South African investors missing out on returns

There can be large differences between the return that a fund generates (fund returns) and the return that investors in the fund actually receive (investor returns). These differences (the investor return gap) stem from the fact that fund returns are meas

By aggregating total cashflows in or out of a fund, we can approximate the average investor return and compare it to the fund return. The differences can be attributed to collective investor behaviour; the switching in and out of funds. We analysed the 15 largest South African equity unit trust funds over the past 10 years and compared fund returns to investor returns.

Some interesting observations emerged and include the following:

· Overall, investors fared on average 1.7% per annum worse than the fund in which they were invested. This 1.7% per annum loss of potential return is significant - if compounded over 10 years, it means that investors ‘lost’ nearly 20% of the compound return that a simple buy and hold strategy would have delivered. To put this in context, top quartile equity funds have only outperformed the average fund by 1.5% per annum over the past 10 years. This means that investor behaviour has been a more important determinant of investor returns than the skill of the fund manager they appointed.

· There exists a strong relationship between the investor return gap and the client-turnover rate a fund experiences. In other words, the more clients move in and out of a particular fund, the more likely they are to worsen their performance relative to that of the fund. This is because investors often switch from a fund that is going through a poor patch and switch into a fund that is having a good run, only for the relative performance to reverse thereafter.

· The chart below highlights the strength of this relationship. For example, the orange data point – which represents one of the 15 funds analysed – indicates that the client turnover rate in that particular fund was just over 25% per annum (annual net flows into the fund averaged 25% of the value of the fund over the 10-year measurement period) and the commensurate investor gap was minus 3% per annum.

 (Click image to enlarge)

Source: Nedgroup Investments and I-Net

In general, the higher the rate of client turnover, the more negative the investor return gap. The strength of the relationship is measured statistically by the fit – in this example it means that 49% of the investor return gap is explained by the degree of client turnover in the fund.

The more specialised the mandate, the greater the potential for a large investor return gap. This is due to the fact that the performance of specialised funds tends to fluctuate more than those with wider mandates, which causes discomfort among investors and increases the likelihood of switching during a ‘negative’ fluctuation. As an example of this, we analysed the small-cap unit trust universe. Over the past 10years the investor return gap for one particular fund was minus 12.5% per annum. This fund delivered a total return in the region of 140% over the 10 years, but the average investor suffered a loss. A good fund return with a poor investor return should be seen as such – a poor outcome for investors.

It appears that South African investors may actually behave better than their global counterparts. The often quoted Dalbar survey postures that over a 20-year period, US balanced fund investors received up to an 8% per annum lower return on average than the funds that they invested in.

It is clear from the points highlighted above that investors are not harnessing the full magnitude of the returns available to them from the funds that they invest in. The responsibility to improve the investor outcome rests primarily with us, the investment provider. We make it our business to market our funds appropriately and continually emphasise the importance of investing for the long term. Highlighting short-term performance numbers and promoting funds that are currently ‘hot’ (as well as not talking about funds that are currently ‘not’), effectively encourages our investors to actively switch between funds, which will in all likelihood detract from their performance experience.