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 Robeco Capital Growth Funds have not been registered under the United States Investment Company Act of 1940, as amended, nor or the United States Securities Act of 1933, as amended. None of the shares may be offered or sold, directly or indirectly in the United States or to any U.S. Person (within the meaning of Regulation S promulgated under the Securities Act of 1933, as amended (the “Securities Act”)). Furthermore, Robeco Institutional Asset Management B.V. (Robeco) does not provide investment advisory services, or hold itself out as providing investment advisory services, in the United States or to any U.S. Person (within the meaning of Regulation S promulgated under the Securities Act).
This website is intended for use only by non-U.S. Persons outside of the United States (within the meaning of Regulation S promulgated under the Securities Act who are professional investors, or professional fiduciaries representing such non-U.S. Person investors. By clicking “I Agree” on our website disclaimer and accessing the information on this website, including any subdomain thereof, you are certifying and agreeing to the following: (i) you have read, understood and agree to this disclaimer, (ii) you have informed yourself of any applicable legal restrictions and represent that by accessing the information contained on this website, you are not in violation of, and will not be causing Robeco or any of its affiliated entities or issuers to violate, any applicable laws and, as a result, you are legally authorized to access such information on behalf of yourself and any underlying investment advisory client, (iii) you understand and acknowledge that certain information presented herein relates to securities that have not been registered under the Securities Act, and may be offered or sold only outside the United States and only to, or for the account or benefit of, non-U.S. Persons (within the meaning of Regulation S under the Securities Act), (iv) you are, or are a discretionary investment adviser representing, a non-U.S. Person (within the meaning of Regulation S under the Securities Act) located outside of the United States and (v) you are, or are a discretionary investment adviser representing, a professional non-retail investor. Access to this website has been limited so that it shall not constitute directed selling efforts (as defined in Regulation S under the Securities Act) in the United States and so that it shall not be deemed to constitute Robeco holding itself out generally to the public in the U.S. as an investment adviser. Nothing contained herein constitutes an offer to sell securities or solicitation of an offer to purchase any securities in any jurisdiction. We reserve the right to deny access to any visitor, including, but not limited to, those visitors with IP addresses residing in the United States.
This website has been carefully prepared by Robeco. The information contained in this publication is based upon sources of information believed to be reliable. Robeco is not answerable for the accuracy or completeness of the facts, opinions, expectations and results referred to therein. Whilst every care has been taken in the preparation of this website, we do not accept any responsibility for damage of any kind resulting from incorrect or incomplete information. This website is subject to change without notice. The value of the investments may fluctuate. Past performance is no guarantee of future results. If the currency in which the past performance is displayed differs from the currency of the country in which you reside, then you should be aware that due to exchange rate fluctuations the performance shown may increase or decrease if converted into your local currency. For investment professional use only. Not for use by the general public.