Here’s an investment puzzle. Why do investors often underperform the managed investment funds holding their money?
Investment analysts have examined this phenomenon in the latest issue of the research and educational paper Vanguard’s principles for investing success.
This paper includes a telling chart showing estimates of how much investors’ returns lagged behind the managed funds holding their capital.
Based in part on Morningstar research of managed funds, analysts estimate that from January 2005 to December 2015:
- Equity world mid/small funds: Investors lagged their funds by an average of 2.07 per cent a year.
- Equity Australia large funds: Investors lagged their funds by an average of 1.84 per cent a year.
- Equity Australia mid/small funds: Investors lagged their funds by an average of 1.71 per cent a year.
- Fixed interest international funds: Investors lagged their funds by an average of 0.85 per cent a year.
- Equity world large funds: Investors lagged their funds by an average of 0.19 per cent a year.
- Multi-sector funds: Investors lagged their funds by an average of 0.31 per cent a year.
Analysts identified investor returns by taking into account the cash flowing in and out of the funds together and the actual returns of the funds.
The research confirms that cash flows into managed funds tend to be attracted by, rather than precede, high returns. Often, the mostly-recently hired funds subsequently underperformed the fired funds.
In short, the answer to the investment puzzle of why investor returns often lag the returns holding their money is performance-chasing behaviour by investors. This behaviour involves switching to funds to that have produced high recent returns and later sacking those funds once their performance lags.
