Warning, the image above is hazardous to your eyes.

In my last article, “Why am I always make losses in the stock market?” in the link below,

https://klse.i3investor.com/blogs/kcchongnz/170685.jsp

I have furnished evidences and discussed on why retail investors have done badly speculating in the stock market. It is hazardous to the financial wellbeing if a retail investor does not have the required knowledge, experience and the proper mindset to be successful, and yet hope to get rich quick in the stock market by his own. There are plenty of traps and dynamites littered everywhere in the stock market. There is no free lunch.

In the article mentioned above, I have given some choices for those who do not have the skill to invest through a proper process, and yet wish to invest in the equity market for a higher return expectation. One of them is to invest passively in unit trust.

Passive Investments

The growth in the unit trust industry has been spectacular in the last 20 years. As at the end of 2017, there were 30 unit-trust management companies with 650 funds. There were 19 million unit-trust accounts with a total net asset value of about RM422 billion. The net asset value (NAV) of these funds makes up 22.5% of the market capitalization of Bursa Malaysia.

Unit trust/managed fund is a good form of investing for long-term, especially for those who have career or business of their own and hence have no time, and/or those with little investing knowledge but still wish to participate in the equity market for expected higher return than the fixed income instruments. This fund invests in a portfolio of public listed stocks and its value is determined by the net asset value, or NAV, of the portfolio of stocks. Investors can invest or redeem their “units” anytime of the year, and hence the number of units can increase (with more investment from holders), or decreases with redemptions from existing unit holders.

Among the claims of benefits of investing in mutual funds mentioned are:

1. “Mutual funds provide full-time, high quality professional management services by pooling the resources. The fund manager has instant access to real market information.”
2. “Shareholders benefit from diversification made possible by the amount of pooled investment dollars that most individual investors would not be able to achieve.”
3. “Low Cost, High Quality Investing” in terms of diversification.

However, nothing in this world is free. You also have to pay for professional fund managers for managing your investments. Those others working in the industry needs to earn money to put food on the table too. The total amount paid can be substantial which will adversely affect the return of your unit trust investment.

Expenses and Fees for managed funds

It is important to understand the types of fees and expenses associated with your investments, so that you can make the right investment choices for you…and decide if what you are paying is reasonable for the services you receive. With managed funds, fees are charged for professional management, account recordkeeping, custodial and other basic services to run the managed fund. 

Very few mutual funds investors understand the complexities of mutual fund expenses and know the true costs associated with mutual fund ownership. The following link is a very good read and an eye opener for anyone wishing to invest through managed funds/unit trusts.

       http://www.forbes.com/2011/04/04/real-cost-mutual-fund-taxes-fees-retirement-bernicke.html

The article explained in detail about the six different costs involved in investing in managed funds: management expense ratio averaging about 2% a year, transaction costs (brokerage commissions, market impact cost, and spread cost), tax costs, cash drag, soft dollar cost and advisory fees. The total cost per year, according to the author, can add up to about 4% per annum, which is equal to 40% of a long-term return of equity investment!

It is important to minimize fees relative to the services you receive. Evaluate a fund’s objectives, past performance and other service advantages to determine if the fees paid are reasonable. For example, an index fund is “passively managed”, designed to track a market index and does not conduct individual security analysis. This results in low fees. An actively managed fund attempts to return more than its benchmark index, and charges higher fees for that expertise and security selection.

Funds Distribution Channels and Fees

Years ago, the unit trust funds were solely distributed by a limited number of investment banks through their unit trust agents going around as salesmen/saleswomen. The upfront fee used to be as high as 6%. RM100000 of the investor’s money put into the fund was left with RM94000 for investing, or a 6% was lost upfront before started to invest. Nowadays, commercial banks employees will also push to sell third party unit trust funds to you when they see if you a lot of money in the bank. The upfront fee has reduced to between 2% to 5% now.

If one is technology savvy, he has a choice of unit trust funds, local as well as overseas, through a internet broker-dealer platform such as FundSupermart with a much lower sale charge of 0% to 2%, depending on the type of funds, bond funds or equity funds.

