The Dilemma of the Do-Nothing Mutual Fund Investor
It's well-known that investors don't stand still during a financial crisis. In the wake of the 2008 credit crisis, there was no shortage of stories about lost fortunes, both large and small, and how fear was so pervasive that many investors wanted nothing more than to get out of the market as soon as they could.
For many, that meant locking in losses, selling at or near the bottom of the market, figuring that they were saving themselves further pain. It also meant that they wouldn't get back into the market until they had a better sense of upward momentum.
According to Lipper's flows data, mutual fund investors pulled some $430 billion from their equity funds over the five years from 2008 through 2012, and equity fund assets didn't recover to their pre-crisis level until this year (they stand at $5.6 trillion).
At first glance, $430 billion from $5.6 trillion in equity mutual funds doesn't seem devastating—it's about 7.6 percent—but we wondered what kind of effect all that buying and selling had on investors' aggregate wealth and could they have done better doing nothing at all?
To find out, we calculated the weekly performance of equity and fixed-income mutual funds and compounded the assets of each group at the end of 2007. At that time, equity mutual funds had assets of about $5.5 trillion, and bond funds held about $1.7 trillion (funds of funds and money market funds were not included).
Don't Just Do Something ... Stand There!
If we removed the effects that inflows and outflows had on the weekly assets of those funds (in other words, assumed that investors made zero new allocations to their accounts) the combined balances dropped to over $4.6 trillion in the last week of January 2009.
That was not the lowest equity markets would go, but by then our hypothetical estimates of no-flows investors were ahead of their actual assets—how investor assets were actually split between equity and bond funds at the time—by more than $143 billion.
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It sure looked like doing nothing would make a better strategy than relocating between equity and bond funds during a crisis, but the drop in equity markets didn't go on forever. In fact, the rest of 2009 was quite good, and the balance of the do-nothing strategy began to fall behind.
Despite a strong market for bonds over all periods, solid single-digit annual growth couldn't compete with the returns generated by equities in 2009. In the end, our do-nothing model reached total assets of $8 trillion, a 10 percent increase from its starting point at the end of 2007 but well behind the actual balance of $9.1 trillion reflecting the true flow in equity and bond funds at the end of April 2013.
While pulling $430 billion from equity funds, mutual fund investors also added over $1.1 trillion to taxable bond funds. The trend of favoring bond funds continues. So we had to ask another question: What if they had swapped their flows activities?
Instead of net withdrawals from equity funds, they received the inflows otherwise given to bond funds. This would seem to fit well with the advice of financial advisors that good decisions should feel uncomfortable and that doing things "unconventionally" holds greater promise for success.
Oh, the Irony
We applied the flows that bond funds received to equity funds and gave bond funds the flows that equities received. The first thing we noticed is that there were periods when investors didn't like either asset class, for example, fourth-quarter 2008 and fall 2011, the height of the Greek debt crisis.
In all cases, the swapped flows received the weekly performance that the actual asset class received, and our reinvested returns were done over the same periods. The results were ironic.
In only an 18-week stretch of the past five years would investors have been better off with the opposite behavior. It seems counterintuitive, given the huge inflows advantage that bond funds have had over equity funds and the better performance they've had too: a 21.1 percent total return versus just 10.3 percent for equity funds. But where you end up has everything to do with where you start.
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With a starting point over three times the size of bond funds, equity funds have had the most to gain (and lose) since the financial crisis. Even swapping flows between bond and equity funds created only a fleeting advantage for investors: The smaller returns enjoyed by equities amounted to faster growth in assets because investors continued to keep more money in stock funds than in bond funds overall.
When all the data were totaled, investors would have been down by $170 billion versus their actual, current wealth. In other words, despite all the admonitions against conventional behavior, given the huge asset differential in favor of equities there simply weren't enough flows to make up the difference even if investors had the foresight to buy equities on the cheap.
In the end, two themes emerged. First, investors' recent attention on bond funds hasn't hurt their total wealth; and second, the performance of the equity and bond markets has had a far bigger effect on investors' wealth than their decisions about where to put money—if they made that decision at all.
One more point: Investors' decisions regarding flows and performance weren't always intuitive. We observed many weeks where great performance saw substantial outflows as well as poor weeks with sizable inflows—and everything in between.
Jeff Tjornehoj manages Lipper's research efforts in the U.S. and Canada. He is a regular contributor to Lipper's Fund Flows and Closed-End Funds reports and writes and presents Lipper's quarterly performance review, with an emphasis on fixed income markets.