Solving An Investment Puzzle

Investors are sometimes puzzled about why their own returns may be very different at times from the managed funds currently holding their money – even when seemingly carefully compared on an after-fee, after-tax basis.

There is a straightforward explanation why some investors may under-perform their chosen investment funds.

Many investors adopt a hire-and-fire approach to investing in actively-managed funds. This typically involves selecting a fund on its prevailing status as a top performer, dumping that fund when it begins to under-perform and then switching to the latest top performer.

However, Vanguard research – The Case for Indexed-Fund Investing, updated and published almost 12 months ago – found there was a high turnover in the identity of the top-performing share funds studied. Indeed, there was a strong likelihood that past top performers would under-perform in the future.

In undertaking the research, analysts first ranked all actively-managed US share funds in terms of their excess returns over their stated benchmarks in the five years to December 2008. And then the performance of the funds was tracked over the next following five years.

During a recent Australian visit, one of the authors of that report, Francis Kinniry, emphasised in his talk to advisers about how some investors underperformed their chosen investment funds.

Kinniry, a principal of Vanguard’s Investment Strategy Group, was here to launch another research paper (of which he was co-author) about how advisers can add considerable value through their wealth management and financial planning skills – and as behavioural coaches. This is termed in the paper as "adviser’s alpha".

As behavioural coaches or trainers, advisers have a key role to play in encouraging their clients to adopt disciplined, long-term approaches to investing. And that includes avoiding the trap of chasing the latest winners.

Robin Bowerman is Head of Market Strategy and Communication, Vanguard Australia. As a renowned market commentator and editor Robin has spent more than two decades writing about all things investment.