Much has been written about the performance of mutual fund managers, especially actively managed funds, but what about the performance of investors, who can incur losses or smaller gains simply by buying or selling fund shares at inopportune times?
That question is at the heart of Morningstar's new annual report on investor returns called "Mind the Gap," which it has expanded beyond U.S. and European investors for the first time. The gap refers to the difference between the average asset-weighted investor return and average fund total return; the average investor return is usually lower. Morningstar calculated the investor returns by adjusting fund returns to reflect monthly flows, compounded over time.
The study, which excluded ETFs because of the difficulty in estimating investor intent, found that overall the average investor collects a smaller return than the average fund, but the gap is smaller and maybe even positive when investors use systematic investment programs, as many do in their 401(k) plans, and when they invest in lower-cost funds.
"Steady investment contributions to saving plans and automatic rebalancing proved to be key in generating positive investor returns in countries including Australia, South Korea and the United States," said Russel Kinnel, chairman of Morningstar's North America ratings committee and editor of the Morningstar FundInvestor, in a press release.
The average U.S. investor in asset allocation and concentrated equity funds outperformed the average fund annually by a small margin – five basis points and one basis point, respectively, over 10 years, while the average investor in superannuation funds in Australia (a type of retirement fund mandating contributions from employers and voluntary for workers) and in bond funds in South Korea bested the average fund there by 53 basis points and 47 basis points, respectively, over five years.
While systematic investment programs boosted returns, higher fund fees had the opposite effect. "Investor returns declined as funds rose in cost, often by more than the difference in costs, suggesting that behavior of investor and manager alike in high-cost funds was poor, while low-cost funds represented a meeting of smarter investors and managers," wrote Kinnel.
Higher cost funds tend to take greater risks to overcome their higher fees, according to the study. "Lower cost and lower risks are important," says Kinnel.
It found that in the U.S., the investor return gap in 2016 was an annualized 37 basis points for "all funds" over 10 years, down from 54 basis points in 2015. The average fund returned 4.33% annually compared with the average investor collecting 3.96%.
Contributing to the narrower gap: yearly flows that didn't keep pace with asset growth. "The aggregate mutual fund investors are making fewer market-timing calls that can harm results," according to the report.
