Mutual Fund Investor Performance

I read a study this weekend that discussed the performance variance of typical mutual fund investors in the United States (results for Canada should be similar). Here are the highlights:

This study examines the investment timing performance of equity mutual fund investors and its relationship to the distribution arrangement of the fund. We find that investors who transact through investment professionals using conventional distribution arrangements experience substantially poorer timing performance than investors who purchase pure no-load funds.

Investors in all three principal load-carrying retail share classes (A – Front End Load, B – Deferred Sales Charge, and C – Trailer Fees) significantly under-perform a buy-and-hold strategy. Among all load funds, Class B investors suffer from the poorest cash flow timing, underperforming a buy-and-hold strategy by 2.28% annually, compared with annual underperformance of 0.78% for investors in pure no-load funds. No-load index funds are the only funds found to show no evidence of poor investor timing. Although investors are ultimately responsible for their own investment choices, these findings question the value being added by investment professionals who sell mutual fund shares through conventional / commissioned distribution arrangements.

We examine the relationship between fund distribution arrangements and investor timing performance. Our study expands on the finding that the timing of shareholders’ trades causes their actual performance to lag behind the performance of the funds in which they invest. Given that the majority of fund shares are purchased through investment professionals, we explore whether shareholders who rely on the advice of such professionals benefit by avoiding the perils of market timing.

…..

We find that investors who use investment professionals to purchase load or legal no-load funds experience greater losses due to poor timing than investors who buy pure no-load funds. This finding persists whether the fund is actively or passively managed. Load fund Class B shares have the lowest alpha, reflecting relatively high annual expenses, and existing evidence suggests that B shares are generally a poor choice for investors. The finding that investors in Class B shares also experience the worst average timing performance casts these shares in a further bad light. However, it is worth highlighting the fact that investors in all of the retail share classes, except no-load index funds, experience significant underperformance due to poor cash flow timing.

These results sound a warning to fund investors who are considering whether to attempt market timing, either on their own initiative or through their broker’s advice. Rather than outperforming a given fund, the average active investor is more likely to under-perform a passive dollar invested in the fund, and the use of an investment professional to trade shares is correlated with even worse investment timing performance.

Maybe I'm putting myself out of work here but this study draws interesting conclusions to be sure. In addition to fixed income products, I also sell 'no-load' mutual funds so I am not as bad as most of my colleagues in the business. Watching the fee level on funds is important to me and most of my clients as it directly impacts performance. Investing in funds with good defensive characteristics and long-term outperformance is where value can be added in most of my client relationships.

In Canada, most no-load mutual funds have trailer fees which typically are paid by the mutual fund company to the firm selling the funds and subsequently to the advisor. If you do not have an advisory relationship, there are mutual funds available that do not have trailer fees, which typically saves the investor money. Of course you need to do a little bit of work yourself.

The question I have about this study is what would most of these investors do if they did not have an advisory relationship? Would they invest at all? Would they do as well on their own versus an advisor who sold them no-load funds?