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Last April, macro god Stanley Druckenmiller said that his only conviction trade was to short the dollar. Since then the DXY dollar index has climbed over 2 per cent. Whoops!
It’s a good example of how hard timing can be in markets. Even some of the most celebrated money managers often struggle with this, and for the great unwashed (including FTAV Towers) it’s silly to even try.
Earlier this month, Morningstar hammered that point home with a report exploring the gap between the average returns investors actually experience and the total returns of investment funds. The reality is that the active-passive investment argument is almost a sideshow compared to the cost of investors going in and out of funds at the wrong time.
Here’s Morningstar’s Jeffrey Ptak on the report’s findings:
In this year’s study, we found the average dollar invested in funds earned a 6% annual return over the 10 years ended Dec. 31, 2022, while the average fund gained about 7.7% per year over that same span, for a gap of about 1.7% annually. What this means is that investors missed out on about one fifth of their fund investments’ average net returns, a significant shortfall.
This held across the board of US investment funds. The 1.7 per cent per year annualised gap is about the same as in previous years that Morningstar has done this study, “suggesting that timing costs are a persistent drag on the returns investors earn”.
Looking at the details, it seems that investors do a bit better with allocation funds, which by their nature are broader, steadier and more designed to be held for very long periods.
Most interestingly (but unsurprisingly), the more volatile the fund, the more likely it is that investors will screw up and go in at the top and sell when it’s done badly.
That’s one of the biggest drawbacks of factor investing: an investment style — whether value, small-caps, quality etc — might in theory offer higher long term returns than plain beta, but in practice most investors should just stick to plain-vanilla funds. The frequency and size of the inevitable drawdowns means that too many exit at the wrong time.
Of course, sometimes even nailing the timing doesn’t secure you a win.
A year ago Third Point’s Daniel Loeb basically nailed the bottom of the 2022 bear market, arguing in a letter to investors that people were overly bleak on the economy. Unfortunately, as the hedge fund manager said in his latest missive, that didn’t help much.
Last October, we correctly observed that markets bottom when economic data looks most bleak, and pessimism is high. At that time, inflation still seemed to be accelerating, rates were rising, and the consensus belief was that only a powerful medicine of Fed hikes and a severe recession could break the “fever” of relentless inflation. Instead, we saw the first signs of disinflationary green shoots in easing apartment rental data and concluded that the economy was headed in the right direction. Unfortunately, rather than expressing this constructive view by investing heavily in high-quality tech companies with earnings growth (an obvious choice in hindsight), we primarily committed capital to value situations which have since underperformed.
Thankfully we only have to write about this stuff, rather than actually run money.
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