Testing DALBAR’s Claims About Mutual Fund Investors

Testing DALBAR’s Claims About Mutual Fund Investors

The DALBAR Quantitative Analysts of Investor Behavior (QAIB) report has long been cited by the financial services industry as “proof” of how (mutual fund) investors make poor timing decisions that result in a gap between the returns of investment markets and the returns of investors themselves, by as much as 600 basis points per year.

Yet a number of articles in recent years have questioned the accuracy of DALBAR’s reported 600bps behavior gap in investment results, from a guest post here on Nerd’s Eye View years ago, to a more recent analysis by Wade Pfau. The issue generally isn’t whether there is an investor behavior gap, but the magnitude; for instance, Morningstar’s “Mind The Gap” research from Russ Kinnel finds a behavior gap of “just” about 100bps per year – which is sizable, but 1/6th the DALBAR results. In fact, it’s actually hard to believe that investors could be underperforming by as much as 600bps, given that asset-weighted alpha must add up to zero before fees; in other words, just as the market in the aggregate can’t outperform itself (and thus why positive alpha is a zero-sum game), so too must negative alpha be a zero sum game. Of course, mutual fund investors aren’t the whole market – and the data is clear that investors tend to add more to funds at market peaks, and withdraw at market bottoms, suggesting there is some timing loss (with the opposing gains ostensibly going to the non-mutual-fund investors on the other side of those purchase/redemption trades). But the gap in the DALBAR data in particular appears to be, as noted previously on this blog, an apples-to-oranges comparison of a lump sum investment to someone who dollar cost averages.

In other words, DALBAR appears to compare investor to investing returns over the past 20 years by looking at the cumulative return of markets over 20 years, versus actual investor inflows and outflows over the past 20 years… which fails to recognize that a substantial portion of the investor dollars are simply people earning money and adding it to their savings over time, which means they didn’t miss the bull market of the late 1990s by bad timing, but simply because they didn’t have the wealth to invest dalyet! In addition, DALBAR compares all equities to the S&P 500, rather than segmenting asset classes more specifically, or using a broader-based total market index. By contrast, the Morningstar “Mind The Gap” analysis actually looks at the dollar-weighted internal rate of return calculation of each mutual fund itself, considering all the intervening cash flows as investors systematically save (and also add and subtract due to market timing).

Extending the Morningstar analysis further, Blanchett evaluates the internal-rate-of-return comparisons of mutual funds by Morningstar category against their actual benchmark index returns, and finds that the behavior gap since 1990 was -1.56% in broad equity asset classes and -1.28% in fixed income (although notably, the behavior “gap” for intermediate government bonds was actually a positive 0.60%!). And notably, the bulk of these timing issues were actually in the 1990s, and for a period were actually positive; overall, the average five-year behavior gaps are just -0.32% for equities and -0.16% for fixed income, and the behavior gap actually appears to be shrinking over time.

Although DALBAR has already posted a response to Blanchett’s article, the bottom line conclusion from Blanchett remains: DALBAR’s numbers are wrong, and should not be cited as evidence of the investor bad-market-timing behavior gap, though the behavior gap is real and affirmed by the mutual fund data (just to a much smaller extent than what the DALBAR study suggests).

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