How investor biases can have huge impact on returns
Premium- Funds with defined strategy and style have performed better over the long term
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PremiumInvesting requires patience and a long-term approach. However, a large number of investors do not seem to have the same experience. The reason for this: investors get swayed by market cycles and near-term market performance while making investment decisions. Apart from market timing, investors also exhibit a cycle of performance chasing – i.e. switching between funds on the basis of near-term performance. This behaviour is value destructive and often results in sub-optimal returns over the entire investment period.
From an investor’s perspective, assessing the long-term market prospects and ideology of the fund manager before investing and then sticking to it over the long term are essential for getting the most value out of their mutual fund investments.
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To quantify the effects of Indian investors’ frequent churn decisions on their long-term returns, we analysed investor behaviour, across mutual fund assets, for equity and hybrid funds over the last 20 years (2003-2022) and debt funds over the last 14 years (2009-2022). Apart from calculating point-to-point investor and fund returns, we also looked at returns delivered through systematic investments (such as SIPs). The chart summarizes the findings for equity, hybrid funds and debt funds.
Data shows how investor returns substantially trail fund returns across asset classes. Economic and market specific cycles determine how well a fund house or a fund manager navigates through a cycle. Funds with a defined strategy, style and philosophy have delivered better performance over the long term.
However, investor emotions have derailed their journey especially in today’s environment of ‘information overload’. A simple example of this is the way gross inflows into equity funds act relative to equity market cycles. We have seen time and again the pro-cyclical nature of these flows—investors cut down on their investments when markets go through a correction and add to them when it goes up. “Buy high/sell low" strategy is wealth destructive, however, for most of us, keeping the passions or emotions out becomes tricky. The result is this gap between the fund returns and investor returns.
Systematic investment plans (SIPs) can help bridge this gap. SIPs help mitigate the issue of timing the market through regular, equalized allocations over time and are well-suited for investors who have regular cash flows. Most importantly, since the actual investment decision is automated, the role of emotions is dampened.
What investors should do:
-Start early and invest regularly.
-Set up systematic investing strategies that are largely automated to help overcome emotions.
-Invest in long-term funds/strategies. Avoid risky short-term market fads and performance chasing.
What investors shouldn’t do :
-Overreacting to market sentiment. Avoid greed and fear.
-Avoid chasing short-term performance for long-term gains.
-Avoid knee-jerk investment decisions. Follow a well laid-out investment plan that considers the long-term life objectives
Ashwin Patni is head products and alternatives at Axis AMC
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