Stock gains, target-date funds shrink behavioral gap in investment returns

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CHICAGO — The behavioral impact on investment returns in mutual funds has receded to its lowest level in 13 years, according to Morningstar, in a signal that investors are making better-timed trades. However, many types of mutual funds are still getting much better returns than their investors.

Buoyed by strong equity markets and the use of target-date funds for 401(k) clients, the gap in total annualized returns in the past decade for open-end funds and investors’ actual results is only 26 basis points, Morningstar says. The research firm released a study of the so-called behavioral gap on June 12.

The data on eight types of asset classes provides insight into how well clients and advisors time their investment decisions based on highs and lows across markets. Only in 2005, the first year of the annual “Mind the Gap” study, did Morningstar find a more favorable gap over a 10-year period for investors.

Financial firms and advisors often tap behavioral psychology to study clients’ reactive investment decisions and how to best steer them. The study could help advisors convince their clients to stay the course in volatile times, says Morningstar Director of Manager Research Russ Kinnel.

“This shows the value of advice, but also the value of sticking to a plan,” Kinnel said in a session for the media at Morningstar’s Investment Conference. “The people who came into ’08 with a plan, these people did far better.”

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The bull-market gains in equities since the Great Recession played a major role in the study.

With bear-market funds dragging down returns while turning off investors, alternative products displayed the worst investment results but the best gap for investors among any asset class. Investors earned just nine basis points annually in the past decade, but the products fell by 131 over the period ending March 31.

The class, which also includes market-neutral, long-short, and multi-alternative products, consists of far fewer offerings with 10-year track records than other types of funds, Morningstar notes. The research firm also didn’t look at ETFs because short-term trading makes it difficult to measure their results.

Allocation and traditional balanced funds figured into a 30-basis point gap in annualized returns for balanced funds, with investors getting 5.93% and the funds getting 5.63%. Target-date funds stand out to Kinnel as examples of “boring funds, well-designed for investors” with especially positive outcomes.

“You have people dedicated to putting money in with every paycheck, and that just works very well,” Kinnel said. “Something about committing just really leads to good results.”

Sector stocks constitute the only other area where investors had better returns than the funds. However, clients netted modest gains on their gap in domestic stocks, which have resulted in an 8.32% annualized gain for them compared with 8.93% for the funds.

Large gaps for investors in municipal bonds showed a direct connection, Kinnel says, with a December 2010 segment on “60 Minutes” featuring an analyst’s warnings about state government’s budgetary problems and the more recent Puerto Rican debt crisis.

“Muni investors are so risk-averse that any whiff of trouble scares them off,” he said.

Clients will always feel a need to react to major events or frothy markets, according to Jeff Tjornehoj, the director of fiduciary and compliance research at Broadridge Financial Solutions. They may even begin to believe they can do a better job than their advisors, he says.

“I imagine that every advisor has some clients who want part of their portfolio allocated to aggressive or contemporary opportunities,” Tjornehoj says. “It’s their job to keep them anchored to reality.”

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Behavioral finance Asset allocations Mutual funds Target date funds Municipal bond funds Client communications Client strategies Stocks Alternative investments Morningstar