Lou Harvey Hits Pfau Back Over Criticism of Dalbar Investor Study

Lou Harvey is talking apples. Wade Pfau is talking oranges. And never the twain shall meet, it seems.

This disparity is the crux of a beef between the two respected industry experts, says Harvey, in an interview with ThinkAdvisor. He is president and CEO of Dalbar, a leading Boston-based financial services market research company. Pfau is a professor of retirement income at The American College of Financial Services and a principal of McLean Asset Management.

When, in March, Dalbar released its “Quantitative Analysis of Investor Behavior 2017,” an annual study that now embraces the last 30 years ending December 30, 2016, findings once again showed that the typical mutual fund investor earns less than funds’ performance reports suggest. QAIB looks at retail investor behavior and returns in equity, fixed-income and asset allocation mutual funds; such investments are the most popular for generating retirement income.

(Related: Dalbar: Active or Passive Funds? 12 Factors to Consider)

After assessing the report, Pfau wrote a critical article for Advisor Perspectives charging that Dalbar’s “calculations are wrong.” And he warned “the financial services profession to stop using” the study “as a way to market the value of financial advice.”

In the interview, Harvey, who is president of the Fiduciary Standards Board, vigorously defends his methodology. The study examines investor returns, while Pfau takes the perspective of investment returns – two quite different concepts and numbers, Harvey says.

Because Dalbar’s methodology is flawed, Pfau claims, he advocates for a different approach. Singling out equity funds in the article, his rationale is supported by a table, employing Morningstar data, and several graphs.

Pfau insists that since “the quantitative results of the [Dalbar] study do not properly measure the underperformance of investors,” it “unfairly understates investor returns.”

Meantime, here are some of the study’s important findings: In 2016 “the average equity mutual fund investor underperformed the S&P 500 by a margin of 4.70%. While the broader market made gains of 11.96%, the average equity investor earned only 7.26%,” the report shows.

Further, investors’ pattern of behavior in the fourth quarter of last year, “positions [them] to also miss much of the first quarter market returns of 2017,” the study indicates.

That pattern began surfacing last October, when “fearful investors withdrew heavily early in the month and missed the modest recovery in the last week.  Withdrawals continued post-election, while the markets raced ahead in November. Fear of a correction drove up withdrawals again in December, so many investors again missed the opportunity. [They] lagged the index by 1.34 points for December,” the study found.

Investors’ propensity to buying high and selling low, together with fund expenses, chiefly account for the lower returns.

Dalbar has conducted its annual QAIB since 1994. Institutions provide the study to advisors at no cost. It’s also available on the Dalbar website for $99. According to Harvey, Pfau publishes no competing study.

In the article, Pfau contends that the correct methodology is one based on internal-rate-of-return. But Harvey holds that the math Dalbar employed is the Securities and Exchange Commission standard for calculating annual investment returns.

Before publication, Advisor Perspectives sent a draft of Pfau’s article to Harvey for comment. After his review, some deletions and other changes were made. Be that as it may, Harvey then fired back a “P.S.,” which was posted below the story. He wrote: “It is utter impudence for your author to take the position that the only valid methodology is that which he espouses.”

ThinkAdvisor recently interviewed Harvey, who spoke by phone from Dalbar headquarters. Notably, this is far from the first time that QAIB’s methodology has been disparaged. But compared to past years, Pfau’s story has generated the loudest hue and cry, Harvey says. Here are excerpts from our conversation:

THINKADVISOR:  Wade Pfau’s article about your QAIB 2017 study is headlined: “A Warning to the Advisory Profession: Dalbar’s Math is Wrong.” He charges that the “calculations are wrong” and urges “the financial services profession [to] stop using [the study] as a way to market the value of financial advice.” What do you think of his critique?

LOUIS HARVEY: My assessment is that he had a major problem with the methodology and couldn’t get anybody to pay attention, so the next step is to attack the author – and the blood in the water will attract sharks.

Did it?

I know that [the story] has gotten a lot of pushback, particularly from financial institutions because they told us. There certainly has been more discussion about it than about the actual findings of the study. Such as: Although the market was pretty robust in 2016, investors got it all wrong and came up with relatively poor performance. Instead, the discussion is that we don’t use an internal rate of return. I mean, this is silly!

That’s the methodology that Pfau says is correct.