Morningstar’s annual “Mind the Gap” study confirmed the widely accepted observation that investors in general are not good at timing the market. More often than not, they earn lower money-weighted returns than the performance of the funds they hold would imply. “Time in the market, not timing the market,” has become a financial advisor cliché.
Investors in Asia, however, seem to have worse timing than the average global investor, concluded the report.
The research firm measures timing issues with the “returns gap”, which it defines as the difference between the fund return that is generated by managers and earned by investors.
Generally “investors in Asia tend to suffer more from timing decisions”, as evidenced by a larger returns gap for funds available for sale in Asia compared to all Luxembourg-domiciled funds, measured over the five-year period ending 31 December 2016.
Concentrated fund mistakes
Timing decisions particularly hit returns of concentrated equity funds. The authors of the report, Arthur Wu, senior analyst for manager research and Wing Chan, director of manager research for Asia at Morningstar, offer two possible reasons.
First, having seen commodities outperform many other asset classes in the 2000s, investors tended to jump the gun in calling the bottom of the commodities market in the past five years.
Second, they had a difficult time making calls for volatile sectors and for single country funds, in particular Japan, China and India equity.
Such concentrated equity funds displayed larger return gaps, according to the report. “Over the years, we have seen numerous examples of investors getting attracted to highly concentrated equity strategies on the back of seemingly attractive thematic or stories, only to see markets reverse, resulting in significant losses,” wrote Wu and Chan.
Notably, the funds categorised as “diversified equity” showed lower return gaps in Hong Kong, Singapore and Taiwan than the global average. This suggests that investors use diversified equity funds as long-term holdings in their portfolios, minimising the market-timing effect.
The investors’ “dismal track record in trying to time markets” suggests that they “might be better served by taking a longer-term, diversified approach towards their investments,” concluded the report.
Measuring the gap
The study estimates the effect of the timing of investors’ decisions to purchase or sell a fund on the returns they earn. This is done by comparing the fund return generated by managers, based purely on the value of the fund’s units, to the return earned by investors, which take into account inflows and outflows of money, be it from buying and selling, or from fund dividends.
The former are known as “time-weighted” or “geometric” returns, while the latter are “money-weighted”. The difference between the two, called the returns gap, represents the effect of investors’ market-timing decisions. It could be positive or negative.
The 2017 edition of the study for the first time included investors in Hong Kong, Singapore and Taiwan, in addition to the US and Europe.
“Anecdotally, Asian investors tend to be more active in market timing and have shorter investment horizons than their peers in the US and Europe,” wrote the authors of the study.
They point to the lack of capital gains taxes as well as the prevalence of commission-based distributors in the region as the most likely reasons behind investors’ propensity to switch funds more frequently.
The study is complicated by the factor that all three markets allow offshore funds to be sold. Companies managing offshore funds, sold in many countries, report only aggregate asset flows, without differentiation for individual markets.
The Morningstar study attempted to get around this obstacle by comparing the returns gap of all Luxembourg-domiciled offshore funds to all funds available for sale in the three Asian markets, and also to those funds that are domiciled therein.