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2
most obvious lessons for what we should look for in a
fund and what behavior can be self-destructive.
What the Data Say
For the
10
years ended December
2015
, the investor
returns gap shrank from the average over recent years.
For U.S. equity funds, the gap was
74
basis points,
but international funds had a much wider gap of
124
basis points. Municipal-bond funds continue to be
the most confounding group, with a big
132
-basis-point
gap, while taxable-bond funds had a more moderate
82
-basis-point gap. As usual, allocation investors fared
the best, with a gap of just
17
basis points.
More telling than the latest batch of data is the average
annualized gap for
10
-year periods ended
2012
to
2015
: negative
1
.
13%
. That smooths out some of
the issues with end-date bias to illustrate just how
much we cost ourselves through bad timing moves.
Flows were strong across the board at the beginning
of the
10
-year period. Flows were particularly strong
into foreign and domestic equity because equities had
rallied off the lows of the bear market that ended in
2002
. Some of that money later left in
2008
and
2009
as skittish investors sold near the bottom, but that
initial wave of good flows and a return to equities after
2009
seemed to have ensured pretty good results.
Allocation funds enjoyed steady inflows throughout,
so, while some dumped their equity funds at the
wrong time, many maintained and added to equity
exposure through allocation funds. In addition,
target-date funds are part of the allocation group,
and they consistently show investor returns that
are superior to time-weighted returns. For one, target-
date funds have sufficiently moderate returns to
avoid scaring shareholders away while not attracting
hot money. In addition, target-date funds are mostly
held in
401
(k) accounts where investors buy with
every paycheck. Although they could still panic and
sell at the wrong time, most investors ride out the
downturns. You don’t have to be in a target-date fund,
though, to invest like those who do. Systematic
investing and rebalancing is a great way to stick to
your plan through thick and thin.
Before I started running these figures, I would not
have guessed that boring old muni-bond funds
could be so misused, but it has been going on for a
while. The problem here is that you have some
very risk-averse investors and a sector with scary
headlines. You won’t see many headlines about
how nearly all muni issuers are making their payments
on time or how once-troubled states like California
have improved their balance sheets dramatically.
Rather, you hear about Puerto Rico’s crushing debt
and Meredith Whitney’s ill-informed doomsday call.
Those news events spurred muni investors to sell,
and that led to a drop in muni-bond prices and a spike
in yields. Thus, they created a buying opportunity
just as investors were fleeing. This speaks to the down-
side of trying to time the market and the benefit of
staying focused on the long term. Oddly, sector funds
did quite well as investors had good timing in some
real estate, utilities, and communications funds.
What Factors Are Linked to Investor Returns?
Expenses are strongly linked to investor returns.
Cheapest-quintile funds have significantly higher
investor returns and smaller gaps while both
figures progressively get worse as you move up in
fee quintiles. In fact, the differences are much
greater than the fee differences themselves. There
are two reasons. First, low costs lead to better
returns and therefore investors are in a positive feed-
back loop that makes them more likely to stay
with their fund. Second, investors in low-cost funds
tend to be better-informed investors who will use
their funds correctly more often. The other factor is
volatility, whether measured by Morningstar Risk
Mind the Gap 2016
Continued From Cover
Trailing 10-Year Average Annual Returns and Asset-Weighted Investor Returns (as of December 2015)
U.S. Diversified
Funds
U.S. Sector
Funds
Intl Equity
Funds
Allocation
Taxable
Bond
Municipal
All Funds
p
Average 10-Yr Total Return (%)
p
Asset-Weighted 10-Yr Investor Return (%)
Returns Gap (%) in white numerals
6.58
5.84
-0.74
+0.26
-0.17
-1.24
-0.82
-1.32
5.27
5.53
4.08
3.26
3.63
2.31
4.88
4.35
-0.53
8
6
4
2
0
4.67
3.91
4.50
2.67