Mutual fund investors sell low again as markets crash

It’s another sad twist on the “buy low, sell high” investment credo: stock markets fall into a correction (or worse) and nervous investors hit the sell button.

Canadian investors withdrew nearly $5 billion from mutual funds last month, according to the latest tally from the Investment Funds Institute of Canada (IFIC). It was the first time in a year and a half that IFIC reported net redemptions of mutual funds, as worries about inflation and rising interest rates devalued major stock markets. The S&P 500, for example, is down almost 15% since the start of the year.

This is a sharp reversal of a pandemic buying spree that began as markets surged from late March 2020, after a similar correction that also resulted in net mutual fund redemptions. As markets gained momentum in 2021, IFIC reported an increase of $111.5 billion in mutual fund sales; nearly four times the $29 billion in 2020, which matches average annual sales dating back to 2000.

It’s hard enough to make money with mutual funds without falling into the emotional trap of buying high and selling low. Most Canadians invest in mutual funds for their retirement savings because they are the only investment products that offer professional management and diversification for medium-sized portfolios.

Annual fees often exceed 2% of the total amount invested, even when a mutual fund loses money. This means that the mutual fund holder loses 12% when the investments in the mutual fund lose 10% in one year; further compounding the loss.

Part of this fee is used to pay the management team who selects the investments that go into the fund and the advisor who sells the fund to the investor. Not all mutual funds are purchased through an advisor, but the role of professional management should be risk management to limit losses, and a basic explanation of how the investment works and why it’s a bad idea to sell when the markets are down.

When you remove fees, mutual fund performance tends to work in tandem with the benchmarks they track. In other words, a Canadian equity mutual fund will show gains or losses similar to those of the S&P/TSX Composite Index. Technology mutual funds, for example, often track the S&P 500 technology index.

The close correlation between mutual funds and the indices they track generally means that mutual funds will rally when broader markets rally. It is difficult to determine how close the correlation is or what risk management measures are in place because mutual funds are not required to disclose much about the fund.

Most funds list a few top holdings; but the companies providing it are only required to update the information periodically. Considering that most mutual funds lag their benchmarks by about the same amount as average fees, one can assume that many fund managers are content to replicate their holdings.

According to IFIC, the largest mutual fund net redemptions in April were in balanced funds ($2.05 billion). Balanced funds tend to be the most popular among novice investors because they mimic a balanced portfolio of stocks and bonds.

Lower interest rates and the resulting lower bond yields have weighed on balanced fund performance – but that could change as interest rates rise and fixed income performs better. payments.

By that same logic, better days should also be ahead for bond funds, which, curiously, had net redemptions of $1.75 billion in April. Many bond funds lost value during the nearly three decades of low interest rates as portfolio managers tried to navigate their way to higher yields in the bond market.

And so, it’s likely that investors who sold their bond funds in April were selling low.

Dolores W. Simon