How investor biases can have huge impact on returns


Investing 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 are influenced by market cycles and short-term market developments when making investment decisions. Aside from market timing, investors also exhibit a cycle of performance hunting – ie switching between funds based on short-term performance. This behavior is value-destroying and often leads to suboptimal returns over the entire investment period.

From an investor’s perspective, it’s important to assess the long-term market prospects and fund manager’s ideology before investing, and then stick with it over the long term to get the most value from their mutual fund investments.

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To quantify the impact of Indian investors’ frequent exit decisions on their long-term returns, we analyzed investor behavior across mutual fund assets for equity and hybrid funds over the past 20 years (2003-2022) and bond funds over the past 14 years (2009-2022 ). In addition to calculating point-to-point investor and fund returns, we also looked at the returns generated by systematic investments (e.g. SIPs). The chart summarizes the results for equity, hybrid and debt funds.

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The data shows that investor returns have lagged fund returns significantly across all asset classes. Economic and market-specific cycles determine how well a fund house or fund manager navigates through a cycle. Funds with a defined strategy, style and philosophy have outperformed over the long term.

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However, investors’ emotions have derailed their journey, particularly in today’s environment of “information overload”. A simple example of this is the way gross flows into equity funds behave relative to stock market cycles. We have seen time and time again the pro-cyclical nature of these flows – investors trim their investments when markets correct and add to them when markets are on the up. The “buy high/sell low” strategy is wealth-destroying, but for most of us it becomes difficult to keep the passions or emotions away. The result is that gap between fund returns and investor returns.

Systematic investment plans (SIPs) can help bridge this gap. SIPs help mitigate the problem of market timing through regular, even allocations over time, and are well-suited to investors with regular cash flows. Since the actual investment decision is made automatically, the role of emotions in particular is muted.

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What investors should do:

– Start early and invest regularly.

– Set up systematic investment strategies that are largely automated to overcome emotions.

-Invest in long-term funds/strategies. Avoid risky short-term market fads and chasing performance.

What investors should not do:

-Overreaction to market sentiment. Avoid greed and fear.

-Avoid chasing short-term performance for long-term gains.

– Avoid spontaneous investment decisions. Follow a well thought out investment plan that takes long-term life goals into account

Ashwin Patni is Head Products and Alternatives at Axis AMC

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