Kate Lin: Our Mind the Gap report examines the persistent gap between the returns investors actually experience and the reported total returns by funds, which makes investors’ buy and sell timing one of the most significant factors that can influence an investor’s end results. How is it that you underperform the very fund you own? Morningstar's associate director for manager research, Bryan Cheung, has studied this, and he's here today to tell us more.
Hi Bryan. How does the gap between investor returns and fund returns look like in Asia? And what causes this gap?
Bryan Cheung: Hi Kate. Thanks for the question. So perhaps I'll just give some quick background first before I answer the questions. First of all, for this report, we covered the past five years, between July 2018 and June 2023, which, as you may recall, was a very turbulent but meaningful period to examine because the volatility put investors to the test.
In this study, we analyzed six key fund markets around the world. The most relevant markets for Asian investors would be the funds domiciled in Ireland and Luxembourg, which dominate the cross-border UCITS space and UCITS dominate major Asian fund markets. Also, we cover the Hong Kong- and Singapore-domiciled funds to complement our findings.
To answer your question, first of all, unfortunately, when we look across the six markets, they all saw negative return gaps on average, meaning that investors would have been better off staying with their investments rather than timing the entry and exit. So, timing, as you mentioned, is definitely a key driver behind the gaps. Notably, the cross-border markets of Ireland and Luxembourg show the largest negative gaps compared to other markets.
At the asset class level, the gaps were larger within equities. We think performance-chasing behavior was very evident in equity funds especially those that have had an exuberant time during the past five years such as some technology sector funds that have gone up significantly during 2020 and part of 2021, where investors often bought these funds at peak level and which results in larger gaps eventually. Interestingly, we also observed that equity funds with the largest net inflows over the past five years, i.e. the hottest funds in the market also exhibited the largest gaps.
Finally, the gaps are also negative across fixed income and allocation funds and this is something that we observed within funds domiciled in Hong Kong and Singapore as well.
Lin: Looking closer at your findings in Hong Kong and Singapore, how do you compare this region with the rest of the world?
Cheung: I think it’s worth mentioning that the funds in major Asian markets like Hong Kong and Singapore are often sold as isolated products, rather than as part of holistic portfolio advice, which induces performance-chasing and the selling of most popular funds. We think this in part explains the larger gaps in the cross-border markets and as well as the Hong Kong- and Singapore-domiciled fund markets. Comparatively, markets like Australia and the U.K. are characterized by more comprehensive financial advice and portfolio approach and indeed they showed the smallest gaps in our study.
Lin: after studying all these funds, what are the key lessons learned that you can give to investors?
Cheung: First of all, I think avoid timing the market, avoid trend-following behavior, and also performance-chasing behavior as we mentioned previously. And I think investors in the region should think twice when being sold a fund and I think try to take a long-term diversified portfolio approach for better results rather than always trying to search for the big gains in some gimmicky or niche offerings.
The other point I would like to highlight is that we observed that less volatile products served investors better such as allocation funds which exhibited among the smallest gaps compared to other asset classes. Investors in these products are less prone to bad timing. In contrast, if we look at the higher-risk products like single country or sector equity funds or even Asian high yield funds in recent years, they saw larger gaps in general.
Let me give you an example. A striking example is an Asia Pacific technology equity fund that recorded an annualized return of 3% over the past five years. But investor return was around negative 15% per year, which means the return gap was a whopping 17% per year. What happened was that the fund had an 80% return in 2020, which fueled substantial inflows between late 2020 and early 2021, meaning that on average an investor would likely miss out on the prior rally and then suffer a painful drawdown of over 50% at peak.
Secondly, investors have also struggled to navigate asset classes with large and sharp drawdowns. For example, the Asian high yield funds that I mentioned have generally suffered massively on the back of the China property sector downfall in the last two years. We saw that an Asian high yield ETF listed in Singapore showed a negative return gap of 12% per year due to substantial inflows into the fund following its peak in May 2021, which increased its assets by five times, only to see the returns plummet after that.
Lin: Bryan, thank you so much for your insights. For Morningstar, I'm Kate Lin.
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