Although past performance is not a good indication of future returns, it seems to remain one of the main determinants of investment switching behaviour and consequently the dreaded ‘behaviour tax’.
This behaviour tax is calculated as the performance sacrificed after switching between one unit trust and another.
According to Momentum Investments’ latest Sci-Fi Report for 2023, about R120 million of value was destroyed due to behaviour tax for the 2023 period* in the Momentum Flexible Income Option (FIO) and the Momentum Retirement Income Option (RIO). FIO investors (discretionary investors) paid 4.02% in behaviour tax, while RIO investors (non-discretionary investors) paid 3.27% in behaviour tax.
Using artificial intelligence (AI) algorithms on a dataset of over 12 million observations, we found that past performance is one of the top three considerations when investors switch from one fund to another. The top consideration when investors switch relates to the individual’s circumstance, including their age and how much money they have invested. The more the investor has to lose, and the less time they have to recover from market downturns, the more likely they are to switch between funds. This does not bode well for the more vulnerable investors in retirement. Once again, investors do not manage to add value with their switching behaviour on average. Quite the opposite, in fact, as behaviour tax levels rise to COVID-19 levels once more.
Investors more engaged in trying to time the market
The research also shows that since the onset of the COVID-19 pandemic early in 2020, investors have become more engaged with their investments. Switching levels in general are still approximately 30% higher than pre-COVID levels.
Looking back, since the pandemic nearly R650 million in investment value was destroyed in behaviour tax ‘paid’. An alarming 75% of this value was destroyed by retirees in the living annuity product – the Momentum Retirement Income Option (where part of the investor’s retirement capital is exposed to the market) – on the Momentum Wealth platform. In 2023, 65% of the R120 million of value destroyed was once again attributable to retired investors.
The report further reveals a pattern in switching behaviour by a group called the ‘market timers’ that often destroys the most amount of value. The market timers are active by switching to not only chase higher market returns, but also by switching when they run for the hills during market turbulence. In 2023 the market timers destroyed a staggering 4.79% of their portfolio value with this behaviour pattern in general.
Investors losing twice when they switch
There is a clear pattern of behaviour by the market timer. The JSE All Share Index surged towards the end of 2022 and broke records early in 2023 hurdling 80 000 points for the first time in history. Records are tough to ignore. Following the money, we saw a clear trend here of investors chasing this market upturn. Once again, however, investors are not rewarded for chasing these returns as markets took a persistent downturn for the remainder of the year and investors are left scrambling to get back to safety, thereby losing on both the upturn and downturn of the market. In fact, the top-10 unit trusts in terms of fund outflows (over R1 billion in value) deliver between 3% and 25% better performance in the next period. Investors therefore miss out on these significant returns in the next period, which is exactly how the behaviour tax starts to mount.
Using AI, Momentum Investments is now able to accurately predict investor switching behaviour and intervene using behavioural science principles to help investors stay invested and achieve their long-term financial goals. As we start to collect data on the investor’s personality traits this also becomes an important predictor and one more avenue with which we can help to secure better investment outcomes and manage the behaviour tax.
The Momentum Investments Sci-Fi Report for 2023 is available for download here.
*Note: The 2023 period is defined as 30 September 2022 to 1 September 2023