- What a Synthetic Annuity Is-and Is Not
- Background
- The Effects of Volatility on Investor Returns
- Revisiting Modern Portfolio Theory
- Moving Forward
- How Do SynAs Fit into the Picture?
- Reducing Risk, Seeking Returns, or Both?
This chapter is from the book
This chapter is from the book
This chapter is from the book
The Effects of Volatility on Investor Returns
The mutual fund research group at Morningstar measures the impact of volatility on investor returns. They compare the performance of various funds to the performance of investors in those funds. The difference captures the cost to investors of volatility-related market timing. Table 1.1 shows the average cost for midcap growth and midcap value sectors, the CGM Focus Fund (highly volatile), and the T. Rowe Price Equity Income Fund (highly stable).
Table 1.1. Cost of Volatility
|
Fund |
Reported Return |
Actual Return |
Cost to Investor |
|
Mid-Cap |
3.1% |
0.2% |
2.9% |
|
Mid-Cap Value |
6.4% |
2.3% |
4.1% |
|
T.Rowe Price Equity Income |
2.1% |
1.3% |
0.8% |
|
CGM Focus Fund |
17.8% |
–16.8% |
34.6% |
Annualized returns for the funds for the ten-year period ending July 2009 were compared to the actual returns of the average investor. Except for the Equity Income Fund, the average investor gave up most of the gains. In the case of the most volatile fund, the CGM Focus Fund, investors actually lost 16.8%, compared to a gain of 17.8% for the fund itself.5
The conclusion, consistent with behavioral finance, is that investors stay in less volatile funds, pocketing most of what the managers produce. The opposite is true for volatile funds: people jump into the funds during good times and bail out during bad times.
The same tendencies apply to investors managing individual securities and for anyone trying to impose risk controls such as drawdown limits on positions or portfolios. The more volatile the market, the more often defensive emotions and sell disciplines are triggered.
TrimTabs and others who keep track of money flows say that the real money is now going straight under the mattress. From January to November 2011, $889 billion went into savings and checking, with only $109 going into stock and bond funds. Many investors look at day-to-day volatility and decide they are just not interested.