There can be large differences between the return that a fund generates (fund returns) and the return that investors in the fund actually receive (investor returns). These differences (the investor return gap) stem from the fact that fund returns are measured from the start of the investment period to the end, and assume no investor cashflows. In reality, investors contribute and withdraw from their investment over the investment period, or even switch between different funds, making their performance experience different from that of the fund in which they are invested.

By aggregating total cashflows in or out of a fund, we can approximate the average investor return and compare it to the fund return. The differences can be attributed to collective investor behaviour; the switching in and out of funds.

We analysed the 15 largest South African equity unit trust funds over the past 10 years and compared fund returns to investor returns.  Some interesting observations emerged and include the following:

• Overall, investors fared on average 1.7 percent per annum worse than the fund in which they were invested. This 1.7 percent per annum loss of potential return is significant — if compounded over 10 years, it means that investors "lost" nearly 20 percent of the compound return that a simple buy and hold strategy would have delivered.
  
  To put this in context, top quartile equity funds have only outperformed the average fund by 1.5 percent per annum over the past 10 years. This means that investor behaviour has been a more important determinant of investor returns than the skill of the fund manager they appointed.

• There exists a strong relationship between the investor return gap and the client-turnover rate a fund experiences. In other words, the more clients move in and out of a particular fund, the more likely they are to worsen their performance relative to that of the fund. This is because investors often switch from a fund that is going through a poor patch and switch into a fund that is having a good run, only for the relative performance to reverse thereafter.

In general, the higher the rate of client turnover, the more negative the investor return gap. 49 percent of the investor return gap is explained by the degree of client turnover in the fund.

The more specialised the mandate, the greater the potential for a large investor return gap.

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