“If materials are not clear about what a fund does
and the risks it takes, investors may well end up
having a poor experience with the product”
obviously, but it should also matter to the their investor returns, both in an absolute sense, and as a
advisers and fund houses: if clients continually percentage of stated returns. Th e 20 Morningstar US fund
use a fi rm’s products improperly, it is essential categories with the largest negative gaps over the 10 years to
to the company’s reputation and, in the September 30, 2008 exhibit an average annualised standard
long-term, its survival, to take steps to correct deviation over the period of 19.54%. Particularly poor
the situation. performers with respect to investor returns included: specialty
technology funds, global real-estate funds, foreign small/mid-cap
INVESTOR RETURNS V TOTAL RETURNS growth funds, Latin America stock funds, and Pacifi c/Asia
To measure how investors actually use funds, we ex-Japan stock funds. In contrast, the 20 Morningstar categories
calculate what we call ‘investor returns’. While with the most favourable gaps (those categories with the largest
returns as normally stated are ‘time-weighted’, positive gaps or the smallest negative gaps) have an average
investor returns are weighted by assets. More annualised standard deviation of 8.97%. Although they contain
specifi cally, Morningstar Investor Return™ some surprises, such as specialty fi nancials and communications
accounts for the impact of cash fl ows into and funds, these 20 categories are mostly bond-oriented.
out of the fund to measure how the average To look at it another way, let us consider the most volatile 20
investor performed over the time period categories versus the least volatile 20 categories. Here again, the
evaluated. Investor returns are calculated using trend is clear: the least volatile show an average negative gap of
an iterative process akin to an IRR calculation 0.32%. Th e most volatile categories have a much higher average
and measure the compound growth rate in the
value of all money invested in the fund over the
evaluation period. A fund’s investor return is
STATS.
therefore the growth rate that will link the total
net assets at the start of the evaluation period,
plus all intermediate cash fl ows, to the total net
FIGURE 1: INVESTORS USE HIGH RISK FUNDS POORLY
assets at the end.
10 year investor return 10 year total return IR-TR gap
To clarify the approach, assume a fund
8
returned 50% over a one-year period. It was
volatile, however, and achieved these results by 7
rising 100% in the fi rst half of the year, and
falling by 25% in the second half. If the fund had
6
a single investor who bought in at the start of the
5
year and held until the end of the period, it would %
have an investor return of 50%, the same as its
4
total return. If however, that investor bought in at
the very start of the next six months, the investor
3
return would be -50%. Timing does matter, albeit
not usually by this much over a short period.
2
1
CONCLUSION
Across many studies by Morningstar run in the 0
Low standard
US, we have drawn two clear conclusions. First,
High standard
deviation funds
deviation funds
riskier types of fund are typically harder for
investors to use well. Th us, funds focused on a
single economic sector or a high-risk cap-band,
Notes to chart: High and low standard defi ned as relative to a fund’s
category. Group results based on weighted average of the dollar-
investment style, or region tend to show larger weighted returns and total returns for each fund, using average
negative gaps between their total returns and
assets for the period as weights.
26 WINTER 2008/09
25-2725-27 fund performance.indd 26fund performance.indd 26 27/11/0827/11/08 15:52:5715:52:57
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