Don’t chase the value trend

Trend-chasing value investors are setting themselves up for losses. John Stepek explains why.


It's best to pick the unloved
(Image credit: DanBrandenburg)

You probably already know that many actively managed funds consistently underperform the market. However, one group underperforms even these funds the private investors who put their money in them. The annual Quantitative Analysis of Investor Behaviour (QAIB) report, issued by US financial services research group DALBAR, looks at the actual returns investors make, compared with the returns reported by the funds they invest in.

QAIB finds that investors underperform by as much as 6% a year. Others dispute the specifics of DALBAR's methodology but they still find private investors underperform on average. This also holds true across investment styles. Jason Hsu of Research Affiliates, an investment firm, found that between 1991 and 2013 investors in US value funds (which managed to beat the market as a group) earned an average of 1.31% less per year than the funds themselves. Even after controlling for fund fees, investors fail to keep up.

So what's going wrong? Value investors are supposed to "buy low, sell high". But Hsu's research on fund flows shows there are more "trend-chasing" value investors than buy-and-hold ones. In other words, they trade in and out of the funds in an effort to time the market. Trouble is, they're bad at it. Rather than "buying low" (after value funds have hit a dull period), they buy when the funds are outperforming, and sell when they hit rock-bottom. By buying high and selling low, they "routinely wipe out all, or more than all, of the outperformance produced by value-oriented managers".

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Growth investors did even worse, underperforming growth funds by 3.16%. Also, investors who hold the most costly funds (who, Hsu argues, are probably less sophisticated than their more cost-conscious peers) made even worse timing decisions, underperforming by 4% a year. So smarter investors do better than naive ones. But both do worse than simple buy and hold.

What can you learn from this? Firstly, if you really want to time the market, you mustn't chase performance. If you buy a hot sector, you are by definition "buying high". It might go yet higher, but why risk it? Instead, look for unloved areas. One good rule of thumb is that a good investment rarely feels comfortable.

If you'd rather (sensibly) avoid market-timing, an alternative is to come up with your asset allocation (how you split your wealth between UK stocks, Japanese ones, bonds, etc). Then, as your portfolio deviates from its original allocation, "rebalance" by taking profits on sectors that have risen and buy more of those that have fallen back. It might seem like less fun, but the odds are that it will make you more money in the long run.

John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.