Morningstar Magazine - October/November 2016 - 14
Dispatches
EXHIBIT 2
Investors Are Good at Fund Selection, Bad at Timing
The Good
Asset-Weighted
Return (%)
Equal-Weighted
Return (%)
Selection Gap (%)
U.S. Diversified Stock
7.10
6.58
0.52
U.S. Sector
6.72
5.27
1.45
International Stock
4.41
3.91
0.50
Allocation
5.58
4.67
0.91
Taxable Bond
4.87
4.08
0.79
Municipal Bond
3.87
3.63
0.24
Alternatives
1.07
-1.50
2.57
Selection Gap (%)
Expense Difference (%)
Remaining
Difference (%)
U.S. Diversified Stock
0.52
0.40
0.12
U.S. Sector
1.45
0.44
0.81
International Stock
0.50
0.43
0.07
Allocation
0.91
0.43
0.48
Taxable Bond
0.79
0.31
0.48
Municipal Bond
0.24
0.34
-0.10
Alternatives
2.57
0.40
2.17
Investor Return (%)
Equal-Weighted
Return (%)
Return Gap (%)
U.S. Diversified Stock
5.84
6.58
-0.74
U.S. Sector
5.53
5.27
0.26
International Stock
2.67
3.91
-1.24
Allocation
4.50
4.67
-0.17
Taxable Bond
3.26
4.08
-0.82
Municipal Bond
2.31
3.36
-1.32
Alternatives
0.80
-1.50
2.30
Investors collectively chose funds well...
...And they selected cheaper funds...
Source: Morningstar. 10-Year Returns through 12/31/2015.
The Bad
...But their timing was poor.
Source: Morningstar. 10-Year Returns through 12/31/2015.
star's Russel Kinnel in his Mind the Gap series,
and related on occasion in this column
as well. Fund investors do well enough with their
fund selection, but when it comes to deciding
which asset classes to buy and sell, they
have been far less successful. This can be seen
anecdotally, in observing the tendency of fund
14
Morningstar October/November 2016
buyers to chase their tails by redeeming poor-performing investment categories and purchasing
performance-leading assets, or it can be
measured-albeit indirectly-by comparing the
paper returns on funds with the profits they
actually made for their owners. The latter is termed
"investor return."
I won't delve into the details of those calculations
here, as they are covered in Kinnel's series. Suffice
it to say that every gain humans make over
monkeys with fund selection, they give back with
their investment timing-and then some. The
third table in E X H I B I T 2 shows the investor return,
the equal-weighted fund return (that is, the
return earned by the monkeys), and what Kinnel
calls the return gap, the difference between
what investors theoretically would have earned if
they had put equal amounts of money in all
funds and what they actually received.
Not good. Once again, the puny alternatives and
sector-fund groups are the exceptions, but
that's scant consolation. Allocation funds fare
better than the rest, because target-date funds
have positive return gaps, but they are still
negative. The other groups are even worse off.
These results are even noisier than those leading
to the selection gap. Investor returns are affected
by many factors besides timing decisions. As
skeptics of the measure have pointed out,
shareholders who dollar-cost average into funds
by investing the same amount each month will
show a return gap (perhaps positive, perhaps
negative). That's a fair criticism. On the other hand,
Morningstar has generated its Mind the Gap
research for a decade now, and the pattern
is always the same. The result is unlikely to have
occurred by accident.
Less Is More
Experienced investors and financial advisors,
I believe, can improve their results by judiciously
picking up bargain assets and trimming those
that appear to have overheated. This column
suggested energy pipeline stocks earlier this year,
and I'm currently considering whether emerging-markets stocks and European banks might
be timely. So, I am not a purist for strategic asset
allocation. But it must be granted that most
investors don't do well with their asset timing.
They would be better off doing what they're
already doing with their fund selection
and keeping their asset allocation rigorously,
strictly strategic. K
John Rekenthaler is vice president of research
with Morningstar.
Table of Contents for the Digital Edition of Morningstar Magazine - October/November 2016
Contents
Morningstar Magazine - October/November 2016 - Cover1
Morningstar Magazine - October/November 2016 - Cover2
Morningstar Magazine - October/November 2016 - 1
Morningstar Magazine - October/November 2016 - 2
Morningstar Magazine - October/November 2016 - Contents
Morningstar Magazine - October/November 2016 - 4
Morningstar Magazine - October/November 2016 - 5
Morningstar Magazine - October/November 2016 - 6
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