New indices rapidly lose ability to outperform, study shows

Newly constructed indices often flatter to deceive and rapidly lose the bulk of the ability to outperform they demonstrated in backtesting, according to research from Morningstar.

Based largely on backtested data, a typical new index outperformed its corresponding Morningstar category index by 1.4 percentage points a year during the five years before any fund started tracking it, the researchers found. But that excess total return declined to just 0.39 percentage points a year over the five years after the fund launched. Risk-adjusted performance followed a similar downward trend.