Mutual funds are an attractive investment vehicle for retail investors, but those investors’ whims can pose a threat to RIAs’ clients, according to a white paper issued last week by Gurtin Fixed Income Management.
The paper said many RIAs use retail mutual funds on behalf of their clients, apparently unaware of hidden risks in these vehicles.
The risks are threefold.
Buy-and-hold investors in these funds are at the mercy of their non-professional co-investors who tend to chase past performance, buying high and selling low. This forces fund managers to time their trades poorly.
When flows are positive, managers must scramble to buy securities in order to put new cash to work, and when flows are negative, they are forced to sell securities to provide liquidity to exiting investors.
This means the manager’s decision of when to buy or sell securities, and at what price, is the result of a combination of managerial judgment and the whims of retail investors.
An individual investor’s investment performance is directly affected by the decisions of co-investors. Even buy-and-hold investors cannot escape their fellow investors’ timing decisions.
How ill-informed are many retail investors? The paper cited a study showing that 39% of surveyed investors did not know whether they were invested in no-load funds, 75% could not say what their fund’s investment style was and 72% could not identify their fund as domestic or international.
On an individual level, poor market timing can cost retail mutual fund investors big time. In 2014, the S&P 500 index returned 13.69%, but the average equity fund investor took home just 5.5%, according to an annual study by Dalbar, a financial services consulting firm.
The Gurtin paper said research had documented retail investors’ poor market timing in both fixed income and equity mutual funds, and in both passively and actively managed ones.