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Originally published Saturday, March 15, 2014 at 7:00 PM

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The problem could be you, and not the manager | Chuck Jaffe

New research out from Morningstar shows that investors routinely get less return managing their funds than those funds get from managing stocks, bonds and other securities.


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Your Funds

For as much as people can complain about the performance of their mutual-fund managers, the truth is that, on average, their own experiences running money produce worse results.

Obviously, that statement doesn’t apply to the sharpies who crow on chat boards and in online communities about the killings they are making, but those guys never produce audited financial statements and if you’re reading this, you aren’t trying to invest the way they do anyway.

But new research out from Morningstar shows that investors routinely get less return managing their funds than those funds get from managing stocks, bonds and other securities.

Combine that with research from Strategic Insight showing where consumers are moving their money and you have a good case for why even more investors will be unhappy with their results going forward.

Let’s dig in to the studies to see why.

Morningstar regularly reviews “investor returns,” which is the dollar-weighted results experienced by investors.

If a fund’s assets mushroom after a spate of great performance, investors didn’t experience that run; if the fund declines when those happy days end, all the investors got for their efforts was the misery.

Russel Kinnel, Morningstar’s director of mutual-fund research, raised several key findings that show just how badly investors lag their funds:

• A year ago, the 10-year gap between the average investor and the average fund was just under 1 percent; by the end of 2013, it stood at nearly 2.5 percent.

That difference is why the typical investor booked a 4.8 percent annualized gain over the last decade, while the typical fund gained an average of 7.3 percent per year.

• The smallest gap came in domestic equity funds, where the average investor earned 6.5 percent annualized, compared with 8.1 percent for the typical fund.

• The worst investor return came in alternatives, where the average investor lost 1.15 percent annualized. The average total return for alternative funds wasn’t great, but at least it was positive at just under 1 percent.

• The biggest gap between fund performance and investor returns came in international and sector funds, which delivered respectable results to both parties, but where the average fund generated gains at least 3 percentage points better than the typical investor in those funds actually made.

That brings us to Strategic Insight’s “State of the Global Fund Industry” report, which noted that investors worldwide put over $1 trillion into funds last year, but showed particular interest in “nontraditional income, liquid alternatives, and asset-allocation solutions.”

That means investors are showing increased interest in the very categories that Morningstar shows have the biggest gaps in results, the kind of funds where they are sold on the performance story only to learn that past results don’t guarantee a sustainable trend line.

Strategic Insight noted that U.S. investors accounted for three quarters of the $610 billion that went into equity funds last year, with more than 60 percent of those flows going to index funds and exchange-traded funds.

Index funds, and most ETFs, are based on passive strategies where low costs should ensure that investors do better.

But if investors are using ETFs and index strategies to make tactical investment decisions — tilting their portfolio to what they see as the “right” thing for now — the investor-return numbers are proof that average investors only make those moves late.

The same can apply to financial advisers who are actively managing customer moneys by using passive index and ETF strategies.

Those money managers would claim that investors are getting the best, low-cost products, but by layering an active strategy on top of the passive funds, they blow up the key benefit that investors get from passive funds, namely long-term diversification at reasonable costs.

“In the end — whether we are looking in the U.S., Europe or other markets — the search for managers who can add value through active management hasn’t waned,” said Jag Alexeyev, head of global research for Strategic Insight.

“How people achieve that — whether they hire a fund manager to try to do it or if they hire a financial adviser who moves them in and out of funds and ETFs — investors will always do what they think will work best. ... It just doesn’t always work out for the best,” Alexeyev said.

Indeed, Morningstar research shows that investors do a good job of picking mutual funds, but a poor job in timing their moves between asset classes.

As Kinnel noted, the bigger gap between fund and investor performance was no surprise.

“Fund flows were going in all the wrong directions entering 2013. Investors were buying bond funds, selling U.S.-stock funds, and buying emerging markets. We know now that that was exactly wrong,” Kinnel wrote in a Morningstar commentary.

“That’s not to say that most people were going the wrong direction,” Kinnel wrote. “In fact, most fund investors are rather patient folks who don’t make big moves from year to year. But those who did once more showed how hard it is to time the markets.”

Chuck Jaffe is senior columnist for MarketWatch. He can be reached at cjaffe@marketwatch.com or at P.O. Box 70, Cohasset, MA 02025-0070.

Copyright 2014, MarketWatch



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