One of the major reasons that retail investor portfolios under-perform the market is because they too often chase performance.  Whether it’s real estate, stocks, mutual funds or exchange traded funds (ETFs), retail investors just can’t help themselves when it comes to purchasing securities that have had a significant run-up in value.  And it’s not so hard to understand why.  Many investors fall victim to the cable business news channel talking heads, who continually pump up the high-flying performers each day.  Or maybe their brother-in-law talks them into buying the one stock that he just doubled his money in.  No matter how they get there, retail investors have a persistently bad habit of buying high and selling low.

In a recent report by an analyst and portfolio manager at the Leuthold Group, their research again proved that chasing returns can be bad for your portfolio.  They looked at the fund flow data (investments into) from April 2006 to April 2018 for all ETFs to assess the performance relationship.  They grouped the ETFs into five quintiles using one, two and three month fund flows.  Some interesting takeaways from the analysis:

  • The forward one-month return for equity ETFs with the largest one-month inflows under-performed ETFs in the other four quintiles by .01%.  This pattern persisted in tests based on two-month and three-month fund flows as well.
  • Over six, nine and twelve month periods, the results were the same. Over the course of the twelve year time period, investors who placed funds into ETFs with the highest inflows saw an 8% loss.
  • Meanwhile, en equal-weighted portfolio using the ETFs from the other four quintiles returned 72% during the same time period.
  • Interestingly, the ETF equity pattern did not replicate itself when looking at fixed income ETFs

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As with all securities, their is ultimately a reversion to the mean.  In other words, what goes up has to come back down.  Rapid money flows into ETFs bids up the prices of the underlying stocks and eventually the high valuations/expectations in the stocks trend back downward as companies cannot sustain their expected growth in sales and profits.  At Avista, we avoid chasing the latest market trends and look to rebalance portfolios when asset allocations stray too far from their portfolio weightings. Having a plan, and sticking to it, is the best way to manage risk and return and to ensure that investors achieve their long-term financial goals.