How can you improve your investment returns?

Investors may notice that their investments do not always perform as well as the funds in which they have invested. This is because the returns of the fund are the returns generated by the portfolio manager over a period of time. The returns an investor actually gets depend on his or her participation in the fund. The only way in which the two numbers will be the same is if there was a single lump sum investment in the fund at the start of the performance measurement period – with no switching, additional investments or withdrawals. So says Richard Carter, head of product development at Allan Gray.

The difference between an investor’s actual returns and the fund’s returns is the difference between what is referred to as ‘time-weighted returns’ and ‘money-weighted returns’.

Time-weighted returns are the actual fund returns over time. Most asset managers report time-weighted returns in their documentation.

Investor, or money-weighted, returns are a more accurate measure of returns experienced by the average investor. They take into account when the investment is made, how long it is held and when the returns are generated.

“Investors’ returns will be impacted by how much and when they invest; how long they remain invested; and when they disinvest,” says Carter.

He says that for the best results investors’ behaviour needs to be aligned to the asset manager’s investment approach. Allan Gray, for example, has a long term, buy-and-hold approach to investing.

“The degree to which investors’ investing behaviour is aligned with our long-term philosophy will define how big or how small the gap is between our funds’ returns and investors’ returns,” he says.

Carter says confident investors find it tempting to switch between different funds in the belief that they can ‘time’ performance and generate better returns than by staying in their current fund. “Experience, and research, both locally and abroad has shown that ‘timing’ fund performance is extraordinarily difficult to do, perhaps even more so than ‘timing’ markets. This is something even investment professionals find challenging.”

Of course, more volatile markets increase investor fears, but the price to pay for irrational switching may be high.

“The difference between fund returns and investor returns is likely to increase during times when the market is very high, decreasing, or very volatile. These extreme conditions unsettle investors and increase emotion-based, short-term investment decisions,” says Carter.

Because investor returns are a function of the decisions they take as well as those of the investment team, Carter says it’s important for asset managers to educate investors about their investment philosophy.

“We’ve only done half of our job by ensuring that our funds deliver outperformance. We also need to consider the difference between fund returns and investor returns as a measure of how successful we’ve been at encouraging investors to remain invested for long enough to benefit from our investment approach,” he says.

“A fund may perform well, but if it has no investors, or if they’re in the fund for too short a time to benefit from our approach, little wealth is created.”