Independ and licensed advisors from financial advisory firms can also sell you unit trust funds, either directly from the fund houses, or through the FundSupermart platform, in the later case, a lower sales charge too. However, be aware that financial advisors may persuade you to let them manage your investment portfolio and providing you with investment advice. In return they will charge you another fee called wrapped fee, in the region of 1% to 2% of assets under management. Financial advisors would also sell you many other managed funds from overseas which incur many layers of distribution fees.

One can imagine that with all these fees, it is highly unlikely one can get a satisfactory real return over a long period of time investing in unit trust, unless he can spot a good fund manager. It has also been shown again and again that a fund manager who performed well against the broad index in a year, way underperforms the following year or a really good and consistent fund manager seldom stays in the same firm even more than a couple of years.

My own experience in unit trust investing shows the huge underperformance against the broad index, mainly due to the various fees and costs. There have been heaps of academic researches, among them of the famous Michael Jensen (1968), Grinblatt and Titman (1989), and Burton Malkiel (1995) which comprehensively evaluate fund performance, consistent show that actively managed funds do not outperform various broad market benchmarks as evidenced by the negative alphas.

The underperformance of managed funds/unit trusts

The inability of the fund managers as a whole to beat the market is best explained by the efficiency market hypothesis which postulates that in an efficient capital market, current market prices reflect all available information about a security and the expected return based upon this price is consistent with its risk. Hence, it is impossible for an investor to consistently beat the market and profit from it.

A good fund manager helps and there are many of them around, but it is often hard to find him before the fact. Good fund managers also often move around among the fund houses. Evidence also shown that a fund manager may perform well in the first couple for years, but their performance would turn bad in following years, and vice versa.

How has been the performance of the unit trust funds investing in Bursa?

Performance Malaysian Unit Trust Funds

Table 1 in the Appendix shows the return of 71 equity unit-trust funds invested in stocks listed in Bursa as provided by The Edge Magazine Lipper Fund Table in the August 20 2018 issue.

The return of the unit funds has not been spectacular as shown in Table 1. For the last 6 months, the average return has been in negative territory. The average one-year return is just 1.5%, and the 3-year and 5-year average cumulative return is 18.6% and 20.7% respectively. This translates to a compounded annual return (CAR) of just 5.9% and 3.8% for the 3-year and 5-year period respectively. The 5-year CAR of 3.83% is just about the return of fixed income during the same period.

The performance of each fund also varies a lot. Take for example, the maximum return for a five years investment period was 77.4%, or CAR of 12.1% of Areca Equity Trust with a small fund size of RM65.7m. However, if one was so unlucky to have invested with RH Equity Fund in the last 5 years, he is staring at a huge loss of 38%, while the broad market has gone up by 5.1%.

The return of the unit trust funds above also shows that if one could find a fund managed by a good fund manager, probably the top 10%, to invest his money, he would get better return over the return of the broad market. Otherwise he would be under-performing the broad market, and in some cases, heavy losses.

The problem in finding a good fund manager before the fact is difficult. Very often, some fund managers could out-perform the market in the past, but under-performed subsequently. The power of mean reversion is strong in the fund management industry. Moreover, fund managers, the good and consistent outperforming ones especially, move around the various fund houses frequently.

The above shows that the unit trust funds invested in Malaysian equity has not been that fantastic as it has been shown to us in the image at the top of this article, often by the unit trust agents or financial advisors. It is far from the truth. Also bear in mind that we have ignored the upfront fees charged.

However, for those individual investors who have no knowledge nor skill to invest on his own but still wish to invest in the equity market with the hope of higher return, unit trusts may offer as a better alternative. Even some skilful individual investors who have no time to do on their own, also look for fund managers who have a good process of investing, and invest in their funds.

Is there any other option one can invest with lower fee and hopefully a better return for investors?

We will discuss in my next article.

Meanwhile, those who wish to learn the skills of investment for better return over the long-term, you may email me at,

ckci4invest@gmail.com

KC

Appendix

Table 1: Return of unit trust funds invested in Bursa