Chasing performance hurts load mutual fund investors

[NormR]

Chasing performance hurts load mutual fund investors

The study concludes: “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, B, and C) significantly underperform a buy-and-hold strategy." Some of these load funds underperformed a buy-and-hold strategy by 2.28 percentage points annually, compared with annual underperformance of 0.78 percentage points for investors in pure no-load funds.

"No-load index funds are the only funds found to show no evidence of poor investor timing.”

The paper: Investor Timing and Fund Distribution Channels

[Bylo Selhi]

No-load index funds are the only funds found to show no evidence of poor investor timing.

Even I find that part especially hard to believe

[NormR]

No-load index funds are the only funds found to show no evidence of poor investor timing.

Even I find that part especially hard to believe

oh?

[Bylo Selhi]

Interesting. So Vanguard's strict policy of "discouraging" frequent trading does seem to work. Presumably the same applies to eFunds et al that have restrictions on trading.

I guess that's also why Bogle is so critical of ETFs, especially stuff like SPY and QQQQ that turn over at mind-boggling rates.

[NormR]

Interesting. So Vanguard's strict policy of "discouraging" frequent trading does seem to work. Presumably the same applies to eFunds et al that have restrictions on trading.

Ah, I'm not sure about that. It might happen, but DSCs also 'discourage' trading to apparently no avail. (A bit of a shocker.) I suspect that investor attitude is the culprit with Vanguard attracting more buy-and-holders.

IIRC, index funds from other providers don't fare as well (investor vs fund return) compared to Vanguard.

[Bylo Selhi]

DSCs also 'discourage' trading to apparently no avail. (A bit of a shocker.)

As long as it's an intra-family switch there's nothing (apart from their advisor) to "discourage" the investor.

I suspect that investor attitude is the culprit with Vanguard attracting more buy-and-holders.

And/or Vanguard rejecting those who won't drink their Kool-Aid Either way, it's another reason to prefer Vanguard over others.

[NormR]

DSCs also 'discourage' trading to apparently no avail. (A bit of a shocker.)

As long as it's an intra-family switch there's nothing (apart from their advisor) to "discourage" the investor.

Good point about DSC funds in Canada. (For those who don't know, the study was done in the U.S.) Perhaps such intra-family switches should not be allowed?

I suspect that investor attitude is the culprit with Vanguard attracting more buy-and-holders.

And/or Vanguard rejecting those who won't drink their Kool-Aid Either way, it's another reason to prefer Vanguard over others.

Does Vanguard reject investors? (Aside from Canadian residents.)

[Bylo Selhi]

Does Vanguard reject investors?

Not investors per se but rather frequent trades.

Frequent-trading policy
If you sell or exchange shares of a Vanguard fund, you will not be permitted to buy or exchange back into the same fund, in the same account, within 60 calendar days... Vanguard reserves the right to revise or terminate the exchange privilege, limit the amount of any exchange, or reject an exchange, at any time, for any reason.

[My bold] There are exceptions, e.g. MMFs, ST Bond funds and ETFs as well as "transaction requests submitted by mail".

That last sentence ("Vanguard reserves the right...") may sound like boilerplate but ISTR that they've told people who traded too frequently, but still in accordance with their trading policy, to take their marbles elsewhere. Also ISTR that during the tech bubble Vanguard famously rejected an 8-figure buy of VFINX by an institution that wanted to "park" some cash.

Frequent Trading or Market-Timing
Background. Some investors try to profit from strategies involving frequent trading of
mutual fund shares, such as market-timing. For funds holding foreign securities,
investors may try to take advantage of an anticipated difference between the price of
the fund’s shares and price movements in overseas markets, a practice also known as
time-zone arbitrage. Investors also may try to engage in frequent trading of funds
holding investments such as small-cap stocks and high-yield bonds. As money is
shifted into and out of a fund by a shareholder engaging in frequent trading, a fund
incurs costs for buying and selling securities, resulting in increased brokerage and
administrative costs. These costs are borne by all fund shareholders, including the
long-term investors who do not generate the costs. In addition, frequent trading may
interfere with an advisor’s ability to efficiently manage the fund.

