INVESTING
number of stocks held in their portfolios .
• Funds with a focus on institutional clients are less likely to swing for the fences than retail client funds . This is consistent with previous research finding that investors in funds sold directly are more sophisticated than those in brokersold funds .
• Retail funds ’ tendency to swing for the fences is consistent with the well-documented fact that retail investors are attracted to stocks with extreme returns .
• Younger funds and early-career managers are more likely to “ swing-forthe-fences ”— which agrees with the hypothesis that such investors have stronger incentives to try standing out among competitors .
• As funds grow older , the likelihood of striking out decreases , suggesting that the funds get better at picking potential home runs and that the experience
Investor Takeaways
These findings are consistent with previous research showing that retail investors are attracted to funds with high idiosyncratic volatility , even though chasing it doesn ’ t result in superior performance . Chalmers and Dayani came to similar conclusions .
An interesting question is : Why do fund managers continue to pursue strategies that fail to deliver greater risk-adjusted returns ? The answer : because strategies like swinging for the fences attract higher flows in the future and their managers can charge higher fees . A one-standard deviation increase in swinging for the fences was associated with a 30-basis-point increase in fund flows and a 5.16-basis-point increase in fund fees .
Chalmers and Dayani found that retail investors ’ movement of money into mutual funds was determined by a few factors : for instance , changes in Morningstar
Retail funds ’ tendency to swing for the fences is consistent with the well-documented fact that retail investors are attracted to stocks with extreme returns .
of the manager is important to a fund ’ s performance .
• Funds that are managed by a team of managers are less likely to swing for the fences than solo-managed funds .
• Both strategies suffered from “ diseconomies of scale ”— their costs increase the bigger they become .
• Among growing funds , fund managers invested in less attractive , and perhaps riskier , opportunities to hit a home run . As a result , larger funds struck out more often than smaller funds .
• The swing-for-the-fences group saw higher fund volatility , with returns deviating 3.72 % from average returns , while the batting average category deviated 2.41 %, a difference that is statistically significant .
• These conclusions didn ’ t change with the industry concentration or depending on how many of the funds were actively managed . rankings ( or the rankings of other research firms ), as well as the funds ’ appearance in the media and any record of past home runs and strikeouts . Retail investors were less drawn to funds by sophisticated factors such as risk-adjusted returns .
The authors suggest that these strategies target unsophisticated retail investors who are less sensitive to performance metrics and more responsive to advertisements of past success . Their takeaway is that investors should avoid certain behavioral preferences when choosing stocks and funds . Such choices might be akin to choosing lottery tickets ( when the average return is poor but there is a fat right tail ). Another approach is to simply avoid active strategies altogether .
LARRY SWEDROE is the author or co-author of 18 books on investing , including his latest , Enrich Your Future : The Keys to Successful Investing .
42 | FINANCIAL ADVISOR MAGAZINE | DECEMBER 2024 WWW . FA-MAG . COM