We are no better, but no worse than American investors when it comes to finding the right timing to enter or exit a fund. Almost all of the time, we make mistakes, and our returns suffer. In the United States, Russel Kinnel, director of Manager research at Morningstar, puts it on paper, with lots of empirical evidence, every year since 2005, when for the first time he published the study Mind the gap, which in English means "Beware of empty” and is an expression that was coined in 1969 by the London Underground to warn passengers of the void between the platform and the train door.
In Europe, Matias Möttölä, senior analyst at Morningstar, repeated the analysis and reached the same conclusions, although there are differences in the structure of the fund market compared to the United States and the countries of the Old Continent are not homogeneous with each other in terms of the financial culture, the dynamics in the distribution of products and the stages of development of the asset management industry.
Where investors go wrong
Behavioral errors (behavioural gap) weigh on results and are repeated over time, without having geographical boundaries. Investors are more or less short-term thinking, risk averse and focused on relative returns. They panic during downturns and are hesitant to re-enter markets when they rise. As a result, they tend to buy highs and sell lows, with inevitable losses.
Steve Wendel, head of behavioral finance research at Morningstar, suggests some useful actions to keep emotions under control: establish rules to achieve investment objectives, create the context to act consistently, rigorously measure results, set feedback and be ready to correct your aim if necessary.
Handle with Care
As Möttölä explains, the study, which calculates the difference between total return and investor return (i.e. weighted by inflows and outflows), helps to identify cases in which investors need to be more careful and cautious than usual, in order not to destroy value trying to chase the markets. “The data clearly show that the greatest risks are in the most volatile financial assets, such as funds specialized in individual countries, emerging markets or particular sectors.
Even fashions can be dangerous, as evidenced by the phenomenon of alternatives. In 2015, at European level, I was the asset class with the highest organic growth rate (+27%) and in 2016 the trend continued (+8% at the end of September). Despite their popularity, strategies that are similar to those of hedge funds have in many cases not yielded the desired results. Conversely, the gap between total return and that of the investor was 1,05% in the last five years, among the highest.
Running away is useless
Thinking of escaping market risks by moving your portfolio frequently is wrong. The Morningstar study shows that in most cases investor return gets worse as risk (measured by standard deviation) increases. Exceptions are balanced funds, for which the manager has a certain flexibility in deciding asset allocation and, precisely because of this characteristic, investors are less inclined to enter and exit.
Certainly, much still needs to be investigated in the relationship between total and investor return, such as the so-called corporate pillar (how much weight does a good judgment by analysts have on a management company?); however, the study helps to mentally set red lights to prevent timing errors from irreparably weighing on the investor's returns.
