Investors got it wrong again in October

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larryswedroe
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Re: Investors got it wrong again in October

Post by larryswedroe » Tue Nov 15, 2011 5:54 pm

Some further evidence on individual investors persistently getting it wrong


We also have evidence from a study done by the Bogle Financial Markets Center. The sample consisted of the 200 funds with the largest cash inflows for the five-year period 1996 through 2000. The study compared the TWR of the funds and the DWR of investors in those funds for the 10-year period 1996–2005. The average TWR for the 200 mutual funds was 8.9 percent per annum. However, the actual DWR earned by investors was just 2.4 percent annum, an investment gap of 6.5 percent per annum. Investor behavior resulted in the DWR being just 27 percent of the TWR. The study also found that the TWR exceeded the DWR in all but two of the 200 funds — and there was not a single case where the DWR exceeded the TWR by more than 0.5 percent. Even more shocking was that in the case of 76 funds, the cumulative shortfall ranged from minus 50 percent to minus 95 percent.

Finally, consider this tale of woe. For the four-year period 1998–2001, the annualized return of the average mutual fund was 5.7 percent. Unfortunately, the average investor earned just 1 percent, a loss of 82 percent of the available returns. On an after-tax basis, the average fund returned 1.4 percent while the average investor lost 3.3 percent. Investor behavior created an investment gap of 4.7 percent. The table below shows the five largest gaps between fund returns and investor returns. It shows how costly investor behavior can be.8
Fund Return Versus Shareholder Return 1998–2001
Fund Fund Return(%) Shareholder Return (%) Cost of Investor Behavior (%)
Fidelity Aggressive Growth 2.8 - 24.1 -26.9
Vanguard Capital Opportunity 29.2 5.2 -23.9
Invesco Dynamics 7.0 -14.4 -21.4
Janus Mercury 13.9 -7.4 -21.3
Fidelity Select Electronics 21.7 7.6 -14.0

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Lbill
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Re: Investors got it wrong again in October

Post by Lbill » Wed Nov 16, 2011 9:01 am

Morningstar studied the performance of mutual funds and their investors. It found that in all 17 fund categories they examined the returns earned by investors were below the returns of the funds themselves.
I'm curious about the methodology used in such studies. Are the investigators actually able to track the performance of individual investors in these funds? In order to state that "investors" receive lower returns than the fund itself, we'd have to know what happened to each individual investor over their investing history in the fund: what each one invested and when, what each one sold and when, and then be able to aggregate all those separate bits of information into a single "synthesized" investor. Frankly, I doubt anything like this was done in the "studies" reported by Morningstar. Often in such analyses it's the methodology that accounts for the result and nothing much more than that.
"Life can only be understood backward; but it must be lived forward." ~ Søren Kierkegaard | | "You can't connect the dots looking forward; but only by looking backwards." ~ Steve Jobs

A Devout Indexer
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Re: Investors got it wrong again in October

Post by A Devout Indexer » Wed Nov 16, 2011 2:45 pm

Here is the data from September:
http://www.marketwatch.com/story/mornin ... 2011-10-12
 
September Fund Flows
US Stock Funds = -$6.9B
Non-US Stock Funds = +$3.2B
Bond Funds = +$5.2B
Net Bond Fund Inflows = +$1.5B
 
US Stock ETFs = -$5.3B
Non-US Stock ETFs = +$2.4B
Bond ETFs = +$5.2B
Net Bond Fund Inflows = +$2.3B

September is of course the month before the big jump in stocks (the US market in particular, where fund AND ETF outflows were greatest). More to the point, investors acted the same whether they were buying mutual funds or ETF: out of stocks and into bonds, debunking the myth that equity fund outflows turned into ETF equity inflows.

larryswedroe
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Re: Investors got it wrong again in October

Post by larryswedroe » Wed Nov 16, 2011 3:57 pm

lbill
They cannot tell the performance of individuals individually of course.
But they can tell what the net flows in and out of a fund are each month. Simply take the starting AUM and add or subtract return of the fund and then you get the difference when you look at AUM at end of month.
Then repeat.Then you can see what the fund earned, which is simple, the return reported and compare to returns of investors.

