'Herd' mentality and poor timing leading to underperformance across active funds

Passive funds delivering better results

clock • 3 min read

Investors in virtually all types of active funds are losing out on returns due to a 'short-sighted' investment mentality that is leading them to buy at the top of the market and sell at the bottom.

Volatile funds

The Morningstar report found the difference between the reported total return and actual money-weighted return received by investors on all types of funds over a five-year period to the end of July 2016 was -0.34%.

Riskier categories, such as sector equity and concentrated emerging market funds, had the widest negative return gaps, -1.05% and -1.38%, respectively (see graph, below). 

Conversely, index funds were a striking outlier, with investors in equity index funds gaining a return on average 0.26% higher than the stated total return of the fund over the period.

Majority of active US, EM and global funds underperform index - S&P research

Ben Seager-Scott, director of investment strategy and research at Tilney Bestinvest, pointed to contrarian investing and the rise of smart-beta strategies as a tactic to avoid being hurt by herding behaviour.

"Herding mentality is powerful, for millions of years we have had the idea of safety in numbers. Unfortunately it does not lend itself very well in investments, hence the importance of contrarian investing and discipline in investing," he said.

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