Policies to Address Frequent Trading. The Vanguard funds (other than money
market funds, short-term bond funds, and Vanguard ETF™ Shares) do not knowingly
accommodate frequent trading. The board of trustees of each Vanguard fund has
adopted policies and procedures reasonably designed to detect and discourage
frequent trading and, in some cases, to compensate the fund for the costs associated
with it. Although there is no assurance that Vanguard will be able to detect or prevent
frequent trading or market-timing in all circumstances, the following policies have
been adopted to address these issues:
• Each Vanguard fund reserves the right to reject any purchase request—including
exchanges from other Vanguard funds—without notice and regardless of size. For
example, a purchase request could be rejected if Vanguard determines that such
purchase may negatively affect a fund’s operation or performance or because of a
history of frequent trading by the investor.
• Each Vanguard fund (other than money market funds, short-term bond funds, and
ETF Shares) generally prohibits, except as otherwise noted in the Investing With
Vanguard section, an investor’s purchases or exchanges into a fund account for 60
calendar days after the investor has redeemed or exchanged out of that fund account.
• Certain Vanguard funds charge shareholders purchase and/or redemption fees
on transactions.

See the Investing With Vanguard section of this prospectus for further details on
Vanguard’s transaction policies.

Each fund (other than money market funds), in determining its net asset value, will
use fair-value pricing as described in the Share Price section. Fair-value pricing may
reduce or eliminate the profitability of certain frequent-trading strategies.

Do not invest with Vanguard if you are a market-timer.

That last sentence is their bold, not mine.

[DanH]

Chasing results comes at a cost

A controversial study has come to a distressing conclusion for advisors who sell load mutual funds.

Zero Alpha Group (ZAG), a U.S.-based network of independent wealth-management firms, came to the seemingly counterintuitive insight that clients who buy load mutual funds through advisors underperform those who buy no-load funds or index funds. The latter can be bought directly or through an advisor.

...

A better test would be to compare investor results to what they would have done had they been on their own, but that's not a practical route.

My take? Good advice is better than no advice, but it appears bad advice is worse than no advice at all.

Overall, I think it's a very balanced piece.

[Bylo Selhi]

From TFA:

I was surprised by the frank admission of a senior Canadian fund executive who confessed ZAG was right on the money. "It makes sense to me. Who chases performance more than advisors?," he said. Advisors are always motivated to come up with the next idea, he said. "There are good advisors who get people invested and create portfolios. But many aren't very good and undoubtedly chase performance."...

It appears many advisors are giving clients what they want rather than the tough love they require. Advisors are more informed than typical investors because of how they spend their days, but "that makes them susceptible to being caught up in the latest fad," [president of Toronto-based Strategic Imperatives, Dan] Richards says.

So how does a member of the general public identify and avoid advisors like that?

[DanH]

From TFA:

I was surprised by the frank admission of a senior Canadian fund executive who confessed ZAG was right on the money. "It makes sense to me. Who chases performance more than advisors?," he said. Advisors are always motivated to come up with the next idea, he said. "There are good advisors who get people invested and create portfolios. But many aren't very good and undoubtedly chase performance."...

It appears many advisors are giving clients what they want rather than the tough love they require. Advisors are more informed than typical investors because of how they spend their days, but "that makes them susceptible to being caught up in the latest fad," [president of Toronto-based Strategic Imperatives, Dan] Richards says.

So how does a member of the general public identify and avoid advisors like that?

What's "TFA"?

I'm not sure how you avoid this, except to be careful of advisors that talk of "constantly watching" client portfolios and "making changes as needed". Otherwise, there is no way to tell before hand. But there's another effect not mentioned in the article.

The implicit assumption is that it's all advisor driven. Some of it is and some of it isn't. Tough to say which side weighs more heavily but there's a significant investor effect, even when dealing with an advisor. And that's the only additional piece of info (that I provided) that I wish had been included in the story.

This is a point the authors of the study make. The study looks pretty good from what I can tell but it's just not as broad in scope as it could have been given the time frame studied. That makes me wonder why narrow the scope to U.S. stock funds only.

