Sunday, September 02, 2007

Unit Trusts – 80% of Unit Trusts Under-performed the market from May to August 2007

Interestingly enough, an article in The Edge Singapore this weekend (in the pull-out Personal Wealth section) talked about the returns on unit trusts and how they have been battered left, right and centre by the recent market turmoil. Also on Friday, I was having lunch with two friends who expressed their views on the unit trusts market and one of them, incidentally, was heavily vested in unit trusts. I would like to comment on funds in general and also incorporate some of my friend’s personal views on unit trusts and how they have helped her in growing her money.

In the article, nearly 80% of the 700-odd retail investment funds (i.e. mutual funds) have lost money in the past three months up till August 17, 2007 (the day of the big rout and subsequent recovery). That’s about 560 funds in total, no small number by any measure ! The reason for this under-performance can be traced to the fact that during the correction, all asset classes such as equities, bonds, properties and commodities were hit, sparing no one and nothing. Thus, even a well-diversified investor who held on to equity funds, bond funds and real estate funds would be hard-hit. As an example, my friend had a 13% overall gain from her 8 unit trusts before the major correction, but this dropped to as low as 3% (fees inclusive) during the severe correction. Clearly, these funds could not withstand the battering and most were not prepared for this kind of “storm”.

To be fair, to expect mutual funds to consistently out-perform the benchmark index is a little too much to ask. Mutual funds usually show their performance over a stretch of time and this may include periods of under and over-performance; which in the end translate into an average which is then shown to the potential investor. What I would like to add is that funds have a tendency to be a little over-diversified at times, thus eroding any good gains from any particular investment within the fund. After all, owning just 5 excellent companies is much better than 5 out of 30 when the other 25 are just mediocre. But the problem with funds is that the fund manager is forced to (not literally, but in a manner of speaking) make investment decisions on a daily or weekly basis to increase the investment returns for the unit holder. In the end, transaction costs will pile up as the fund manager tries to get into the better investments and bail out of the worse ones. It’s more like fire-fighting in such cases rather than a case of good investment acumen.

Fund managers are trained professionals with a wealth of knowledge in investing, financial products and financial markets. I have the utmost respect for them because after all, it is not easy to handle large sums of money which are not yours and to be accountable to so many people. Herein lies the problem: Warren Buffett mentions that as a fund manager, you are constantly “forced” to make moves in order to grow other peoples’ money; and this is like being a baseball player who is forced to swing at every pitch, even if it’s a bad one. The analogy is apt because in the investment world, there cannot be that many good investments out there for everyone (otherwise, we would ALL be very rich by now). In fact, after doing several months of independent research on the Singapore Stock Exchange, I dare say there are only a handful of truly outstanding companies with capable management, good earnings growth and an endearing product/service. The fact that fund managers have to take action all the time or be labeled as “lazy” or “inefficient” is sad because all it takes is one really good investment to reap all the returns; instead most funds buy/sell constantly (eroding gains through transaction costs) and they also buy/sell into mediocre companies or investment products, further stunting performance. This is why there are only a few truly outstanding funds in this world (which, incidentally, are managed by fund managers who have a value investing mindset).

So I tell my friend: “Why don’t you invest in equities in order to enjoy a higher return ? Fund managers regularly under-perform the index plus you have to pay them an annual management fee even if they fail to perform !” Her reply was that these fund managers “know their stuff” and it was important to “diversify her risk” by investing in a myriad of asset classes. The sad fact is that the entire fund industry likes to convince retail investors that it is difficult and tough to invest on their own and thus the services of such professionals are required. The truth is that even though it is not simple to invest on our own, it is also far from being rocket science ! What most people don’t realize is all it takes is a keen interest in business news, basic accounting knowledge and an understanding of businesses and companies. I have a previous entry on the pros and cons of unit trusts so please refer to that posting for more detail.

For diversification of risk, apparently it also comes with a condition that you also “diversify” your returns ! Wide diversification is necessary if the retail investor does not know what he or she is doing, and even though diversification helps you to “weather” the storm, the flip side is that it cannot guarantee superlative returns. Most of my friends who are heavily into unit trusts report an overall gain of at most 15-20% for their entire portfolio (and that’s for the very outstanding individuals who have picked almost all the out-performing funds). For most value investors who regularly do their homework and research, focusing on just a few excellent companies can help weather storms much better and give much better returns as well.

Note: Kindly feel free to comment on this post as I know the issue is rather contentious (there will be people in strong support of UT, like my friend is). Rather than skew my discussion towards pure equities, I invite views from readers as well.

Also Note: From the feedback of readers, I have organized my blog into sections using labels so that it is easier to navigate and to read up on specific posts (e.g. on Ezra, Swiber or research series). Kindly use the right-hand toolbar called "Categories" to navigate through my blog's older posts. In future, I will "tag" each posting with a label for easier reference. Feel free to leave comments on ANY posting and I will attend to it when I have time.


