There is a "widespread" issue of investors buying into funds at an inefficient time, according to Morningstar, as the ratings agency calculated the negative impact on overall returns and suggested passive investors were less affected.
In its Mind the gap 2016 – Europe paper, Morningstar analyst Matias Mottola warned the “unfortunate timing of investor cash flows” had resulted in a gap between a fund’s reported returns and those received by an investor.
Analysis of the five-year period from August 2011 to July 2016 found that, across all funds, an investor’s asset-weighted return came to 5.07 per cent, lagging the 5.41 per cent asset-weighted total return from a portfolio.
In the equity space, a total return of 7.46 per cent compared with an investor return of 7.06 per cent, while in Morningstar’s “alternative” category – taking in commodity, convertibles and property offerings – a fund achieved a total return of 1.59 per cent compared with an investor’s return of 1.01 per cent.
Morningstar warned that, in a sense of total returns lost, the average gap could be significant.
“The 58 basis point gap in alternatives is a big performance loss for investors, corresponding to 36 per cent of total annualised returns,” Mr Mottola said. “For equity funds, the gap corresponds to 5 per cent of returns that could have been accrued with a buy and hold strategy.”
He added that while the five-year period used had seen some volatility spikes, among them the peak of the eurozone crisis in the third quarter of 2011, the oil price decline which began in 2014 and a nervous opening quarter of 2016, the investment environment had been fairly benign.
And while the analyst claimed that such a problem was ubiquitous among funds, he noted that timing has become a bigger issue for some offerings than others.
“The phenomenon of bad timing is widespread,” he said. “Within equity funds, timing has done the most damage within concentrated funds, such as single-country emerging markets funds and sector funds, which tend not to be used as core holdings.”
More generally, the analyst pointed to a disparity in behaviour between those choosing active and passive products.
Mr Mottola described the difference between index and active funds as "massive. Investors in the latter only experienced an asset-weighted gap of 26 basis points below the fund return compared to non-index investors' gap of 37 basis points.
“It’s hard to pinpoint exactly what is causing the behavioural difference in the use of index and non-index funds," he said.
"An educated guess is that index funds are typically used as long-term investing tools as part if the core of a portfolio, whereas non-index funds include many kinds of specialised funds, which investors tend to go in and out of.”
Other factors, such as price, could also play a role in investor behaviour, the paper suggested. The research uncovered a "strong relationship" between investors being better at timing, and lower cost funds.
“Among equity funds, investors in the two cheapest quintiles have been able to accrue investor returns almost at the level of total returns, whereas for the three most expensive quintiles, investor returns have lagged because of poor timing," Mr Mottola added.
