NEW YORK ( TheStreet) -- Plenty of investors are abandoning actively managed mutual funds and shifting to index funds.
Investors figure that it's simply too hard to pick active winners. Just because a fund delivered double-digit returns in the past does not mean that it will repeat the performance in the future, their thinking goes.
But a growing number of research studies indicates that there are ways to pick winning actively managed funds.
The researchers suggest following risk-adjusted performance as measured by an indicator known as "alpha." By considering alpha, investors can compare a fund to its benchmark.
Say a fund takes as much risk as its benchmark, the
. While the S&P returns 10%, the fund returns 11%. The fund is said to have an alpha of 1.0. If the fund returns 9%, then it has an alpha of -1.0.
Alpha is particularly important because it tends to be persistent. If a fund had a positive alpha in the past, it is likely to have a positive alpha in the future.
Investors should pick funds with high alphas and below-average expenses, says a study by W. Van Harlow, director of research of Putnam Institute, which is funded by
, a fund company.
Van Harlow found that funds with high alphas have a 60% chance of outperforming peers in the future on a risk-adjusted basis.
Not many funds deliver high alphas. The average large blend fund has an alpha of -1.25. Clearly investors should steer away from average funds. But there is a small number of funds that have delivered high alphas over long periods of time.
Among the top performers are
Weitz Partners III Opportunity Investor
, which has an alpha of 9.68,
with 6.25, and
Hennessy Focus 30
Sequoia has a long track record for success. During the past decade, the fund returned 6.3% annually, outpacing the S&P 500 by 2 percentage points while taking much less risk than the benchmark as measured by an indicator called beta.