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The Markets June 1, 2017
TDFs Help U.S. Investors Avoid Market-Timing Mistakes
Morningstar found for allocation funds, the do-nothing portfolio, such as TDFs, and investor returns were
nearly identical and both were ahead of the average fund.
Reported by Rebecca Moore
Research from Morningstar finds automatic savings plan produce better investment outcomes for investors.
“Steady investment contributions to savings plans and automatic rebalancing proved to be key in generating positive investor returns in countries including Australia, South Korea, and the United States,” says Russel Kinnel, chair of Morningstar’s North America ratings committee and editor of Morningstar FundInvestor.
The “Mind the Gap 2017” study measures how the average investor fared in a fund and the impact investor behavior can have on investment outcomes. The study uses the Morningstar Investor Returns methodology to derive a dollar-weighted return of a fund that incorporates the effect of cash inflows and outflows from purchases and sales, as well as the increase in a fund’s assets. The “gap” refers to the shortfall between funds’ money-weighted and time-weighted returns, reflecting how opportunely investors have timed their investments.
During the five-year period through December 31, 2016, the study found that investor returns across the globe varied from stated returns, on average, by a range of -1.40% to 0.53% per year. However, investors achieved better outcomes when using systematic investment programs and invested in lower-cost funds.
The report says, in the U.S., allocation funds had positive gaps. The link across these markets were automatic investment plans. In the U.S., target-date funds (TDFs) have consistently had positive gaps because U.S. investors contribute to their 401(k) savings with every paycheck. “This is a structure that many regulators around the world are considering as a way to encourage retirement savings,” the report says.
The overall 10-year gap in the U.S. has shrunk from 55 basis points at the end of 2015 to 37 basis points at the end of 2016. Adding another year of solid market returns likely helps. A second factor that is driving the aggregate gap lower over the long haul is that yearly flows have not kept pace with the growth in assets under management. Thus, in the aggregate mutual fund investors are making fewer market-timing calls that can harm results.
NEXT: The Do Nothing PortfolioThe Do Nothing Portfolio uses fund total returns that are asset-weighted using assets at the beginning of the time period. Essentially, it tells what would have happened if investors had left their portfolios untouched.
Performance for this measurement was mixed around the globe, but in the U.S. it performed surprisingly well. In the U.S., the portfolio weighted with beginning-of-the-period assets produced better results than either investor returns or a straight average of returns in each asset class. For example, the typical diversified equity fund investor would have had a return of 5.31%, topping the 5.15% average fund return and the 4.36% average investor return.
For U.S. bond funds, the Do Nothing return was 4.30% compared with 2.99% for the average investor return and 3.72% for the average fund return.
For allocation funds, the Do Nothing Portfolio and investor returns were nearly identical and both were ahead of the average fund. The reason, as Morningstar previously stated, is that TDFs are a fast-growing segment of the allocation group.
The data was fairly clear for fees and manager tenure. Testing fees, Morningstar generally saw investor returns decline as it moved from low-cost to pricey returns. In addition, the gap usually grew as it moved up in price The impact appears to exceed the stated expense ratio. There are likely two additional factors at work. First, higher-cost funds frequently take on greater risks to overcome their lofty fees. Thus, they may be more prone to inspiring fear and greed in investors, leading to poor timing decisions in both directions. Second, there is likely a meeting of savvy investors and responsible fund companies in cheap funds and a meeting of less-responsible investors and fund companies in the high-cost zone.
Manager tenure results were quite similar across markets. They showed no trend whatsoever when Morningstar grouped funds by manager tenure. This isn’t much of a surprise, Morningstar says, as manager tenure hasn’t shown much of a link with returns or risk. Manager tenure does not equate to experience and, more importantly, it does not account for quality of experience.
The full report may be downloaded from here.