliably predict future performance because stock market prices are unpredictable. The only reliable guide is lower management fees.

“Our research shows that the disclaimer ‘Past performance does not guarantee future results’ isn’t effective at informing good decision-making. We found that investors either didn’t pay attention to the disclaimer and thought that they could beat the system, or invested on the basis of higher cost in the belief that higher management fees means better outcomes.”

The research also suggests that the wording of the disclaimer is part of the problem.

Professor Peter Ayton, Director of the Centre for Decision Research at Leeds Business School, said: “The vagueness of the disclaimer is an issue: while it tells investors that past performance does not ‘guarantee’ future results, it would seem that they still believe that there is a relationship between the two, if not a 100% correlation. This is in fact wrong, as there is no relationship at all between past performance and future performance.”

The Leeds researchers tested a new disclaimer, initially proposed by Dr Philip Newall from CQ University, Australia: Some people invest based on past performance, but funds with low fees have the highest future results. This was found to be much better in limiting investors from chasing past performance and helping participants choose the low-fee fund more often.

Dr Newall said: “The new disclaimer triggers a social comparison in relation to other investors, which has been shown to be more efficient in nudging behaviour. It also proposes more clear guidance on the ideal way to choose a mutual fund, which is focusing on lower fees.”

The Financial Conduct Authority is currently consulting on how to improve the Key Investor Information Document (KIID), a standardized template of information provided to retail investors when investing in mutual funds. The FCA’s aim is to rely less on past performance and more on future expected performance.

Dr Cohen said: “The FCA’s direction of travel is right, but we believe that there should more focus on educating investors about the detrimental impact of fees on their investment.”

A copy of the paper “Persistence is futile: Chasing of past performance in repeated investment choices” is available on request.

The research was carried out by Professor Peter Ayton (Leeds University Business School), Dr Leonardo Weiss Cohen (now at Kingston University) and Dr Philip Newall, CQUniversity, Australia.


Contact: Guy Dixon, Media Relations, Leeds University Business School: 07954 277 539 or g.dixon@leeds.ac.uk