While mutual fund investors have problems over the timing of when they buy and sell funds, they aren’t really that “dumb” in the traditional sense, says John Rekenthaler, vice president of research for Morningstar.
Rekenthaler, who spoke on Thursday during the Morningstar Ibbotson Conference 2013 in Hollywood, Fla., told an audience of about 70 guests that the myth of “dumb investors” deserves “close scrutiny.”
He and his colleagues looked at why investors were “not making money that one might expect from funds,” a conundrum they defined as the “return gap.”
Most analysis looks at total returns, which are time weighted, and compares them to investor returns, which are dollar weighted. But the Morningstar experts decided to calculate a money-weighted measure of returns to help them assess a fund’s internal rate of return and then compare these numbers with time-weighted returns. The result? A return gap, which could help the analysts better assess investor behavior.
From 2002-2012, the initial research revealed that this gap was 1.01% for domestic-stock funds, 3.11% for international-stock funds, 1.35% for municipal bonds, 0.87% for taxable-bond funds, and 0.84% for allocation funds.
“This doesn’t mean that fund investors are ‘dumb,’ though it is true that the timing of purchases matter,” Rekenthaler said.
The Morningstar team then dug deeper to look at whether or not investors were buying the “wrong funds,” funds with high charges, poor fund managers or the wrong assets. “These are the four ways to get this wrong,” he explained.
The researchers then discovered that investors got fund selection right across the five fund categories (mentioned above). They also concluded that investors were overpaying.
“The expenses are larger than the benefits of their fund selection,” said Rekenthaler, implying that there should be continued fee pressure on fund companies.
Other conclusions of the research? Fund managers over all are not buying the wrong securities, but investors are allocating their assets in a less-than-stellar fashion.
The rigorous analysis also found that the return gap combined with investor selection produces an overall gap in investors’ performance versus that of index funds of 1.38% for domestic-stock funds.
This is related to expenses (0.72%), the manager (0.33%) and asset allocation (0.33%). “The biggest negative is expenses,” Rekenthaler said. “And investors are hurting themselves by [poor] asset-allocation decisions, like moves they made to get out of emerging-market funds in the ’08-’09 timeframe, for example.”
That is bad news for investors, but it is a positive situation for advisors and other experts, according the analyst: “The greatest value that Morningstar, advisors, fund companies and the press can provide is improving asset allocation,” he concluded.