Looking for an explanation to the value effect? The value premium’s persistence and magnitude run counter to the behavioral explanation of the value anomaly. How can investors continue to make the same widely recognized mistake? This paper1 provides a hint.
By examining the difference between mutual funds’ reported buy-and-hold or time-weighted returns, and the average dollar-weighted returns or IRRs end investors earn, the authors quantify the consistently negative effect of value investors’ market-timing decisions: from 1991 to 2013, value mutual fund investors underperformed the funds they invested in by 131 basis points.
Their analysis also reveals that investors in growth, large-cap, and small-cap funds are similarly prone to unproductive allocation timing. They also find that less sophisticated investors tend to make poorer timing decisions. The authors suggest that, by giving away the excess return, value investors themselves finance the value premium and ensure its continuance.
1Hsu, Myers & Whitby, “Timing Poorly: A Guide to Generating Poor Returns While Investing in Successful Strategies”, Journal of Portfolio Management, Vol. 42, No. 2, 2016, pp. 90-98.
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