Chasing Recent Winners
Chasing Recent Winners
The highest-returning fund from the past decade has a 70% probability of being in the bottom half over the next decade. Buying it after that outperformance is a bet on mean reversion to work backwards.
Key takeaways
- ARK Innovation ETF (ARKK) was the best-performing growth fund in 2020–2021, returning 146% and 25% respectively; by 2022 it was down 67%, locking in losses for those who bought at the peak
- Past fund returns predict future performance so weakly that random selection would match the average return of "star" fund pickers within a few years
- The psychological trap is sharp: most of us see a 50% gain in a fund and feel we have missed something, when the past performance is precisely the signal to avoid it
- Reversion to the mean is not a guarantee—some outperformers do repeat—but betting on repetition after years of outperformance is odds-against
- Index funds bypass this entirely by capturing the full distribution of returns in a given asset class, without the sting of having picked the loser
The ARK phenomenon (2020–2022)
Cathie Wood's ARK Innovation ETF is the most vivid modern example, but it is worth walking through carefully because it encapsulates every element of the performance-chasing trap.
ARK focused on disruptive technology: genomics, autonomous vehicles, cryptocurrency, 3D printing, energy storage. These are real, important trends. In 2019, ARKK was obscure; it returned 36% that year. In 2020, it returned 146%. In 2021, it returned 25%. By late 2021, ARKK was the most downloaded ETF in several brokerages. Money flowed in rapidly. Asset managers began buying ARK funds to include in their diversified portfolios.
Then in 2022, ARKK fell 67%. A person who invested $10,000 at the end of 2021 (at peak enthusiasm, right before the drop) lost $6,700 by year-end. More importantly, they had bought a fund in the top 1% of recent returns, right before it reverted to—and below—the median.
Why did this happen? Several factors:
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Style concentration. ARKK was not a diversified technology fund. It was a concentrated bet on "disruptive" companies, and the definition of disruption had been expanding. It held meaningful positions in Telsa, Square, Roku, Coinbase. When growth-stock enthusiasm reversed in 2022, all of these fell together.
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Valuation reach. By late 2021, many ARKK holdings were trading at 20, 30, or even 50 times sales—price multiples that assumed perfect execution and perpetual growth. The market repriced these in 2022, not because the companies failed, but because the multiples normalized.
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Flow-driven performance. Part of ARKK's outperformance in 2020–2021 was mechanical: inflows of investor capital pushed up the prices of its holdings faster than fundamental value. When inflows stopped and reversed, price momentum reversed.
The trap, then, is not subtle. An investor sees:
- ARKK returned 146% in 2020
- ARKK returned 25% in 2021
- "I should buy this fund now, before I miss more gains"
- ARKK falls 67% in 2022
- Investor is forced to sell at a loss, or hold through years of underperformance while other funds recover
Contrast this to an investor who held a diversified low-cost portfolio: VTI (total U.S. stocks), VXUS (total international stocks), and BND (bonds). In 2021, their portfolio returned maybe 15–18%, well below ARKK. In 2022, their portfolio was down 18–22%, also below ARKK's fall (because they held bonds). But in 2023 and 2024, their portfolio recovered faster because it was not concentrated in the hardest-hit names.
Why performance chasing is mathematically rational but behaviorally fatal
A body of research (starting with Morningstar's analysis in the 1990s and continuing through work by Vanguard and others) shows a consistent pattern: funds that are in the top 25% of performers in one decade have a 30% to 40% probability of being in the top 25% in the next decade—barely better than random chance.
This is not because fund managers are bad at their jobs. It is because:
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Markets are partially efficient. The stocks and styles that worked best in the past are often already expensive, reducing their capacity to outperform in the future.
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Valuation mean-reversion is powerful. Stocks that have done best often get the most attention and inflows, pushing valuations to extreme levels. The biggest future outperformers are usually in unloved sectors.
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Momentum is temporary. A fund's outperformance over the past 5 years was driven by exposure to specific factors—growth, momentum, technology, small-cap value—that had been winning. Those factors tend to cycle.
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Investors buy high and sell low. By the time a fund has been in the top quartile for three years, most of its inflows come from retail investors buying at the peak. Those investors then panic-sell when the cycle reverses.
The mathematical insight is stark: if you picked a fund at random from the universe of equity mutual funds, your expected return over the next decade would be within 50 basis points (0.5%) per year of any "star" fund. The expected value of picking the best of the past decade is essentially zero, adjusted for the sting of being in the fund when it reverts to normal.
How to break the performance-chasing habit
The first step is emotional reframing. When you see a fund that has returned 50% in the past two years, your natural instinct is FOMO—fear of missing out. Instead, reframe: "This fund has already captured the move. The question is not whether it will go up more, but whether mean reversion will pull it down."
The second step is mechanical. Use only index funds or funds with extremely low turnover and clear criteria. If you want growth exposure, buy VUG (large-cap growth). If you want the highest-returning growth fund of the past three years, you are setting yourself up to buy ARKK at $120 and sell at $40.
The third step is rebalancing. A 60/40 portfolio that drifts to 70/30 due to equity outperformance is easy to rebalance. A concentrated fund that doubles and then halves is harder to rebalance because you are selling after it has already fallen.
The fourth step—and this matters most—is understanding why the outperformance happened, and whether that reason still applies. Did ARKK outperform because:
- All growth stocks were outperforming? (Yes, this applied to all growth funds)
- Or because ARK picked better growth stocks than competitors? (Unclear; the average ARK position has not beaten the broader growth index)
If the first is true, then buying ARKK after the growth rally is betting that growth will keep outperforming, not that ARK has skill. If the second is not proven, then why buy it?
The one exception: systematic outperformers
There is a narrow exception: funds that have outperformed through multiple market regimes, using a clear, documented, repeatable strategy, and with a reasonable explanation for why the outperformance persists.
An example: the Vanguard Value ETF (VTV), a large-cap value index fund, has outperformed the S&P 500 index (VTI) over the past 15 years because value stocks (measured by low price-to-book ratios) have been undervalued relative to growth stocks. This is a structural, explainable outperformance. Value investors can cite the value premium from academic research and argue that mean reversion will continue to favor it.
But even here, the dynamic is fragile. From 2009 to 2020, growth stocks so dramatically outperformed value that the value premium largely disappeared. An investor who bought VTV in late 2020, after a decade of outperformance relative to growth, would have been right—value rebounded in 2021 and 2022. But the bet still required an explanation (value is cyclical) and a time horizon (wait through drawdowns).
Most people chasing ARK or whatever this year's hot fund is do not have an explanation. They have a return chart.
How it flows
Next
Chasing recent winners in funds leads to buying near peaks and selling near troughs. But many investors make the related mistake at the individual stock level: they buy a hot stock after it has already run up, based on a tip or hot take from social media, without any real research into the company itself.