Direct answer: Performance chasing is the documented pattern of investors allocating capital to assets, funds, or strategies that have recently outperformed and withdrawing it from recent underperformers. DALBAR's annual quantitative analysis of investor behavior consistently shows that the average equity fund investor earns 1.5 to 3 percentage points less per year than the funds they hold, because they buy after strong performance (near peaks) and sell after poor performance (near troughs). This gap between investor returns and fund returns is sometimes called the 'behavior gap.'
Failure Pattern: Performance Chasing
Key Takeaways
- DALBAR's 2023 Quantitative Analysis of Investor Behavior found the average equity fund investor earned 6.3% over the 20-year period ending 2022, versus 9.8% for the S&P 500, a gap of 3.5 percentage points per year driven primarily by poor timing of fund purchases and sales.
- Fund flow research (Sirri and Tufano 1998, Frazzini and Lamont 2008) shows that investors pour money into funds after strong performance and withdraw after weak performance, consistently buying high and selling low at the category level.
- The performance of actively managed funds reverts: Carhart (1997) showed that past winner funds' outperformance deteriorates within 1 to 3 years as the underlying conditions reverse, strategies become crowded, or manager skill regresses to the mean.
- Performance chasing is not exclusive to individual investors: institutional investors and financial advisors also exhibit the pattern, reallocating to recent strong performers in manager selection.
- The antidote is a rules-based rebalancing strategy: buying the recent underperformers (which are below target weight) and trimming the recent outperformers (which are above target weight).
The Evidence From Fund Flows
Quarterly Morningstar data consistently shows that money flows into the best-performing fund categories in the prior year and flows out of the worst-performing categories. Hot categories in 2020 (technology, growth, ARK-style disruptive innovation funds) received billions in inflows in late 2020 and early 2021, immediately before those strategies underperformed by 30% to 50% from 2021 to 2022. Commodities funds saw massive outflows in 2020 and early 2021 as commodity prices were depressed, immediately before the 2021 commodity boom produced 30%+ returns. The pattern is consistent: aggregate fund flows are a reliable contrarian indicator of near-term category performance.
Why Performance Chasing Fails: Mean Reversion
Asset classes, sectors, and investment styles have historically mean-reverted in relative performance over 3 to 10 year periods. Growth stocks outperformed value stocks dramatically from 2017 to 2021; value stocks significantly outperformed growth from 2000 to 2007 and outperformed in 2022. Emerging markets outperformed U.S. from 2000 to 2010; U.S. outperformed from 2010 to 2020. An investor who chased recent performance by adding to growth in 2021 and selling value bought at the top of a cycle. The mechanism behind mean reversion is valuation: strong performance drives up prices, which reduces future expected returns from the same starting point.
The Category Allocation vs. Manager Selection Problem
Performance chasing operates at two levels: category allocation (moving between asset classes, sectors, or geographies based on recent returns) and manager selection (picking funds or managers based on recent performance). The evidence on manager selection is particularly clear: a study by Fama and French (2010) found that the top-decile funds by past performance showed no statistically significant persistence in future performance beyond what chance would produce. An investor who selects funds based purely on their 3-year Morningstar rating is selecting based on recent performance, which predicts future performance poorly.
The Behavioral Root: Recency Bias and Narrative
Performance chasing is sustained by recency bias (overweighting recent observations in forming expectations) and narrative (plausible explanations for why recent winners will continue winning). Technology stocks outperformed for a decade; investors developed narratives about permanent structural advantages that justified paying any valuation. These narratives are constructed after the fact to explain past returns and then applied forward to predict continuation. The stronger the narrative and the longer the outperformance period, the more investors become convinced of its permanence, which is when valuation has typically become most stretched.
Frequently Asked Questions
Is momentum investing the same as performance chasing?
Momentum investing (systematically buying recent winners and selling recent losers, typically over 3 to 12 month lookback periods) is related but distinct. Academic momentum (Jegadeesh and Titman 1993) is a documented factor with positive expected return over short to medium horizons. Performance chasing by retail investors operates at longer horizons (buying 1 to 3 year winners) where momentum has historically reversed. The distinction matters: systematic short-horizon momentum with clear entry and exit rules and position sizing is different from chasing a hot sector or fund after 2 to 3 years of outperformance.
How should I evaluate a fund manager's track record?
At minimum, look at: track record length (less than 5 to 7 years is not statistically meaningful); performance relative to a relevant benchmark, not in absolute terms; consistency of outperformance (one or two exceptional years can dominate an otherwise mediocre record); and whether the investment style has changed. The Morningstar analyst rating (gold, silver, bronze, neutral, negative) incorporates qualitative assessment beyond past returns; it is more predictive of future performance than the purely quantitative star rating.
What is the 'behavior gap' and how is it measured?
The behavior gap refers to the difference between time-weighted returns (what the fund earned) and dollar-weighted returns (what the average investor in the fund earned). Because investors add money before good periods and withdraw before bad periods, the dollar-weighted return (what the average dollar invested actually earned) is typically lower than the time-weighted return. Morningstar's 'Mind the Gap' study calculates this for thousands of funds annually; the average gap across categories is 1% to 2% per year, with the largest gaps in volatile categories where investor timing is poorest.