To view the article to which this refers, go here.
Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
It is unfortunate that this article misses the central point that the Quantitative Analysis of Investor Behavior (“QAIB”) measures the mutual fund investor experience and not the areas raised as concerns. In fact, the author admits by his ignorance of its contents that he has not read the report that he so roundly criticizes.
The fundamental flaw in the critique is that the term “investor return” defined in QAIB is very different the use of the same term in the article. In QAIB, “investor return” is the difference between the net paid in and the current value. This is what the investor experiences.
May I suggest that the author actually read the report and replace the assumptions and guesses with the actual contents of the report? As an indication of how far off the mark this article is, the following suppositions contained in the article are answered with facts.
Supposition #1.
Dalbar’s Quantitative Analysis of Investor Behavior… is “proof” that mutual fund investors have historically made poor market-timing decisions.
Fact
The report is a quantitative representation of investor experience. While there is evidence of the negative effect of market-timing, it is not offered as proof of poor market-timing decisions. The report presents the contrast between what investors experience in their own accounts and what is published about the funds they own.
The QAIB report suggests that the investor experience is in part attributable to poor market timing decisions, but this is only one of several factors that account for the investor’s experience of underperformance.
Supposition #2.
DALBAR does not publicly disclose its approach
Fact
Dalbar publishes the methodology in its report and has done so since the first edition. This methodology is delivered to every buyer of the report. Low priced extracts have been made that do not include the methodology.
Instead of guessing at what the approach is, interested persons can simply purchase the report.
Supposition #3.
I use a transparent and industry-accepted methodology, based on publicly available data, to demonstrate that investors’ returns have not been nearly as bad as DALBAR claims.
Fact.
Dalbar’s QAIB report seeks to quantify the investor experience which not provided by any other industry-accepted methodology. The results are by definition different as is evidenced by the fact that investor surveys show a perceived gap between industry-reported returns and the investor’s own experience.
Supposition #4.
DALBAR suggests that equity mutual fund investors have underperformed the S&P 500 by over 600 basis points annually. In contrast, Russ Kinnel, my colleague at Morningstar Research Services has noted a more muted impact in his annual Mind the Gap report, typically in the neighborhood of 100 basis points annually.
Fact
The “Mind the Gap” report shows returns earned by funds after considering the burden of flows. Dalbar’s Quantitative Analysis of Investor Behavior reports returns experienced by investors which includes the lost opportunity of being out of the market.
The 100 basis point difference that the “Mind the Gap” report attributes to market timing is in line with the QAIB estimate of the same factor. The 600 basis point difference in QAIB includes not only the 100 basis point market timing loss but also the cost of delayed investment decisions, withdrawals to satisfy individual’s need for cash, sales charges, fund expenses as well as portfolio transaction costs! The two data points are simply different.
Supposition #5
I’ll conduct my own analysis using historical mutual fund data to better calibrate the intelligence of mutual fund investors’ market-timing decisions.
Fact
While this is a valuable exercise it does not contradict nor support QAIB since QAIB does not attempt to calibrate mutual fund investors’ market-timing decisions.
Supposition #6
Every active investor (i.e., one who doesn’t hold the market-capitalization weighted portfolio) will lose or make money, and there will be a corresponding, offsetting winner or loser. While there can be more winners than losers (and vice versa), the asset-weighted alpha must be zero before fees (i.e., a lot of investors can win if one large investor loses).
Fact
While the zero sum principle may be true, it has no bearing on QAIB which is highly selective by including only mutual funds which are predominantly held by retail investors. The winners and losers in mutual funds are offset by institutional and direct investors.
The zero sum principle also fails to consider that equity mutual funds also contain cash and bonds that provide downside protection for investors but also reduces return in relation to an index.
Additionally, the zero sum theory does not account for opportunity cost of being out of the market.
Supposition #7
DALBAR has a significant flaw in its calculation. It considers its methodology proprietary and, based on publicly available information, Pfau conducted a relatively comprehensive analysis. He concluded that DALBAR is likely comparing the return for a lump-sum investment to the return for a dollar-cost-averaged investment. This means the results are meaningless – essentially comparing apples to oranges.
Fact
Pfau did not purchase QAIB and has not requested a complimentary copy of the report. The conclusion is meaningless since the assumption is incorrect.
Additionally, QAIB makes no assertion that investor returns are calculated the same way as index returns. The point is that the index returns are widely used and accepted, so this creates a disparity with the investor’s own experience of the difference between the net that was paid in and current value. This disparity is consistent month to month, year to year as well as over longer periods.
Louis S. Harvey is the CEO of DALBAR.
Read more articles by Louis S. Harvey