BTW-Lynch once did study covering his fund over period that fund did okay but had up and down years and found that while the fund did okay the average investor actually lost money during the period, having bought AFTER it did well and sold AFTER it did poorly, not participating in the rebound. Sorry wish I could cite that one, but it is from memory

Larry

peter71
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Re: Investors got it wrong again in October

Post by peter71 » Wed Nov 16, 2011 6:47 pm

Lots of previous threads on here on the M* "investor returns" methodology (as Larry knows), and the bottom line is that the figures are very period-dependent (with older data that includes the late 90's tending to make investors look worse).

I believe the 3 biggest stock mutual funds are VTSMX, Fidelity Contrafund, and American Funds Growth, and as you can see they generally show investors doing pretty well over the past 1, 3, 5 and 10 years, but less well over the past 15 years . . .

http://performance.morningstar.com/fund ... ge&t=VTSMX

http://performance.morningstar.com/fund ... ge&t=FCNTX

http://performance.morningstar.com/fund ... ge&t=AGTHX

So my personal theory (consistent with people flocking to VTSMX itself) is that mutual fund investors have gotten a little smarter since the late 90's (even though a very small behavior gap along the lines of the 0.27% estimated by the Finance Buff may persist).

Alternatively, it's all just random noise and the investor returns data don't really tell us anything!

Best,
Pete

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Re: Investors got it wrong again in October

Post by larryswedroe » Wed Nov 16, 2011 7:42 pm

Peter actually I don't see any signs of investors getting smarter
In 2009-10 (till late in year) from what I have read investors pulled out over $30b from retail equity funds missing the greatest rally since 30s.
Then after Meredith Whitney's dire forecast they pulled out huge amounts from muni funds, missing that rally as rates fell and there were nowhere near the default levels she predicted
Best
Larry

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Re: Investors got it wrong again in October

Post by peter71 » Wed Nov 16, 2011 8:06 pm

Hi Larry,

The ICI fund flows data is also tricky (I had several exchanges with SmallHi on this years ago and my critique of the way he was using it is similar to Renditt's critique of how you're using it) but I thought we were now focused on investor returns:

As I posted upthread, I think TFB's blog post on this is the most persuasive analysis I've seen, and he explains the period-dependence of the data without reference to investor learning.

Even so, I certainly agree with you about CGM Focus Fund, and I think there's a style of "invest in whatever fund I saw advertised during the football game" that was much more widespread in the late 90's, but lived on through the mid-2000's with a few rare funds like CGM Focus -- I can still remember all those stupid circa 2007 "you had all the moves today!" ads with the two guys fencing . . . so it could also be that there were a lot more ads and a lot more people falling for them over the 1996-2000 period in which the Bogle Center measured inflows for the study you cited above than there are today.

Or not (see again TFB's article) but the fact remains that investors in the biggest funds (as opposed to the most heavily advertised) are doing just fine over the past 1, 3, 5 and 10 years.

Best,
Pete

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Re: Investors got it wrong again in October

Post by larryswedroe » Thu Nov 17, 2011 8:26 am

Pete
Will take look but that doesn't seem consistent with the data on fund flows, How can that be when $350b came out of retail equity mutual funds in 09-through most of 10 and huge amounts came out of munis?
It is also inconsistent with the findings of Barber and Odean on investor behavior.
BTW-my fondest wish is that you are right.
Larry

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Re: Investors got it wrong again in October

Post by larryswedroe » Thu Nov 17, 2011 10:24 am

Pete
Read TFB's post and while I don't disagree with the line of thinking, a problem I think is that he is looking at say an individual investor and on the margin for that investor.
Take say a Vanguard TSM fund. Say it starts with $100b and the market doubles and next ten years does nothing. Well over next ten years you have individuals both adding and withdrawing (probably bit of net add) but the bulk remains invested, so the math doesn't work the way he shows if in fact investors in aggregate do stay the course. If they stay the course the DWR and TWR will be very close in all likelihood, but that is not the kind of data we tend to see.
Best
Larry

peter71
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Re: Investors got it wrong again in October

Post by peter71 » Thu Nov 17, 2011 11:16 am

Hi Larry,

On TFB's study, the methods are definitely tricky and as TFB himself posted upthread I'll let him jump in if he wants to.

