Fund managers across the world speak a similar language while addressing investors who look to allocate money across equities. It is common parlance to speak about equity investing with a 5-year horizon in mind. However, looking at data across investments in funds over the last 40 years shows that an average investor holding in mutual funds is currently at 2.2 years.
The same number was at an average of 3.3 years, 10 years back. Fidelity Investments conducted a study on their Magellan fund from 1977-1990, during Peter Lynch's tenure. His average annual return during this period was 29 percent. This is a remarkable return over the 13-year period. He was easily one of the best-performing fund managers for his asset class. It should be noted that this was not a secret. Fidelity's Magellan fund became one of the largest mutual funds due to its success under Peter Lynch. Given all that, you would expect that the investors in his fund made substantial returns over that period. However, what Fidelity Investments found in their study was shocking. The average investor in the fund actually lost money – again has to do with how long the investors held the fund, and when they entered the fund.
A look at an alternate asset class in investors' portfolios, real estate, and land combined paints a very different picture. The average holding period for the asset class for investors in the residential asset class has been 9.5 years in India and 8.6 years globally. This is in sharp contrast to the holding period of equities. The two reasons one can attribute to this relate to the high transaction costs and the relatively low liquidity of the asset class in comparison to equities.
Every fund manager wants their investors to stay with their fund and increase their duration for which they can manage their client's money. However, it is important for the fund manager to realize that the odds of doing the same are against them. There are some learnings from the real estate holdings of investors that one can apply to equities to increase the same odds, and in turn, ensuring investors stay invested for a longer cycle within the fund.
One of the important aspects of equity investors that real estate investors would not have to see is news-based volatility that immediately translates into price moves. These for the most part are unnerving for investors which tends to make them pull out money during periods of volatility – though they often tend to be periods of opportunity (with the benefit of hindsight).
It is important that fund managers consider it imperative to educate their investors and clients on the investments they hold alongside the rationale. The human mind derives comfort out of the known and panics out of the unknown. While real estate prices may fall too, we derive comfort with the location at which we own the asset. However, in many cases, the same comfort does not come from the fund, as that has predominantly been the area of the unknown for investors.
The second aspect that fund managers would be better doing is to manage the downside risk for investors. While the pressure to be the best performing fund each year exists for all funds, it is imperative for the fund to be the most consistent (rather than the best performing) - consistency is measured from how often the fund is among the top 10% of the funds each year. This puts a bigger onus on risk management rather than looking at absolute performance each year.
While it is easy to blame investors and say that they do not look at the asset class from a long-term perspective, it is imperative that the industry looks inward and takes steps as an endeavor to consciously increase the holding period of investors – this will provide a large win-win situation for the industry and tremendous tailwinds to equity investing as an asset class in our country.