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Morningstar’s Annual “Mind the Gap” Study Shows Better Timing and Market Conditions Led to Solid Investor Returns

At its 30th annual investment conference in Chicago, Morningstar, Inc. (NASDAQ: MORN), a leading provider of independent investment research, today published its annual study of investor returns, “Mind the Gap,” which measures the performance of the average dollar invested in a fund and estimates the impact investor behavior had on investment outcomes. Overall, the study shows that the gap between U.S. open-end funds’ reported total returns and the returns experienced by investors narrowed to 0.26 percent per year over the decade ended March 31, 2018.

The “Mind the Gap” study leverages the proprietary Morningstar® Investor Returns™ data point, which estimates a fund’s dollar-weighted return by incorporating the effect of cash inflows and outflows from investors’ purchases and sales, as well as the change in a fund’s assets.

The “gap” refers to the difference between funds’ dollar-weighted and time-weighted returns, reflecting how opportunely investors timed their investments.

“Investors tend to buy high or sell low when markets are volatile, potentially missing out on a fund’s gain. However, with the last bear market far in the rear-view mirror, investors’ steady investment contributions over the last 10 years appear to have paid off,” said Russel Kinnel, chair of Morningstar’s North America ratings committee and editor of Morningstar® FundInvestorSM. “Similar to last year’s Mind the Gap study, we found that investors have largely succeeded in using balanced funds, such as target-date funds, where the behavior gap was narrow. On the flipside, investors fared poorly with alternative funds, which had the worst dollar-weighted returns, reflecting the funds’ generally lousy performance.”

Key highlights of the study include:

The average dollar invested in open-end funds gained 5.5 percent per year over the 10 years ended March 31, 2018, while the average fund returned 5.9 percent. This is the narrowest gap recorded since the first issue of this study in 2005.

In comparing the 5.5 percent per year dollar-weighted return against the 6.9 percent annualized asset-weighted average return of all funds, the gap grows to 1.4 percent per year for all funds over the 10 years ended March 31, 2018.

The gap narrowed for the typical investor in diversified domestic-equity funds; they earned an 8.3 percent dollar-weighted annualized return for the 10 years ended March 31, 2018. Compared with the average fund’s 8.9 percent annual reported return, the 0.61 percent per year shortfall is a modest improvement over the previous report, which ran through December 2016.

Balanced funds—which include allocation funds, target-date funds, and traditional balanced funds—saw a positive gap of 0.30 percentage points annually for the decade ended March 31, 2018, with the average dollar gaining 5.9 percent per year. This improvement reflects the continued strength of target-date funds, both in terms of investor behavior and strong gains among well-diversified funds.

While the gap for municipal-bond funds shrank to 1.3 percentage points per year, it still represents more than a third of the returns the average fund earned over this span, reflecting the impact of media headlines such as the Puerto Rico debt crisis.

The gap widened in some asset classes, including international equity and taxable bond. Regional funds dedicated to European and Asian stocks saw wide behavior gaps, as did funds in the Foreign Large Growth category, suggesting investors struggled to use these investments successfully.

Alternatives funds had the worst dollar-weighted returns, a dismal nine basis points annually over 10 years. Remarkably, this was still nearly 140 positive basis points per year better than the average alternative fund’s 1.3 percent reported annual loss.

The five-year investor return gaps are generally much narrower than the 10-year numbers. In fact, the average dollar invested in U.S. open-end funds returned 7.0 percent per year, outgaining the average fund which earned 6.6 percent annually.

It’s important to note that estimates of the behavior gap can be sensitive to the inputs. For instance, if comparing funds’ aggregate dollar-weighted returns to their asset-weighted—instead of equal-weighted—average total returns, the calculation can yield a materially different estimate of the behavior gap. Given this, the behavior gap should be viewed as a range of potential shortfall or surplus investors experienced with their fund investments in aggregate over a given time period.

The “Mind the Gap” study is available here and an article summarizing the findings is available on Morningstar.com® here. The U.S. investor returns study is available in the June 2018 issue of Morningstar FundInvestor.

Morningstar has approximately 120 manager research analysts worldwide who cover approximately 4,500 funds. The company provides data on approximately 233,200 open-end mutual funds, 11,100 closed-end funds, and 15,000 exchange-traded product listings as of March 31, 2018.

About Morningstar, Inc.

Morningstar, Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. The company offers an extensive line of products and services for individual investors, financial advisors, asset managers, retirement plan providers and sponsors, and institutional investors in the private capital markets. Morningstar provides data and research insights on a wide range of investment offerings, including managed investment products, publicly listed companies, private capital markets, and real-time global market data. Morningstar also offers investment management services through its investment advisory subsidiaries, with more than $201 billion in assets under advisement and management as of March 31, 2018. The company has operations in 27 countries.