“Returns gap” the biggest failure in investment industry

investor returns gap investor research affiliates funds management alpha asset managers portfolios research house John West Jason Hsu Smart beta

24 October 2018
| By Nicholas Grove |
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The investor returns gap means that even for asset managers skilled enough to produce alpha, chances are their clients won’t be able to fully capture it in their own portfolios because of the clients’ investment timing decisions, according to Research Affiliates.

It is for this reason that the research house calls the investor returns gap “the biggest failure in the investment industry”.

In a new white paper, John West and Jason Hsu of Research Affiliates looked at how the gap between the returns realised by the investor and the returns earned by the strategy or fund the investor owns was overshadowed by the spotlight focused on alpha.

Smart beta was no exception, they said.

So, West and Hsu proposed two ways to reframe the client performance review that they believed would result in better long-term outcomes.

“The negative gap between investor returns and fund returns is the biggest failure in investment management. Alpha is only a sideshow,” they said.

“If we extrapolate the investor returns gap to smart beta strategies, poor client timing will completely negate the potential for positive excess returns.

“The client service model for smart beta strategies needs to be radically different from other types of strategies to produce better investor outcomes.”

West and Hu said investment professionals must also strive to help clients understand how to stay the course by understanding the styles in which they choose to invest.

“A new mindset is called on for both professionals in how they frame their advice and for clients as they learn to adjust their expectations and adopt longer horizons for assessing performance,” they said.

West and Hu said that sadly, many high-tracking-error smart beta strategies may actually exacerbate the investor returns gap, especially if “noisy” short-term performance is sold to trend-chasing clients.

“The investor returns gap of nearly 2 per cent will wipe out the majority of smart beta strategies’ long-term returns. But we’re optimistic. We believe this cycle can be broken. Robust, academic-quality research and efficiently designed products are important, but no longer enough,” they said.

“To avoid the biggest failure in investment management, we must embrace a new 

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