Morningstar's inaugural UK Mind the Gap study into the effects of behaviour on investment returns has found the average investor's returns are lower than the reported returns on a fund.
The Mind the Gap study compares the reported total returns of open-end investment funds with the money-weighted returns that represent the average investor experience over the five-year period to 31 December 2016.
Morningstar's aim was to assess how the timing of investment flows into funds has affected the experience of the average investor in terms of returns on capital.
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The study found UK investors' returns tend to be lower than reported returns, mirroring the findings from its US study and reflecting the "suboptimal timing" of cashflows into investment funds.
Total vs investor returns
In the study, the ‘gap' refers to the difference between a fund's reported total return and its investor return (ie the money-weighted return that takes into account all cashflows, providing an impression of the return experience for the average investor).
The largest gap observed in the study was -0.51 percentage points for the asset-weighted return on diversified equity funds over five years, while the average gap for all UK funds is -0.19 percentage points.
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The lowest gap was in the fixed income space, at -0.24 percentage points, while the only sector that showed a positive gap was the concentrated equities category, which includes single country and sector equity funds, such as UK equity vehicles. Here, investor returns were 0.46 percentage points higher than the reported fund return.
However, investors in the UK had not seen better returns from asset allocation funds, in contrast to the US, with a gap of -0.39 percentage points in this area.
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Morningstar said this differed from its US study, where investors were making regular contributions into asset allocation products for their retirement and savings plans, thus removing the potential for negative gaps as a result of bad timing.
Investor behaviour
Simon Dorricott, associate director of equity strategies at Morningstar, said: "One possible explanation is investors tend to allocate to funds, markets or categories that have already shown strong absolute returns, and are subsequently invested through a period of lower absolute performance.
"To lessen the potential for reduced returns due to such behaviour, investors have two simple strategies open to them. The first is to make regular contributions across their investments rather than infrequent lump sum contributions.
"The second involves setting an appropriate balanced asset allocation and using flows to re-balance, thus reducing the likelihood of buying into asset classes at recent highs."
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