Timing investments is tough and the average investor is unfortunately not good at it. When mutual fund investors start allocating massively to a certain style, their ‘buy’ signal is often more of a ‘sell’ signal, since on average they move in at the wrong moment. The reverse is also true: when mutual fund investors start avoiding that style, this can be seen as a contrarian signal.
This collective bad timing explains most of the difference between investment returns and investor returns, sometimes referred to as the ‘behavior gap’. Investor returns take into account the timing effects and cash flows of investors. For example, when a large fund has a loss, or when a small fund has a gain, the difference between fund return and investor return can be considerable.
In a 2016 research paper1, Jason Hsu, Brett Myers and Ryan Whitby analyzed this interesting question using US mutual fund data, over the January 1991-June 2013 period. They found that the average mutual fund investor lagged a buy-and-hold strategy by 1.9%. This finding was persistent across different styles, varying from 1.3% for investors in value funds to 3.2% for investors in growth funds. Meanwhile, ‘passive’ investors, in market index funds, underperformed a buy-and-hold strategy by a whopping 2.7%.
What’s more, these results were all gross of fees and transaction costs. So, in practice, the gap between investor returns and fund performance is actually even larger. It is an established fact that the average mutual fund investor underperforms the index after costs, but the significant performance drag caused by poor timing is less well-known.
These findings are consistent with those reported by Ilia Dichev2, back in 2007, who showed that overall, US stock investors lag the buy-and-hold equity return by 1.3% (period 1926-2002, table 3 in the study). For international investors this figure is 1.5% (period 1973-2004, table 4). Figure 1 summarizes the findings from the literature.
1J. Hsu, B. Myers and R. Whitby, ‘Timing Poorly: A Guide to Generating Poor Returns While Investing in Successful Strategies’, The Journal of Portfolio Management, 42(2), pp. 90-98.
2I. Dichev, ‘What Are Stock Investors’ Actual Historical Returns? Evidence from Dollar-Weighted Returns’, American Economic Review, vol. 97, no. 1, March 2007 (pp. 386-401)
These empirical studies prove that adverse market timing is not just an anecdotal observation, but a widespread phenomenon, with serious consequences for investors. In the particular case of factor investing strategies, such poor timing skills, or ‘weak hands’, can completely cancel out the benefits of being exposed to well-rewarded premiums.
Having strong hands is difficult for the impatient
Patient long-term investors with persistent style exposures, in other words ‘strong hands’, are more likely to be able to harvest the factor premiums. The problem is that having such strong hands is difficult for the impatient. This usually requires years of practice.
Due to overconfidence, most investors think they have strong hands, which is by definition not possible. Everyone pays lip service to patience and a long-term vision. But these are meaningless concepts if they are not specified. It is crucial to make the investment horizon very concrete and translate ‘a long period’ into a specific number of years. The length of this horizon will depend on the risk or return objective.
Partnering is often a useful way to ensure you stick to your plans. For example, in sports, study, and work it helps if someone knows your plan and is willing to help you execute it. Many successful investors acknowledge that the biggest enemy is you. The best way to win this internal battle is to create a plan and seek allies in order to successfully execute it.
Finding the right partner might help to successfully reach long-term investment goals. In the case of factor-based investing, the first obstacle is to narrow the factors down to a limited set of the most robust and effective factor groups. This is needed since some factors will turn out to be fake.
A disciplined approach pays off and might help to avoid the average 2% booby trap. Education is key since teams change and investment horizons are often short. This continuing education fosters a successful investment culture, which leaves no room for harmful emotions or misaligned incentives. Deeper knowledge of weak hands and strong hands will help to increase humility and patience and limit harmful trading.
The contents of this document have not been reviewed by the Securities and Futures Commission ("SFC") in Hong Kong. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. This document has been distributed by Robeco Hong Kong Limited (‘Robeco’). Robeco is regulated by the SFC in Hong Kong.
This document has been prepared on a confidential basis solely for the recipient and is for information purposes only. Any reproduction or distribution of this documentation, in whole or in part, or the disclosure of its contents, without the prior written consent of Robeco, is prohibited. By accepting this documentation, the recipient agrees to the foregoing
This document is intended to provide the reader with information on Robeco’s specific capabilities, but does not constitute a recommendation to buy or sell certain securities or investment products. Investment decisions should only be based on the relevant prospectus and on thorough financial, fiscal and legal advice. Please refer to the relevant offering documents for details including the risk factors before making any investment decisions.