[Bylo Selhi]

What's "TFA"?

TFA (which to my surprise is not in the English version (but this variant is, TFA, which works too.))

P.S. I always mean "fine" for the letter "F"

[George$]

It took a while to decide where to best post my recollection of an early investment with
Go-Go fund manager Gerald Tsai Jr (1929-2008)

In 1965 I was a young naive investor, a student in graduate school, living on $2,500 income a year, keen to find the fund that would doubly my money, run by a 'great investor', and so sent some $500 to the Manhatten Fund as it was opening up for business. The papers and magazines were full of hype about this investment genius, Gerald Tsai. Years later I closed out at a loss - and went chasing other investment stars .... to more repeated losses.

Manhattan Fund was my third investment ever. The first two were T Rowe Price Growth Fund and its New Horizons Fund. They did ok over the years.

A bit from the above NY Times link to Tsai ...

After a dazzling 1965, Tsai set out on his own. Seeking to raise $25 million for his new Manhattan Fund, he wound up with 10 times that amount, as investors clamored to get into the fund. He had two middling years, and then the roof fell in. By July 1968, the Manhattan Fund was the sixth-worst-performing fund in the country. Tsai responded shrewdly — for himself at least — by selling the fund to an insurance company for $30 million. A year later it had lost 90 percent of its value.

[ockham]

From TFA:

I was surprised by the frank admission of a senior Canadian fund executive who confessed ZAG was right on the money. "It makes sense to me. Who chases performance more than advisors?," he said..

I know a number of financial advisors personally. In the last couple of weeks two have confided in me that they are actively trading the HBP bull and bear units in their personal accounts -- while assuring me they would never advise clients to do the same.

[Bylo Selhi]

OK, here's another anecdote about an adviser (who in this case should know a lot better) chasing performance with his client's money.

Lessons learned: Investing pros talk about 2008

But as the events of the past fall showed, the stock market can pick your bones clean in the short term. John De Goey, an investment adviser with Burgeonvest Securities, learned that lesson well in the past year.

Well actually it was his client (keep reading) who learned the expensive lesson.

A client had sold his house and wanted to park the proceeds for a year or so while he waited for a planned move into a condo in 2009. Mr. De Goey considered a GIC or money market fund, but thought he could do better in an exchange-traded fund (an index tracking fund that trades like a stock) targeting blue-chip dividend stocks.

Excuse me? The client needs the money in a year's time so you put him in a dividend fund?

Several hundred thousand dollars went into the ETF in the fall, after the stock markets had fallen by an amount that now seems modest. "I said come on, we've got a year before we need the money, the markets are down 10 or 15 per cent and this ETF's holdings are all solid companies paying dividends," Mr. De Goey recalls thinking.

In mid-December, after steady losses, the client reached the limit of his tolerance and the ETF was sold at a loss of about 25 per cent.

"I don't take a lot of risk in my client portfolios - my assets under management are only down about 17 per cent from the peak in June," Mr. De Goey said. "But I'm chastened. We all learn our lessons from these things."

The most charitable thing I can say is to praise De Goey for his candour. However, if I was the client I'd cut out this piece from the G&M, hand it to my lawyer and direct him to sue the pants off my advisor for gross malpractice.

[squash500]

Bylo, what am I now going to do with the two John De geoy books that I bought at Chapters ?
I wonder if I should throw them out ?

De geoy probably bought his client the xdv

I wonder if De geoy will actually get sued over this?

He'll probably hope that this particular clients KYC form will get him out of hot water!

[Doug]

"No-load index funds are the only funds found to show no evidence of poor investor timing.”

This doesn't surprise me. For an index fund investor who is going to get the market return at best, frequent trading will only increase costs and decrease return. Those who want to beat the market will not be buying no-load index funds. If you want to beat the market, the rationale for frequent trading is stronger. Since comparatively few people beat the market, the end result of frequent trading will be lower returns overall.

I wonder how much this has to do with the investors, and not the advisors. Could advisors actually be a restraining force that prevent these investors from losing even more money?

P.S. I'm not an advisor, and I've never had an advisor.