A Case Against Market Timing

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Don’t Play In The Street

A Case Against Market TimingMarket Timing Image

There have been numerous studies over the years detailing the importance of staying invested in the market: picking an active, passive or combination strategy, refraining from trying to time the market, and then letting the strategy work for you.  The ongoing Dalbar study, has shown that when investors don’t stay the course, they do quite a bit of damage to their portfolio through poor timing—selling at or near the bottom and/or buying after the market has already appreciated. 

Dalbar, Inc. is the nation’s leading financial services market research firm and performs a variety of ratings and evaluations of practices and communications.  “Since 1994, Dalbar’s Quantitative Analysis of Investor Behavior (QAIB) has been measuring the effects of investor decisions to buy, sell and switch into and out of mutual funds over both short- and long-term time frames.  The results consistently show that the average investor earns less-in many cases, much less-than mutual fund performance reports would suggest.  The report explains how investors and advisors adapt to changing market conditions and produce investor returns using investor behaviors, the psychological factors that drive them and the knowledge of how investment classes have acted in the past.”

To demonstrate this effect, the chart below focuses on the last twenty years of daily returns for the Weitz Partners Value Fund-Institutional Class (the “Fund”, WPVIX) and the S&P 500 through the end of April 2016. Assuming an initial purchase of $10,000 I calculated comparative performance assuming an investor missed the best 10, 20 and 30 performance days of the S&P 500. The results below show the impact of missing just a few important investment days. 

Comparative Historical Returns

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Over the full historical time period (May 1, 1997 through April 29, 2016) the WPVIX had a cumulative return of +542% vs. the S&P 500 cumulative return of +359%. 


Past performance does not guarantee future results. The investment return and the principal value of an investment in WPVIX will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than the original cost. Average annual total returns for WPVIX for one, five and ten year periods ended April 29, 2016 were: -8.81%, 7.92% and 5.85%; respectively. Comparative returns are the average returns for the applicable period of the S&P 500® Index. S&P 500 average annual total returns for the one, five and ten year periods ended April 29, 2016 were, 1.21%, 11.02% and 6.91%. The returns above assume reinvestment of dividends and redemption at the end of each period, and reflect the deduction of annual operating expenses, which as stated in the most recent Prospectus are 1.05% (gross) of WPVIX’s net assets. The returns above also include fee waivers and/or expense reimbursements, if any; total returns would have been lower had there been no waivers or reimbursements. The Investment Adviser has agreed in writing to limit WPVIX’s total annual operating expenses (excluding taxes, interest, brokerage costs, acquired fund fees and expenses and extraordinary expenses) to 0.99% of average daily net assets through July 31, 2016. WPVIX became available for sale on July 31, 2014. For performance prior to that date, this chart includes the actual performance of Weitz Partners Value Fund-Investor Class (WPVLX), (and uses the actual expenses of WPVLX), without adjustment. For any such period of time, the performance of WPVIX would have been similar to the performance of WPVLX, because the shares of both classes are invested in the same portfolio of securities, but the classes bear different expenses. Current performance may be higher or lower than the performance data quoted. Performance data current to the most recent month end may be obtained here.


By removing just the top 10 performance days of the market (10 out of 5034 days), the cumulative performance of both the WPVIX and the S&P 500 drops dramatically.  The WPVIX dollar return netted $35,800 (a decrease of ~44% from the full historical calculation), resulting in a cumulative return from the initial investment of +258%. The S&P 500 dollar return netted $22,913 (a decrease of ~50% from the full historical calculation), resulting in a cumulative return from the initial investment of +129%.

The trend continues with the removal of the top 20 performance days of the market (20 out of 5034 days). The WPVIX dollar return netted $25,438 (a decrease of ~60% from the full historical calculation), resulting in a cumulative return from the initial investment of +154%.  The S&P 500 dollar return netted $14,278 (a decrease of ~69% from the full historical calculation), resulting in a cumulative return from the initial investment of just +43%.  That’s an approximate 20 year average annual return of roughly +1.8%! Investors could have likely done better in a conservative bond fund.

The trend not only continues but becomes ugly with the removal of the top 30 performance days of the market (30 out of 5034 days). The WPVIX dollar return net is now just $19,115 (a decrease of ~70% from the full historical calculation), resulting in a cumulative return from the initial investment of +91%. The S&P 500 net negative dollar return was $9,432 (a decrease of ~80% from the full historical calculation), resulting in a cumulative return from the initial investment of -5.7%.  Having invested in the S&P 500 over the last 20 years and missing the best performing 30 days (still maintaining an investment period of 5,004 days) would have resulted in a negative return: wrap your head around that one!

The point of all this is twofold:

First, while some people claim that market timing is possible because markets move in cycles, and there are, unquestionably, indicators that reflect the particular market phase at a given time, this does not mean that one can determine when to get in and out both accurately and consistently.  The biggest cause of underperformance by investors is psychology. Behavioral biases that lead to poor investment decision-making is the single largest contributor to underperformance.  According to a 2015 Advisor Perspectives article the two biggest of these behavior biases for individuals are the “herding effect” and “loss aversion.”  

“Herding effect is following what everyone else is doing, which leads to ‘buy high/sell low.’ Loss aversion is the fear of loss that leads to a withdrawal of capital at the worst possible time, also known as panic selling. These two behaviors tend to function together compounding the issues of investor mistakes over time. As markets are rising, individuals are to believe that the current price trend will continue to last for an indefinite period. The longer the rising trend lasts, the more ingrained the belief becomes until the last of the ‘holdouts’ finally ‘buys in’ as the financial markets evolve into a ‘euphoric state.’ As the markets decline, there is a slow realization that ‘this decline’ is something more than a ‘buy the dip’ opportunity. As losses mount, the anxiety of loss begins to mount until individuals seek to ‘avert further loss’ by selling.”

The data shows just how easy it would be to underperform a buy-and-hold strategy.  Even if one could eliminate behavior bias risk, you would not likely be able to outperform a buy-and-hold strategy unless you are incredibly accurate and consistent with exits and entrees into the market. This is also complicated by the fact that 72% of the S&P 500 top 30 performance days were followed by bottom 30 performance days within two weeks. Good luck market timers!

Second, the case study above is also a real-life demonstration of how active management can outperform a benchmark over time. For the 20-year period studied, and for S&P 500’s top 30 days as noted above, S&P 500 outperformed WPVIX for 25 of those days for a total cumulative 30 day outperformance of $48,677 vs. $33,562. Despite the importance of these top 30 days, WPVIX still outperformed the S&P 500 for the entire 20-year period.  This outcome illustrates that active management (stock selection that is different from a benchmark) does not move in tandem with the benchmark on a day-to-day basis, and that active management does have the potential to outperform over time. See our prior blog post on Active Management.  


Calculations including the removed of trading days are hypothetical. The S&P 500® is an unmanaged index consisting of 500 companies generally representative of the market for the stocks of large-size U.S. companies. All investments are subject to risk, including the possible loss of the money you invest.  There is no guarantee that any particular asset allocation, or mix of funds, or any particular mutual fund, will meet your investment objectives or provide you with a given level of income. 

Investors should consider carefully the investment objectives, risks, and charges and expenses of WPVIX before investing. The Fund’s Prospectus contains this and other information about WPVIX and should be read carefully before investing. The Prospectus is available from Weitz Investment Management, Inc., 1125 South 103rd Street, Suite 200, Omaha NE 68124-1071, weitzinvestments.com, 800-304-9745 or 402-391-1980.Weitz Securities, Inc. is the distributor of the Weitz Funds.

 

 

 

 

 

 

 

 

 

 

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