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Investor returns, misperceptions and the art of active management

The last Watch out for the gap Morningstar research shows that over the past decade, investors have lagged equivalent market returns by an average of 1.7% per year.

Complete this over a period of 10 years or more, and you’ll end up giving up a lot of money!

In 2011, a study by DALBAR’s Quantitative and Investor Behavior Analysis (QAIB) group showed that over the previous two decades, the average investor in a mutual fund had underperformed the S&P 500 Index by 4.3% per year, while investors in bond funds lagged the Barclays US Aggregate Bond Index by up to 5.5% per year.

Before the 2000s, investor returns were even worse. While performance over the past decade has arguably been less severe, consistent underperformance persists.

Why such bad results?

Excessive fees, heuristic-backed processes, lack of repeatability, and misalignment of interests are perhaps some of the main reasons for poor long-term results for clients.

The biggest cost to clients, however, has been the ‘timing and selection penalty’ – the cost of investing in a fund after a period of good performance and then selling it after a period of good performance. period of poor performance.

Poor execution is primarily the result of behavioral biases, a topic frequently discussed, but rarely practiced.

The market – or more specifically, parties with a particular interest, which include consultants, custodians, trustees, third-party research providers, wealth managers, and even academics – have come up with solutions to overcome the poor performance of financial institutions. clients.

Generally recognized and accepted solutions include the diversification of specific security risks, the use of passive indexation strategies and the systematic rebalancing of investor portfolios.

Taking them at face value is, in our opinion, misguided and in fact increases some risk without addressing the fundamental problem.

Below, we discuss the factors that we believe are crucial to achieving strong and consistent long-term results.

A significant amount of evidence shows that fund flows follow performance.

A typical fund investment is only three years, which we believe is far too short to prove or disprove a manager’s competitive advantage, or even sustainability.

Indeed, performance over a period of three years or less is mainly impacted by asset allocation factors.

All of these factors can be managed through better and more in-depth fundamental research: a better understanding of the intrinsic value of the security – or fund – in which you invest and how that intrinsic value composes over time.

This should allow investors to better understand their safety margin, manage downside risk and allocate capital more efficiently.

Ultimately, better long-term results while involving less short-term risk are possible.

However, it requires a willingness to be different; a portfolio of high conviction and quality; efficient capital allocation, underpinned by a fundamental understanding of intrinsic value… and patience!

Ernst Knacke is Head of Research at Shard Capital

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