On Barber and Odean, we've had some previous threads on their work. I think they control for some of the problems TFB is talking about but because they have to use brokerage and/or (IIRC) specifically Taiwanese brokerage data to get the sort of individual-level info that allows them to introduce those controls it raises the question of whether their sample of "traders" can represent "individual investors" more generally . . . plus IIRC they're also looking at least in part at the late 90's.

Anyway, only time will tell . . . I'd certainly concede that, if indeed investor learning has happened, it's happened in an environment in which investors have consistently been told that they're foolish, so perhaps it's not doing any harm. :D

Best,
Pete

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Re: Investors got it wrong again in October

Post by nisiprius » Thu Nov 17, 2011 1:56 pm

larryswedroe wrote:Here are examples from the Quest for Alpha

I would say source pretty credible
What I want is the explanation. People give evidence that ordinary investors underperform, but they don't explain how they can do it. If the best professionals can't succeed in the Quest for Alpha, how do the worst ones succeed in finding the anti-grail?

What's the recipe for "bad trading," the formula that guarantees I can underperform the funds I invest in by that 2%, 3% per year? What do I do to spot the bottom so that I can sell at it?
Last edited by nisiprius on Thu Nov 17, 2011 3:58 pm, edited 1 time in total.
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Re: Investors got it wrong again in October

Post by larryswedroe » Thu Nov 17, 2011 2:16 pm

Nisprius
The explanation is RECENCY, they drive forward while watching the rear view mirror, buying what WENT UP and selling what WENT DOWN. So they end up buying high and sellling low.
Best wishes
Larry

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Re: Investors got it wrong again in October

Post by GregLee » Thu Nov 17, 2011 2:52 pm

larryswedroe wrote:... they drive forward while watching the rear view mirror, buying what WENT UP and selling what WENT DOWN.
There's no choice about watching the rear view mirror, if we watch at all. But what I find hard to understand is the moral that seems often to be drawn: Close your eyes. Doesn't it make more sense to keep watching, but sell what WENT UP and buy what WENT DOWN? That's what I do, and I don't think it's hard.
Greg, retired 8/10.

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Re: Investors got it wrong again in October

Post by bob90245 » Thu Nov 17, 2011 3:28 pm

GregLee wrote:Doesn't it make more sense to keep watching, but sell what WENT UP and buy what WENT DOWN? That's what I do, and I don't think it's hard.
Then again, not everyone is Greg Lee. :beer

(read any Behavior Finance book and you'll understand why investors in general get tripped up over this)
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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Re: Investors got it wrong again in October

Post by umfundi » Thu Nov 17, 2011 3:55 pm

how can the average returns earned by investors in a fund be different from the returns of the fund itself?
Chasing performance might account for some of that. People buy only after the price has gone up.

The fund may be up 20% (for example), but most investors only bought after it had already gained 10%.

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Re: Investors got it wrong again in October

Post by nisiprius » Thu Nov 17, 2011 4:11 pm

larryswedroe wrote:Nisprius
The explanation is RECENCY, they drive forward while watching the rear view mirror, buying what WENT UP and selling what WENT DOWN. So they end up buying high and sellling low.
Best wishes
Larry
Well, reduce that to a rule and test it. Tell me, what does "went up" mean? When the naïve investor gets excited, how far back is he looking and how fast a rise does it take to unleash his animal spirits?

Looking in the rear view mirror is right sometimes. It's not automatically wrong all the time every time. People keep telling me that there is a momentum factor and that it works over, IIRC, about a three-to-twelve month period, so is looking in the rear view mirror, say, a month or two behind you dumb, or is it sophisticated?

These statistics on flows into and out of funds are fairly well-known public information; why can't you use them to create a surefire market timing formula?
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larryswedroe
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Re: Investors got it wrong again in October

Post by larryswedroe » Thu Nov 17, 2011 5:19 pm

Nisprius
Yes there is momentum but it ONLY lasts a very short time, about 4-5 months. And it is only after a year period. Individual investors don't act that way or they would not be getting the results we see
All one needs to benefit is to simply rebalance. No timing or formula needed, but investors instead of acting in concave way, invest in convex manner
Larry

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