Anonymous said...


this is harry, i left a comment in your earlier post.

i'm trying to study the FY07 annual report of Pac Andes, at the same time trying to practice calculating some ratios. i have some problems identifying the right items in the report to plonk into the various formula.

i shall list the ratios and the items i plonked in. since you had done an analysis, perhaps you can comment whether i had done it correctly? if it's wrong, can you point out which page or which note number the correct item can be found?

btw, FY07 report is before the increase in share base, and i'm using HKD since ratios do not factor in currency type. thanks!

ROE 54.32%
ROI 43.15%
Current Ratio 1.91
Quick Ratio 1.04
Debt-Equity Ratio 0.72
Interest Cover Ratio (no idea)

Note: all in HKD millions
Current Asset ($m)$3,633.205
Current Liab ($m) $1,907.162 Inventory, Prepaid Expense $1,641.938
Loan > 1yr $450.825
Total Debt ($m) $1,246.664
Earnings ($m) $946.100
Interest fr Debt ($m) (No idea)
Cash & Bank Bal ($m) $169.776

Ao said...


i was reading a book 'the intelligent investor'. they talked about investing in a comapany with an adequate size. and their definition of such a company would be one that does 'at least $100m in business'.

i was wondering what's your take on this?

fishman said...

Hi musicwhiz,

as you know, I'm more involved in UT now then equities due to concious lack of knowledge.

My opnion is that different asset has its role and uses at different time frame. For someone who is early in the investment journey, UT might be a much better choice. Than to follow some hot tip and gamble in the guise of investing. Then these people are starting on the wrong path.

Just my two cents worth!

musicwhiz said...

Hi Harry,

Will get back to you on that in a while....wah now you giving me more "homework" to do haha !


musicwhiz said...

Hi Ao,

I think the size of a company does matter, definitely. But more importantly, will it still keep growing or is it on the verge of decline ? That's the more important thing to look at I think. When I invest I look more at overall financials, margins and prospects rather than absolute size.

regards, musicwhiz

musicwhiz said...

Hello fishman,

Good to hear from you, been checking your blog for updates recently but your most recent was August 13, 2007.

For most people, UT are seen as "safe" as they are handled by "professionals" and are well "diversified". But the truth is that most of these funds do not do much better than long-term investors of equities. You mentioned following hot tips (gambling). I believe if one is disciplined enough, they will find out more before putting their money into either UT or equities. A gambler will always be a gambler, the stock market is just the medium; the person can choose lottery, horses or casinos as well.

Thanks for your comments ! :)

Anonymous said...

Hi MusicWhiz,

I am directed to this site because of your posting on Wallstraits. I have always enjoyed your blog.

I am very sad that ppe. with money do not spend time learning to invest instead, they rely on so called "fun managers".

A lot of them know CRAP about how the market really works. ALl the teachings in their MBA classes are worth zero if they do not understand how the market really works. Remember, for every seller, there is a buyer.

MOst ppe. do not understand that when they sell a stock, who on the other side is betting that they have made a mistake. In other words, who is trading against you in the market.

MOst fun managers do not have ANY IDEA how to beat the market. I am just sad that they still do not know how to read market signals that a correction is coming.

These can be read if you are a shrewd trader. Market ALWAYS gives out signals before the correction comes in. THe market was giving out signals from Jul 18-24. Those who understand it will have gotten out before the Jul 26 storm and avoid getting hurt.

Those who do not believe in market timing will always be hurt long term. No body here is a Warren B. All stocks will top and all stocks will break down. It is just the nature of the stock market. Just a matter of time.

Good luck to those who still choose to invest in unit trust. BEcause they are lazy and do not want to put in the hard work, they deserve to see their money evaporate away in the market.

musicwhiz said...

Hi Anonymous,

Thanks for your post; it helps me to see your thoughts on this subject. Fund managers are humans just like you and me and thus they are prone to mistakes as well. Their use of timing the markets usually causes the fund to suffer as most have imperfect timing and get out too late or get in too early. Transaction costs also pile up and cause the fund performance to suffer.

For every seller, there is a buyer. The seller sells because he/she feels that his price target has been reached. The buyer will buy because he sees more value to be crystallized in the business. I will always buy and hold if I see promise in the business plans and model of the company. That said, it is also an act of faith somewhat as plans do not always materialize as hoped for.

I would agree that some of the people who choose to invest in UT are "lazy"; but there are others who also believe the mantra of diversification and thus choose this form of investment. It's not always a matter of putting in hard work; some people (I believe) genuinely are not good or sensitive with numbers and thus avoid analyzing equities and companies on their own. In such cases, wide diversification is OK for them to ensure they earn above inflation, but they will never achieve the superlative returns which are possible through value investing.

Cheers, musicwhiz

Anonymous said...

hi musicwhiz

harry here! dun stress lah! since you had already done such a detailed analysis on Pac Andes, i thought you might already have all the stats ready mah. Nevermind, take your time! (not said in the Army Sergeant's tone hor!)

