An article in The Wall Street Journal claims that many investors earn lower returns than their investments do. This is caused by buying and selling mutual fund shares at a wrong time. The author cites an example of the PIMCO Total Return Fund:
In the year ended Sept. 30, its largest share class lost 0.74% — a respectable result, considering that the bond benchmark the fund seeks to beat, the Barclays U.S. Aggregate index, lost 1.89%.
According to people familiar with the fund, its investors incurred an average loss of 1.4% over this period, nearly double the loss of the fund itself. That is because investors bought high and sold low, locking in the fund’s interim losses and missing its later gains.
First, the largest share class of the fund, returning -0.74% in one year to September 30, is institutional (PTTRX). This share class requires a minimum initial investment of $1 million, which is impractical for most individual investors. Therefore, for further analysis this post will use the class A shares (PTTAX) with a minimum initial investment of $1,000.
Second, the problem with this assessment is that it is solely based on the general cash inflows and outflows of the fund, and not the analysis of circumstances of individual investors. This subject was already covered in a previous Alpholio™ post, which found a problem with
…a notion that there exists an “average investor” whose investments into and withdrawals from the fund precisely mimicked the inflows and outflows generated by all of the fund’s investors in both time and relative scale (for one, there is no proof that these same investors who cashed out later reinvested into the fund).
To illustrate that point, let’s analyze a situation of a hypothetical market timing investor who invested into PTTAX on September 28, 2012 (the last trading day of that month) and did not pay the front load of the fund. In May 2013, the investor was observing rising interest rates, which caused the NAV of the fund to fall, and decided to terminate the investment on May 31, 2013, i.e. in the middle of the May/June massive withdrawal period quoted by the article. According to Morningstar’s “growth of $10,000” figures, which assume reinvestment of all fund distributions, the investor realized a return of +0.502% in that period. Had the investor instead retained the investment in the fund until September 30, 2013, the total return would have been -1.128%. This clearly shows why doing an “average investor” return calculation solely based on fund inflows and outflows is misleading.
Furthermore, the above scenario does not take into account what the investor did with the proceeds from the May 31 sale. If the investor kept the proceeds in a money market fund with a typical annual yield of a few basis points, then the return through September 30 would be only slightly higher than the +0.502% calculated above. However, the investor certainly had many other investment possibilities, both in fixed income and in equities.
For example, let’s assume that in the face of rising rates (the duration of PTTAX is approx. five years) the fixed-income investor decided to invest the proceeds in a short-term taxable bond fund, such as the PIMCO Short-Term Fund (PSHAX, class A shares), again without paying a front load. From June 3, 2013 to September 30, 2013, the total return of PSHAX was -0.057%. Therefore, this hypothetical market-timing investor would have realized a total return of (1 + 0.502%) x (1 – 0.057%) – 1 = +0.445%, still better than the -1.128% for PTTAX alone. This again illustrates that estimating fund investors’ returns without taking into account follow-up investments (into which an analyst may not have visibility) is misguided.
In sum, while a buy-and-hold strategy can certainly produce good long-term results for most investors, in a case of prolonged rock-bottom interest rates, some market timing may be warranted.