There is some confusion around why the total investor return data published by Morningstar differs from the returns that investors are actually earning. Russ Kinnel, director of manager research for Morningstar, unravels the discrepancy.

Investors’ actual returns, explains Kinnel, are the dollar-weighted returns that reveal how well investors used the fund and how well they timed their transactions. If, for example, investors buy into a fund because it’s showing great returns, this flood of dollars would result in actual investor returns falling below the fund’s published total returns. Since markets are cyclical, factors that once worked well (and bolstered returns) may have fallen out of favor. This can lead to what Kinnel calls an “unhealthy cycle” for folks who chase performance.

According to Kinnel, investor patterns tend to go south at “pivot points”. He explains that “after a bear market, maybe we sell, and of course that was the best buying opportunity. Or after a rally we buy, when maybe that was the best selling opportunity.” It’s this type of poorly timed behavior that can increase the spread between published and actual investor returns.

The issue of how and when a fund becomes “closed” can also insulate investors from their own “worst instincts.” Kinnel says that, ostensibly, managers are closing funds because they don’t want returns to be diluted by a further inflow of dollars. It might happen after the fund has had a good run and wants to prevent “hot” money from coming in. It also helps returns because, when the fund “cools off”, the same hot money doesn’t then rush out (since investors know they can’t get back in). This relieves pressure on the manager to sell stocks.

Actual investor returns, therefore, illustrate how investor behavior influences returns, and how the timing of dollar inflows and outflows can create differences compared to a fund’s published total returns.