If someone looks at the performance statistics and finds last year's top-performing fund, what it tells them is exactly that – what last year's top-performing fund was.
There are numerous reasons why it was the best-performing fund. However, the major ones are:
It was the right economy.
It was the right sector of that economy.
The fund manager had chosen the right stocks.
The fund manager might have taken a huge bet in which sector of which economy he was investing.
The fund manager had also probably got several buy-and-sells extremely right.
The fact that it was the top-performing fund gives no indication whatsoever whether the average investor should get out his chequebook and fill his boots with the units. All it tells him is that he should have filled his boots a year ago.
Now, if the investor wants to spend hours of work, he could interpret past-performance figures and it would help him in establishing a first-class portfolio of investments.
First of all, he would have to make sure that the person who had created this excellent performance had done it out of sensible, straightforward, non-speculative stock selection. He would also have to know what style of investment this particular fund manager was employing – was it a valuestyle or a growth-style?
He would then have to find out whether the fund manager had been in small, medium or large companies and whether this style was maintained.
He clearly would have to make sure that the fund manager was still managing the fund and likely to continue managing it in the future.
It would also be very important to establish whether the fund manager had a long track record of always adding value in the particular investment style in which he invested. If he changes investment style his past performance is meaningless.
Why is it meaningless? Well, he might be the greatest value investor in the world but let him loose with a few technology stocks and he could lose you your shirt.
It is also important to know whether the fund he managed was based on short-term performance on a very small fund where the fund was heavily massaged (and I can think of one or two of those that are about at the moment which will not continue to perform like they did in the past).
It would be worth establishing whether this fund manager was capable of managing a £10m fund, a £100m fund and a £500m fund. If he is only capable of managing the £10m fund, the fact that he has sucked in another £490m will mean that the future performance will be lacklustre.
It would also be quite helpful to know that the investment department in which he works has high morale. If half the fund managers are thinking of leaving because they are not happy with the latest internal environment then you can rest assured the fund performance will not be great.
It is also useful to know whether the fund manager is interested in managing his own fund or whether he is more interested in managing his own investments (that situation abounds in the City).
If you know all the above about any particular fund, then past performance is a fantastic tool. However, without huge ancillary analysis, past performance will tell you only where you should have invested your money a year ago.
It is unlikely that most advisers have the quantitative ana-lysis to decide whether a fund is worthy of investors' attention. The one thing that no fund adviser knows is which sector, economy or investment style is going to be the best area for investment in the near future.
Even when you have all the information you require at your fingertips and you can make an assessment you have only found funds likely to perform well among their peer groups.
A portfolio taking no bets in weightings and choosing the funds with most potential in each style, economy, market cap and sector should be the ultimate goal – and who can attain that utopia?
Peter Hargreaves is the managing director of Hargreaves Lansdown