Investors who “sin” with their mutual fund portfolios may feel the poetic justice of lower returns.
At the 2016 Morningstar Investment Conference conference, investment gurus Rob Arnott and Cliff Asness said it was okay for investors to “sin a little” by timing their use of market factors, but a study of investor returns by Chicago-based Morningstar found that “sinning” investors experience lower returns than they would in a buy-and-hold strategy.
Those who attempt market timing cost themselves between 74 and 132 basis points each year compared to a fund’s total returns across the 10-year period ending Dec. 31, 2015.
Morningstar defines investor returns as dollar-weighted returns as opposed to time-weighted returns typically listed for funds. The firm calculates investor returns by adjusting a fund’s total returns to reflect monthly flows and their compounding effect over time.
For U.S. equity funds, the average annualized gap between investor returns and total returns in the 10 years ending Dec. 31, 2015 was 74 basis points. International funds had a wider gap at 124 basis points.
“Investors tend to buy high and sell low, missing out on a fund’s gains in value,” said Russel Kinnel, chair of Morningstar’s North America ratings committee, in a released statement. “Our investor returns data has shown that investing decisions made a decade ago have an impact that compounds powerfully over time. Though investor return figures have somewhat improved year over year, the latest data shows that investors still face challenges in using mutual funds correctly.”
Municipal bond fund investors fared the worst, lagging total returns by 132 basis points over the same 10-year period, while investors in allocation funds experienced the smallest gap between total returns and investor returns at 17 points. Morningstar says continued, steady inflows to allocation funds and the tendency of target-date fund investors to hold their investments has helped narrow the gap between fund returns and investor returns.
Generally, investor returns lag a fund’s time-weighted returns because of people’s natural inclination to buy after a fund has gained value and to sell after a fund has lost value, thus missing out on the fund’s return stream.
According to Morningstar, total investor returns lagging total fund returns by 113 basis points on an average annualized basis for 10-year periods ending from 2012 to 2015, but the gap between investor returns and fund returns is shrinking.
Morningstar’s report evaluating U.S. open-end mutual funds was released on the same day as Arnott and Asness’s plenary indulgence to factor investors. The study calculated the average asset-weighted investor returns and average fund returns, and also tested for four factors and their effect on investor returns: standard deviation, tracking error, expense ratios and the Morningstar Stewardship Grade.