Target date funds and benevolent market conditions have improved investors’ money-weighted returns, according to new research from Morningstar.
At its 30th annual investment conference in Chicago, Morningstar released the results of its annual study of investor returns, “Mind the Gap,” which measures the performance of the average dollar invested in a fund and estimates the impact that investor behavior had on investment outcomes.
Overall, the study shows that the gap between U.S. open-end funds’ reported total returns and the returns experienced by investors narrowed to 0.26% per year over the decade ended March 31. This is the narrowest gap recorded since the first issue of this study in 2005.
Balanced funds — which include allocation funds, target date funds and traditional balanced funds — saw a positive gap of 0.30 percentage points annually for the decade ended March 31, with the average investor enjoying a 5.93% annualized return.
This improvement reflects the continued strength of target date funds, both in terms of investor behavior and strong gains among well-diversified funds, according to the research.
“You can see very clearly that the target date funds are working for investors better than anything else,” Russel Kinnel, chair of Morningstar’s North America ratings committee and editor of Morningstar FundInvestor, said at a press briefing during the conference.
Target date funds, which are collectively the largest and fastest-growing subset of balanced funds, have proved remarkably consistent at producing good results for investors. As the research states, target date funds are easy for investors to use because performance swings are muted, and most investors buy in through 401(k) retirement plans with automated savings processes, which creates a disciplined track of continued savings.
Morningstar also notes that in the U.S. and in other countries where investors commit to consistent investment regimes, investor returns are strong and the gaps are often positive.
“We think that the tremendous diversification of target date funds, combined with the steady investment of 401(k) plans, shows the fund industry at its best,” according to Morningstar. “This is where well-designed investments meet a well-designed structure to help investors save and grow their retirement nest eggs.”
Kinnel also said that he thinks these findings also show the value of advice and the value of “sticking to a plan.”
“Whether that means you’re doing it through an advisor or on your own — clearly sticking to a plan helps from a behavioral standpoint,” he told press.
While target date funds continue to stand out for producing outstanding results for investors, the research found that alternatives funds stand out for providing little to no returns for investors.
According to the research, alternatives funds had the worst dollar-weighted returns, “a dismal nine basis points” annually over 10 years. However, this was still nearly 140 positive basis points per year better than the average alternative fund’s 1.3% reported annual loss, according to the research.
The “Mind the Gap” study leverages the proprietary Morningstar Investor Returns data point, which estimates a fund’s dollar-weighted return by incorporating the effect of cash inflows and outflows from investors’ purchases and sales, as well as the change in a fund’s assets. The “gap” refers to the difference between funds’ dollar-weighted and time-weighted returns, reflecting how opportunely investors timed their investments.
The study is limited to open-end mutual funds because there is not sufficient data on exchange-traded fund flows.
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