The contents of this document are based upon sources of information believed to be reliable. This document is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.
Investment Involves risks. Historical returns are provided for illustrative purposes only and do not necessarily reflect Robeco’s expectations for the future. The value of your investments may fluctuate. Past performance is no indication of current or future performance.
Please read this information carefully.
This website is prepared and issued by Robeco Hong Kong Limited ("Robeco"), which is a corporation licensed by the Securities and Futures Commission in Hong Kong to engage in Type 1 (dealing in securities); Type 4 (advising in securities) and Type 9 (asset management) regulated activities. The Company does not hold client assets and is subject to the licensing condition that it shall seek the SFC’s prior approval before extending services at retail level. This website has not been reviewed by the Securities and Futures Commission or any regulatory authority in Hong Kong.
2. Important risk disclosures
2. Important risk disclosures Robeco Capital Growth Funds (“the Funds”) are distinguished by their respective specific investment policies or any other specific features. Please read carefully for the risks of the Funds:
3. Local legal and sales restrictions
The information contained in the Website is being provided for information purposes.
Neither information nor any opinion expressed on the Website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. The information contained in the Website does not constitute investment advice or a recommendation and was prepared without regard to the specific objectives, financial situation or needs of any particular person who may receive it. An investment in a Robeco product should only be made after reading the related legal documents such as management regulations, prospectuses, most recent annual and semi-annual reports, which can be all be obtained free of charge at www.robeco.com/hk/en and at the Robeco Hong Kong office.
4. Use of the Website
The information is based on certain assumptions, information and conditions applicable at a certain time and may be subject to change at any time without notice. Robeco aims to provide accurate, complete and up-to-date information, obtained from sources of information believed to be reliable. Persons accessing the Website are responsible for their choice and use of the information.
5. Investment performance
No assurance can be given that the investment objective of any investment products will be achieved. No representation or promise as to the performance of any investment products or the return on an investment is made. The value of your investments may fluctuate. The value of the assets of Robeco investment products may also fluctuate as a result of the investment policy and/or the developments on the financial markets. Results obtained in the past are no guarantee for the future. Past performance, projection, or forecast included in this Website should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. Fund performance figures are based on the month-end trading prices and are calculated on a total return basis with dividends reinvested. Return figures versus the benchmark show the investment management result before management and/or performance fees; the fund returns are with dividends reinvested and based on net asset values with prices and exchange rates of the valuation moment of the benchmark.
Investments involve risks. Past performance is not a guide to future performance. Potential investors should read the terms and conditions contained in the relevant offering documents and in particular the investment policies and the risk factors before any investment decision is made. Investors should ensure they fully understand the risks associated with the fund and should also consider their own investment objective and risk tolerance level. Investors are reminded that the value and income (if any) from shares of the fund may be volatile and could change substantially within a short period of time, and investors may not get back the amount they have invested in the fund. If in doubt, please seek independent financial and professional advice.
6. Third party websites
This website includes material from third parties or links to websites maintained by third parties some of which is supplied by companies that are not affiliated to Robeco. Following links to any other off-site pages or websites of third parties shall be at the own risk of the person following such link. Robeco has not reviewed any of the websites linked to or referred to by the Website and does not endorse or accept any responsibility for their content nor the products, services or other items offered through them. Robeco shall have no liability for any losses or damages arising from the use of or reliance on the information contained on websites of third parties, including, without limitation, any loss of profit or any other direct or indirect damage. Third party off-site pages or websites are provided for informational purposes only.
7. Limitation of liability
Robeco as well as (possible) other suppliers of information to the Website accept no responsibility for the contents of the Website or the information or recommendations contained herein, which moreover may be changed without notice.
Robeco assumes no responsibility for ensuring, and makes no warranty, that the functioning of the Website will be uninterrupted or error-free. Robeco assumes no responsibility for the consequences of e-mail messages regarding a Robeco (transaction) service, which either cannot be received or sent, are damaged, received or sent incorrectly, or not received or sent on time.
Neither will Robeco be liable for any loss or damage that may result from access to and use of the Website.
8. Intellectual property
All copyrights, patents, intellectual and other property, and licenses regarding the information on the Website are held and obtained by Robeco. These rights will not be passed to persons accessing this information.
10. Applicable law
The Website shall be governed by and construed in accordance with the laws of Hong Kong. All disputes arising out of or in connection with the Website shall be submitted to the exclusive jurisdiction of the courts of Hong Kong.