A paper published in the U.S. in December compares U.S. equity mutual funds’ published performance from 1991 through 2004 with estimates of what investors in those same funds actually earned over the same time period. The paper, Investor Timing and Fund Distribution Channels, by Mercer Bullard, Geoffrey Friesen and Travis Sapp, highlights the “timing performance gap,” defined by the authors as the difference between published fund returns and their estimate of investor returns.

This gap is generally influenced by the timing and size of investments and withdrawals made by investors between measurement dates. The formula used for published returns generally neutralizes the effects of investor flows.

Surprisingly, one of the findings is that load fund investors (who tend to work with advisors) experience a larger timing performance gap than their no-load counterparts (typically, do-it-yourselfers). This is counterintuitive, as I would have expected investors guided by advisors to have smaller timing errors.

The study, however, has some limitations. For instance, only U.S. equity funds are studied, which effectively excludes half of all U.S.-sold funds. Also, the percentage of no-load investors advised by fee-only advisors is unknown.

Although I’m not convinced that this study is directly applicable to Canada, it serves as a reminder of three important lessons in minimizing the timing error.

First, I expect timing performance gaps to be smaller when a portfolio is guided by a written investment policy statement. A well-constructed IPS puts objectives and constraints on paper and contains justifications for the overall strategy and chosen investments. Wild market swings will inevitably nudge clients to want to try something different. A written IPS will serve as a reminder of why the portfolio looks the way it does and should challenge any desire to make significant changes.

Second, treat your investments like a bar of soap; the more you touch them, the smaller they get. This saying is so true. In practice, I’ve rarely found any need to make many changes more often than every two years. Advisors who can’t resist the itch to rejig client portfolios should at least keep a running score of how their “new” advice fares against the “old,” unchanged portfolio in subsequent years. If the changes detract from performance more often than not, this should be kept in mind the next time the itch to switch returns.

Finally, advisors must stand firm against a phenomenon the authors acknowledge may have affected their results: clients demanding certain investments against their advisors’ counsel. Anecdotally, I know many such clients. I suspect they don’t really want advice, but rather an advisor’s validation of their desired strategy.

This was all too common in 1999, when technology stocks were booming. I personally consulted with dozens of advisors faced with the seemingly no-win situation of either investing the bulk of some clients’ money in technology or losing those clients.

There is a simple solution, albeit not an easy one: advisors should first explain why they strongly feel the client’s desire is so unsuitable, assuming that’s the case.

If this has no impact, the client should be offered a referral so that he or she can implement his or her desired course of action elsewhere.

Not everyone will agree with this advice, but it’s better than being party to unsuitable trades, which are the riskiest type of business to accept. Following these tips also gives your clients a better chance of realizing better returns. When that happens, everyone wins. IE



Dan Hallett, CFA, CFP, is president of Dan Hallett & Associates Inc. of Windsor, Ont., which recommends mutual funds and provides investment research to advisors.