|Anup who is the Chief Investment Officer at IIFL AMC recently shared an anecdote from his time at DSP Mutual Funds. When DSP mutual fund completed 20 years of the DSP Equity fund they wanted to send a thank-you note to all the investors who had been with them on the journey. The fund at that time had handily beaten the index over the 20-year time horizon. When they ran the numbers they found only a handful (less than 20 is what Anup tells me) investors stuck with the fund for 20 years. Most investors never got the benefit of the fund outperformance.
Long term readers of our newsletter will recognize this as the behaviour gap – something we have written extensively on. The behaviour gap is the difference between “the rate of return an investment would earn in a fixed period, and the return an investor, in reality, earns from that very investment.” This is caused by the inability of the investor to time the market. Simply put, investors buy after good returns and sell after bad returns.
Research has repeatedly shown that behaviour gap is higher for high volatility investments. Big rallies and falls, which are common in individual stocks, re-enforce the profit-taking and get out before the stock goes to zero feelings. Investors hold higher volatility investments for lower durations than low volatility investments. Combine this with high bid-offer spreads in stocks and also short term and long term capital gains taxes due to churning and it becomes really hard for stock investors to actually have better outcomes than a humble index fund.