The decisions mutual fund investors make are vastly more important to their long-term success than any individual fund performance, reports U.S.-based research firm Dalbar Inc.

Every year, Dalbar releases its quantitative analysis of inves-tor behaviour, showing the results of its examination of investor behaviour going back to 1987. As in previous years, the most recent study’s results show that the average equity fund investor earned significantly less than fund performance reports would suggest.

The study found that the average annualized return over the 20-year period was only 4.5%, whereas the overall market had an annualized return of 11.8%. Dalbar’s analysis argues that it is erratic investor behaviour, rather than the selection of funds, that causes this tremendous performance erosion over time.

Even if investors believe that timing strategies work, they have to decide if they’ll be any good at it. It’s extremely easy to miss the best-performing days; if they do, they’ll have substantially poorer performance than if they had stayed in the market the entire time. Market-beating strategies are also hard to implement, particularly for retail inves-tors, who also have to choose how best to execute trades.

In a recent paper entitled Inves-tor Timing and Fund Distribution Channels, University of Mississippi professor Mercer Bullard, along with University of Nebraska’s Geoff Friesen and Iowa State University’s Travis Sapp, examine the investment-timing performance of equity fund investors and the relationship of this performance to both the type of fund and the distribution channel.

Using data for 6,164 U.S. equity funds during 1991-2004, the study’s authors concluded that investors in actively managed funds leave 1.7% of their potential annual return behind because of poor timing, more than three times the index fund investors’ shortfall of 0.5%. The worst investor timing tends to occur among funds of the largest size, highest volatility and best risk-adjusted past performance, the researchers report.

In previous studies, researchers found that larger, older and more costly funds seem to attract less sophisticated investors, thus increasing this relative performance gap. The studies’ findings also suggest that fund companies may actually be somehow contributing to this ineffective behaviour.

Those investors who stick with pure no-load funds don’t do as poorly when compared with investors utilizing various intermediaries. This is true for both actively and passively managed portfolios. Whether these lackluster returns are the result of poor decisions by advisors or by investors cannot be determined, the researchers acknowledge.

So, if timing doesn’t work, should funds institute or increase their redemption fees in order to protect investors from themselves? Or, do these fees actually protect underperforming fund managers?

In a recent paper entitled Re-demption Fees: Reward for Punishment, David Nanigian and William Waller of Texas Tech University studied the impact of short-term redemption fees on long-term fund performance, based on fee size and the time interval before charges kick in.

Using monthly after-tax returns for U.S. equity funds over the period of July 2003 to May 2007, the researchers concluded that the percentage of funds charging a redemption fee increased from 3.9% in 2003 to 14.6% in 2007.

Among funds imposing a redemption fee, the proportion with fee durations of one year or longer fell to 5.5% in 2007 from 29% in 2003, while the proportion of funds with fee duration greater than one month rose to 48% from 14.4%.

Funds with redemption fees tend to be small in size, have low expense ratios, favour value over growth and lean toward small-capitalization stocks, the researchers report.

Redemption fees mostly indicate fund outperformance, especially for fee durations greater than one month, the study results suggest. Funds with small redemption fees and long durations tend to outperform those with no redemption fees by about 3% per year. On the other hand, funds with larger redemption fees and long durations outperform their no-redemption cousins by only 1.2% per year.

Properly structured, fund redemption fees tend to protect long-term investors by penalizing frequent traders and encouraging prudent behaviour, the researchers concluded. IE