Investor fund flows and return gaps

stocksbondscashInvestors have the tendency to invest in markets as they perform well, and disinvest as they perform poorly.

This pattern extends to the stock, bond, and money markets.

Stocks

The chart below shows investor net new fund flows into stock mutual funds versus world equity total returns over the 2000 – 2013 period.  As you can see, investor fund flows tend to track market returns. This results in investors buying stocks at higher prices and selling stocks at lower prices and is one factor in investor returns trailing fund returns.

Equityfundflow

Source: 2014 Investment Company Fact Book 1  Net new cash flow is plotted as a six-month moving average.2  The total return on equities is measured as the year-over-year percent change in the MSCI All Country World Daily Total Return Index.

Performance chasing in stocks

One likely culprit in the equity returns gap is performance chasing, as investors buy and sell funds based on past performance .  A recent Vanguard study, Quantifying the Impact of Chasing Performancereports return gaps from investor turnover of funds (three years is the average investor holding period).  Investors tend to move in and out of styles (growth vs. value and large vs. small) after a style has outperformed.

Performance gap across U.S. stock styles

Bonds

Investor fund flows into and out of bond funds tends to follow the trend of bond fund total returns. In this instance, investors tend to buy bond funds when interest rates are falling (as fund net asset values rise) . Investors tend to sell bond funds when interest rates  are rising (as fund net asset values fall). This results in investors buying bonds at higher prices and selling bonds at lower prices.  Once again, this is a factor in reducing investor returns relative to fund returns.

bondfundflow

Source: 2014 Investment Company Fact Book 1 Net new cash flow to bond funds is plotted as a three-month moving average of net new cash flow as a percentage of previous month-end assets. Data exclude flows to high-yield bond funds.2 The total return on bonds is measured as the year-over-year percent change in the Citigroup Broad Investment Grade Bond Index.

 

Money Markets

Investor flows into and out of money market funds tends to track the relative differential between money fund interest rates and the rates available on bank money market accounts and bank CDs.  Investors tend to shift to the higher yielding account.  Investors can increase interest returns on cash balances by using the higher interest return on comparable cash instruments. (Keep in mind that treasury bills and FDIC insured cash instruments have very low credit risk).

moneyfundflow

Source: 2014 Investment Company Fact Book 1  Net new cash flow is the percentage of previous month-end taxable retail money market fund assets, plotted as a six-month moving average.2  The interest rate spread is the difference between the taxable retail money market fund yield and the average interest rate on money market deposit accounts.

Morningstar

Morningstar reports the return gap between investor asset weighted returns and fund total returns over the ten year period ending in 2013.

Investorreturns

Source: Mind the Gap 2014, Morningstar

Reducing fund gaps

One can attain most of the returns provided by investment markets by investing in a low-cost balanced portfolio allocation that is bought, held, and rebalanced according to a set plan.  This strategic decision can help eliminate:

  • The tendency to buy and sell investments according to current news, or current market predictions.
  • Avoid being overly enthused and investing too much into an asset class during market advances or being overly depressed and investing too little in an asset class during market declines.

About

Barry Barnitz, administrator of both the Bogleheads® wiki and of Financial Page, a Bogleheads® blog

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Posted in Investing, Market statistics, Mutual funds
September 2014
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