With regards to UT, i feel that, unless you have a lot of spare cash to invest, you should just focus on S'pore Shares. this is because (assuming you stay in SG) you spend SGD, you would not want to incur forex risk that will erode your gains. since you are limited by your "bullets", you do what you do best i.e. local markets, especially in industries that you have knowledge in or studied in depth.

once you have more bullets/funds, you can choose to buy index funds or ETF that are tagged to foreign markets that are still undervalued as a whole. this is the way for me as i do not have the time to study NASDAQ, Dow Jones, Hang Seng counters. following STI is already tiring enough!

so unless there is no such ETF or cheaply available index fund in STI, and you still die die must invest in a particular country or sector, go hunt for a UT that is cheapest in terms of expense ratio.

lastly, anon mentioned about market signal in July on correction. i sold half of my holdings in the morning where the bull run was the most spectacular i.e. CH Offshore, Aqua Terra, Advance Holdings all flied to record high prices. but i sold early so did not touch the higher prices.

however, i sold w/o regret as i felt the party is over soon and the US woes are getting obvious. why half my holdings? once i decided to sell, i went through my list of holdings (slightly over 10 stocks) and identified the ones that have the highest P/BV ratio. thus i sold the above three shares for very good profits (even when i sold before the bull run spikes).

for the rest that i'm still holding, obviously the paper profits are eroded, but they are all still in green and i feel comfortable with them. they are either financially sound, have substainable business or expected to enjoy good growth within 10 years. thus, full potential not reached yet.

in essence, value investing and setting very objective selling and buying prices help to take the emotion part out of your investment strategy.

Anonymous said...

hi harry, historically, s&p index fund returns 12% p.a. is a sure win... do you see same performance going forward? btw, is etf as affordable as index funds?

musicwhiz said...

Hey Harry,

Haha thanks for the assurance. :P Too bad I don't have the ratios and figures readily on hand and I have been busy with work + personal stuff these days. I think UT in the form of ETF is a good idea, at least you benchmark to the index which has a tendency to go up over long periods of time, rather than down.

Good that you also "read the signals" right. For me, I am lousy at market timing and would simply wait for Mr. Market to offer me a good price for a particular company. Once I can buy at a reasonable price, I will hold till fundamentals erode or growth isn't higher than inflation rate.

Value investing does take the emotion out of investing; it requires cold, hard logic. Cheers !

musicwhiz said...

Hi Anonymous,

Wow I did not know S&P Index Funds returned 12% p.a. on average; that's a very good return I think considering you do not need to do much research.

But moving forward, can the same be said for our local ETFs ? :)

Anonymous said...

Harry here.
On Anon's question, i think you will have to compare the fees you incur if you buy ETF vs Index Fund. I'm not sure how much it cost to buy Index Fund, maybe i should take a look at Fundsupermart and see what is available with the cheapest expense ratio and low management fee.

For ETF, it's easier to calculate the % of the fee from the amount invested as the fee is simply the usual ones you incur from trading in STI. i think there is a small annual management fee by e.g. Streetrack.

Will S&P continue 12% p.a.? i need a crystal ball to answer that, i'm afraid! but let's be honest with you, i dun see good performance from USA economy within 5 years period. thus, i'm avoiding any investment thathas to do with US economy or denominated in USD. this is to minimise exchange risk etc.

then again, my bullets also limited, which kinda make my decision and choice easier to make i.e. very ngeow and picky when choosing a counter to buy. trying to be "one shot one kill"!

Anonymous said...

harry here.

you can see the 10-yr performance for major indices here:

STI 6.88% p.a., S&P 5.14 p.a.

the morale of the story? it's all numbers, and it all depends on the time frame that you tag the "per annum" figure to. 12% p.a. could be the annualised return for S&P for past 80 years. so essentially, what makes or breaks is the prices that you buy at. Margin of Safety!

Remember, no one points a gun to your head and force you to buy a counter. that's what i always tell myself when i have doubts on a seemingly irresistible opportunity.

musicwhiz said...

Hi Harry,

Many thanks for your inputs, especially the links to Fundsupermart. I am not a funds kind of person but nevertheless the links will be useful for other readers. Fees for ETF should be minimal I think since they are listed on the exchange (only commission perhaps ?). But I do agree that S&P may not continue to return 12% p.a. due to the weakened state of the USA economy at this point in time.

Generally, I also avoid foreign stocks due to unfamiliarity; Singapore stocks are enough for me to make my gains. Yes, it's a one-shot kill most of the time; we want to be more right rather than wrong, and even if wrong, we make sure we lose very little. :)

Margin of safety does guarantee that you do not lose too much money, which is why I reject almost 99% of all "recommendations" by friends because sometimes, the story seems too good to be true. Most people I know simply buy indiscriminately but start lamenting when they lose money - seems strange to me cos in the first place they did not assess the higher risks when buying higher instead of having a 30-40% margin of safety. Most end up holding babies for the long-term which is a sad situation.

Cheers, musicwhiz

Anonymous said...

thanks harry, when i invest in index fund, i took a very long term approach (should be at least 20 yrs) and of course as a small part of my portfolio of investments. thus i use 12% p.a. returns. next i use cost avg so that emotions and impulse don't not get to much in the way. with etf, i thought if one stick strictly to the format and not to trade it like stocks and share guess the costs will not erode the returns. for outlook in the next 5 yrs in usa, yr guess is as good as mine, long term, 5 yrs is not a big deal... good chatting with you.