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Sunday, May 2, 2010

The Ugly Truth of Unit Trusts & Mutual Funds

Funds or trusts were created largely for the public looking for the benefit of diversification with a small pool of money while enjoying the chance of higher returns compared to conventional savings (e.g. fixed deposit). One big misconception I have observed is that many people think the diversification of some of these funds means less risk in investing so most people just close their eyes and simply pick the best. And the best has always comes to looking at the returns/popularity first. This is in reality speculating when you think you are investing.


Almost all the time an agent ask what is your risk level and then proceed to tell you this fund is good because it has good returns + being popular and all sort of nonsense. No offense to agents reading but there are a few which I personally know which are good in financial advise but the fact is the majority are not and are looking for quick closure to get commissions. A classic example of those working for making ends meet, working for passion but there is a new breed like me sharing to help others


The idea of giving greater incentives to agents who get the most investors have led to a phenomenon that quantity is better than quality. People are greatly misinformed because they don't know what to ask and they believed the agents are these so called 'experts'.

"Do you prefer to let people screw up your hard earned savings for investments, or prefer to spend some hard time (one day in weekend) to understand where and what risk you are putting that money?"

Aboi has a few strategy you can use when choosing funds. I have greatly simplified it in 5 rules (no, it is not a Law yet unless I can prove it scientifically) and to show you good illustrations and real-life examples whenever possible. 

Rule no1
Avoid choosing big sized popular funds! If you have RM1bil to manage, you cannot dump them into 30 different stocks as they will be too overvalued. What they do is they spread it out vastly on more companies like 300 which make them look like their are the stock market itself - and probably end up spreading the fund manager's attention too thin. Like the example below, biggest Malaysia equity fund (RM1.7 billion in total size).


Warren Buffett, the world’s most successful investor (the #2 richest man in the world) who runs Berkhshire Harthaway that is worth over USD 200 billion ($200,000,000,000) owns less than 50 stocks! So for a typical mutual fund that is worth RM1 billion to diversify as much as 300 stocks is meaningless. Do you know all the stocks your fund owns right now if it has 300 over?

Top 5 biggest Malaysia equity funds are all from Public Mutual (sorry to hamtam you), it shows you how popular they are BUT their 5 years returns are not even in the top 10. One can argue they still give better returns than the benchmark but another example below (2nd biggest fund) over a 10 year period only manages to give a 5.49% annualized return. Heck you can even get that close % from a balanced fund which has 5 times less risk than an equity fund



High risk comes with high returns says Mr.Agent. How can you get high returns when the fund itself acts like the stock market? Are you telling me that KLCI can go up to 2000 points when there is a bull run like now? Please don't sell a fund to me because it is popular.

The one and only good performing equity fund is iCap (closed-end fund). iCap owns around 20 stocks, its performance will not rely too much on what the overall market is doing therefore less correlation. A mutual fund that holds too many stocks will not be able to outperform the market in the long run. But an intelligent investor who focus on a few well researched and strong performing stocks and easily outperform the market by a large margin. In iCap's case 20% annualised returns since launching.


If you have a heart in investing in equity, do it yourself or look at unco Tan's iCap. I am 100% sure that if you put effort in time and research wisely you can easily get 15% annualised returns. The only fund I have is less risky balanced fund & fixed income fund, they are some good ones out there including Public's offering. Don't let others screw up your investments, why don't invest in aboi's Mutual Fund 2009 haha.


Rule no2
Compare fund expenses! This is overlooked by a lot of people and even agents. Did they ever tell you about the impact of the fund's expenses on its returns? The higher a fund's expenses, the lower its returns. Also the more frequently a fund trades its stocks, the less it tends to earn. (goes back to rule no1). It often costs more to trade stocks in very large blocks than in small ones; with fewer buyers and sellers therefore it is harder to make a match. A pure equity fund (~100%) and especially the big ones have to trade very often thus reducing your actual returns.





At first glance, wow they punish people by actually taking more risks (equities) by imposing higher service charges. At 5.5% service charge and ~6.5% annualised returns, plus the other fees you get nothing in the 1st year and you need subsequent years to catch up on your no returns for 1st year. Compared to a balanced fund, you still have a return equal to a FD rate in the 1st year PLUS the fact they don't trade a lot because they invest mostly in bonds with fixed maturity and defensive stocks with high dividend yield like unco Tan's iCap style.


It all goes back to commissions, the higher service charge is used to offset commissions to agents and this is WHY they like to recommend equities FIRST and made them so popular. So who is stealing your money then? High returns are temporary in volatile stocks while high fees are nearly as permanent like granite. If I had God's power, I would have changed the structure that these agents get what their clients get in return. Instead of they get what the clients are willing to put their hard earned cash in. 

Rule no3
Information on the fund manager! It is not important to know who is handling your money? If you had the choice to choose between Warren Buffett and your fund manager you would choose Warren. Then why is it that many are unknown about their manager's reputation and investment track record? Because the public people are being bombarded by ads on the best mutual company, best returns by this company, awards that they get and etc. This company is famous and popular, it doesn't matter which fund you invest just put it in this company and you can rest well!

A rule of thumb is to ensure that the manager's reputation is good, has good track record in his current investment holdings and also his previous fund that he manages (if he is that old). You can easily ask this through the company or even try googling if his name appears. Even better if he is holding some units himself as his is likely to manage your money as if it were his own.


Beware that they are some very good managers but they have a history of jumping ship to other rival companies once they are offered better salary & incentives and another Ah Beng will come and take over your fund. I don't know of such jumping in Malaysia but it has happened in the US many times (their investment fund history is way longer than us here). Do a little bit of research on the fund's manager and it will pay off.

Rule no4 and no5
Good funds don't advertise. They don't appear constantly on papers boasting their awards or their No. 1 returns because they don't want to get popular and manage too much money.


Most people look at past performance > riskiness of fund > manager's rep (some don't) > fund expenses > popularity of fund. You should as an intelligent investor look from the opposite direction and do your filtering from there.

Know When to Fold Them
Once you own a fund, how can you tell when it's time to let go? If the principles of the fund stand do not lock yourself out by selling and miss the recovery. Then when should you sell? 
  1. swift change in fund strategy: suddenly the balanced fund 'hiong hiong' go load up in up & down technology stocks or try to be bullish (follow market which means follow emotions rather than being logical)
  2. an increase in expenses: the fund manager decided to have more pocket money for him and his family of 'experts'
  3. sudden erratic returns: as when a conservative fund generates super big loss (or even produces a giant gain). You don't expect this kind of fund to give you 15% returns per annum
  4. large and frequent bills: generated from excessive trading (a cue that the fund is growing bigger and bigger each year), you can get this from their yearly report 
To sum it up
My philosophy of intelligent investing in funds is to put some exposure on fixed income securities (balanced funds or fixed income funds) as part of my portfolio's conservative side. I could also buy iCap as a defensive selection but really not other equity or aggressive funds. The Americans have shown us that there is no such a thing as "too big to fail".


In the long run you will be able to get decent returns without a heart attack or sleepless nights. Each time the market crashes both iCap and the balanced fund will leap ahead of the equity fund. This is why they will outperform the equity fund eventually. 


Remember, investing means trying to get the most of your money with the least risk as possible. I hope you get my point here. It took me 4 hours to write this..eyes so blur now :)

*Special thanks to the book Intelligent Investor by Benjamin Graham, father of value investing.


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