Investors not cashing in on mutual funds’ gains, report says

(November 27, 2002) Mutual fund performance rates can be a useful tool when choosing investment products for clients, but those impressive long-term rates are elusive for the majority of Canadians who just don’t buy and hold, a study suggests.

Only 6% of those invested in Canada’s 100 largest mutual funds managed to match or outperform the fund’s 10-year rate of return as of September 2002, according to a recent report from FundMonitor.com.

“The problem is that while funds do fine, people don’t,” the report says. “The rate of return shown in the newspaper relies on the assumption that a person buys and holds the fund for the full period. Our study shows that this is extremely uncommon.” Investors tend to either buy funds after they’ve gone up substantially or sell after a big drop, the study found.

For example, AGF’s popular International Value Fund gained 13.5% over 10 years, but investors’ returns averaged only 4.9%. That’s an extreme example, but FundMonitor.com says the average investor-posted return was more than four percentage points lower than the fund’s return.

Still, that doesn’t mean mutual funds’ advertised rates of return aren’t useful. FundMonitor.com says the rates show how the fund performed independent of any cash flow from investors, providing an excellent picture of the manager’s skill.

“As a measure of how people have done in these funds, these standard return figures are completely inadequate,” the report says.

The AGF example also provides a perfect illustration of how chasing performance can negatively impact investor returns. FundMonitor.com found that the International Value fund performed best in its first 10 years, well before it was popular. Since 2000, sales have skyrocketed, but the markets have slumped and returns have been modest.

That means most investors bought in after the fund had torn up the charts, and did not benefit from its past stellar numbers. “Investors have proven that they are terrible when it comes to choosing the right time invest,” says FundMonitor.com analyst Aaron Brown.

“The best way to avoid this problem is to simply ease your money into your investments instead of guessing the best time to invest,” he adds. “If you have a well-defined and well-balanced investment strategy that you stick to religiously, it will minimize your downside risk, and help you to survive the current markets.”

Dan Hallett, senior investment analysts at Sterling Mutuals, notes that historically, mutual fund investors tend to follow performance. “Ironically, where fund investors tend to invest their money is usually a good contrarian indicator, that is where not to go.

“Successful stock market investing, whether through funds or stocks, requires the confidence to buy early and the patience to wait until your expectations are realized,” Hallett says.

Filed by Doug Watt, Advisor.ca, dwatt@advisor.ca .