Recent Performance Influences Fund Choices

A mutual fund’s recent returns and its relative performance significantly influence whether investors choose to buy or hold onto the fund. The magnitude of these returns and whether the fund is already owned also plays a role.

Researchers gave participants in a study a series of investment decisions to make using actual return data from a randomized sample of funds. For each fund, participants were provided with basic background data, including the previous year’s return. Participants could also purchase additional data to help them make a decision.

Among the data points purchased, the previous year’s market return and the two-year relative return for the fund being considered were acquired for approximately one-third of all fund choices. The Morningstar Rating for a fund was purchased by male participants 62% of the time and by female participants 39% of the time.

These indicators give background on a how a fund has historically performed, but not how it will perform in the future. The study’s authors noted that these indicators are mostly “negatively correlated with the five-year expense-adjusted returns.” Data on factors influencing future returns realized—including the expense ratio and the turnover ratio—were acquired at a far lower rate. Similarly, a fund’s standard deviation (a measure of how volatile a fund’s returns are) largely ranked near the bottom in terms of participants’ preferences.

The impact of past returns on decisions was non-linear. Participants bought a decreasing amount of data as a fund’s past returns were increasingly negative. They bought more information as a fund’s returns rose from 0% up to approximately 50%. After prior returns exceeded 50%, interest in seeing more information decreased.

When participants were given the option of selling a fund, the probability of them choosing to hold onto a fund with a 30% loss was 45% (meaning the majority were unwilling to take a loss). When given a chance to buy a fund with a similar loss, participants chose to act only 33% of the time. The probability of buying went up to 44% and 55% when the prior year’s return was 0% and 30%, respectively.

Source: “Gender Differences in Asset Information Acquisition,” Matthew Taylor and David Wozniak, Journal of Behavioral and Experimental Finance, 2018.