Investor returns reveal why sometimes investors are their own worst enemy.
The easiest way for mutual fund investors to gauge the performance of their investments is to pull up trailing- or calendar-year returns from a website like Morningstar.com. With a few clicks, they can see how a given fund did on an absolute basis and when compared with its peers and an appropriate benchmark.
But does that exercise reveal a correct picture of performance?
Not really, which is a key reason why most investors would be smart to analyze a fund's investor returns, too. Investor returns, also known as dollar-weighted returns, measure how the average investor fared over a given time period by incorporating the impact of cash inflows and outflows.
By incorporating purchases and sales into a performance measure, it becomes clear when investors chased performance or sold an offering just as it was about to experience a rebound. Indeed, investor returns can reveal considerable information about investor behavior--for better or worse.
To dig deeper into how and why investors make poor decisions, I sat down with Jason Hsu and Russel Kinnel. Hsu is co-founder of Research Affiliates, where he is vice chairman. He is also chairman and CIO of Rayliant Global Advisors. In addition, he is an adjunct professor of finance at the Anderson School of Management at UCLA and has published more than 40 peer-reviewed articles, including "Timing Poorly: A Guide to Generating Poor Returns While Investing in Successful Strategies."1 Kinnel is director of manager research with Morningstar and editor of Morningstar FundInvestor, a monthly newsletter. He runs Morningstar's annual "Mind the Gap" study, which compares the returns of the average fund investor with the average fund. Our conversation took place in April and has been edited for clarity and length.
John Rekenthaler: Why don't we start with this simple question: What are investor returns?
Russel Kinnel: Investor returns are essentially a way to understand the relationship between fund returns and investor behavior, and the returns that investors actually get. Because in the real world, performance is not simply a reflection of an average of fund returns or anything close to that; it's investors making buy-and-sell decisions all along the way.
Investor returns use dollar-weighted returns versus time-weighted returns. Time-weighted is the total returns we're used to seeing every day--the official returns. But if you instead dollar-weight them, you're saying: How did the average investor do? You're factoring the money that was flowing into this fund at this time and out of that fund at that time.