Returns seen far more dependent on investment behaviour than fund performance.

IF YOU still doubt that investors tend to be their own worst enemy, US-based Dalbar's latest update of an annual analysis of US investor behaviour should make you change your mind.

The firm's 2003 study - Quantitative Analysis of Investor Behaviour - makes this observation:

'Investment return is far more dependent on investment behaviour than fund performance.' Mutual fund investors who held their investments were more successful than those who timed the markets, it said.

The study found that between 1984 and 2003, which spans the best of the US equity bull market as well as the worst, the average equity fund investor's annualised return was only 2.57 per cent per annum on a compounded basis. This failed to beat even the annual inflation rate of 3.14 per cent. The S&P 500 index, used as a proxy for a buy-and-hold strategy, returned 12.22 per cent.

The latest survey shows that individual returns were substantially lower than at the study's previous update in 2001, reflecting the bear mauling. In fact, Dalbar notes that average investor returns for both fixed-income and equity funds were the lowest recorded since it began to monitor investor behaviour in 1984.

'A combination of the recent bear market and constant entering and exiting funds, has made mutual funds a dubious proposition for investors,' the study says.

At the previous update, the annual return of the individual equity investor between 1984 and 2000 was 5.3 per cent, compared with the S&P 500's 16.29 per cent. The average fixed-income investor reaped 6.08 per cent, compared with the 11.8 per cent returns from a long-term government bond index.

This time, the average fixed-income investor continued to fare slightly better than the equity investor, with a return of 4.24 per cent. That beat inflation by a whisker but is less than half the 11.7 per cent return of the long-term government bond index.

In Dalbar's analysis, as market returns rose, investors poured cash into funds in an attempt to capitalise on high returns. When the market swung low, investors scrambled to redeem their shares. This is symptomatic of the age-old tug between the emotions of fear and greed that often proves to be investors' undoing.

The average investor remained invested in equity or fixed-income funds for less than three years, and his decision to buy or sell was motivated mainly by the market swings. 'The end result is investors buy high and sell low and earn significantly less than the market indices,' says Dalbar.

The study examines funds' monthly cash flows as well as retention rates that reflect the average length of time investors stay with a fund, calculated through a comparison of net redemptions to the fund's overall assets. These are the study's other highlights:

The average holding period for funds is at its lowest level since 1988. The average equity investor remains invested for two-and-a half years, down from around three-and-a-quarter years in 1992.

The average fixed-income investor stays invested for three years, down from a high of four-and-a-quarter years in 1988.

Investors remain invested in fixed-income funds longer than equity funds, Dalbar says. This is despite the mutual fund industry's attempt to tell people that equity funds should be long-term vehicles.

Investors chase market performance. Major world events such as terrorist attacks, presidential elections and war did not cause a major spike or drop in mutual fund trade volume.

When held for the long term, equity funds gave the best long-term gains. But ironically - because of investor behaviour - equity investors earned just over half the returns of the average fixed-income investor.

Is the same sort of investor behaviour manifest in other countres?

Yes, say some fund managers.

'Literally at the bottom of a market, we start getting enquiries from people who say 'I can't take it anymore. Can you suggest something not so volatile? Put me in a bond fund',' says a manager. 'In the industry, we call that capitulation, and it's a sign the market has bottomed.'

Such enquiries came in around March when equity markets suffered a rout because of uncertainty over the Iraq war and Sars.

A similar US study in 2001 by Boston-based Financial Research Corp found that the 'best' quarterly returns of mutual funds were followed by fund inflows of an average US$91 billion a quarter, against just US$6.5 billion in inflows following the 'worst' quarters.

The study's author, Gavin Quill, FRC's director of research, found that the average return of mutual funds was much higher than the actual returns of the average investor. This was because investors held for short periods and tended to buy high and sell low. Because of the tendency to buy at the wrong time, the more frequently investors trade their funds, the worse their results
as their timing mistakes are compounded.

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