Hi, I’m Ian.
Lately, I’ve met up with a unit trust consultant.
‘Seriously? But Ian, I thought you are an avid stock investor. Why do you need a fund manager when you can build and manage your own stock portfolio by yourself from scratch?’
Good question. Yes, I’ve built a profitable stock portfolio from scratch. I believe all of us can do it too without a fund manager. We can be our very own fund manager. As such, normally, I don’t really meet up with a unit trust consultant as I don’t have any intention to invest in a unit trust fund.
However, as I write, I’m still a young chap. I’m qualified to enjoy the PRS Youth Incentive where I’m able to receive an additional RM 1,000 in my PRS fund from the government if I invest at least RM 1,000 in a PRS fund. Also, I would be able to enjoy some savings from tax payments if I invest in a PRS fund. The total returns seem attractive even before mentioning the performances of a PRS fund. That’s why I agreed to meet up with a unit trust consultant.
The meeting was casual. We had coffee. After some pleasantries, the unit trust consultant (let’s call him Tan) began his presentation which was well rehearsed. In addition to PRS funds, Tan has also introduced a handful of unit trust funds which are not under the PRS scheme. After the meeting, I began to collect my thoughts on his sharing and do further studies on unit trust funds, both PRS and non-PRS funds.
In this article, I’ll share 5 things that you may need to know about unit trusts first before you invest in them. Probably, these are stuffs that unit trusts may not tell you beforehand when you are considering to invest in them.
#1: Beating FDs & the EPF
Tan: ‘Ian, it’s not enough to rely on FDs and the EPF to finance our retirement.’
Ian: ‘What do you suggest?’
Tan: ‘How about our equity fund’
Ian: ‘What’s the sales charge?’
Tan: ‘5% of your capital’
As I write, most FDs are paying out 3% interest a year and the EPF has paid out 5.70% in dividends in 2016 after strings of above 6% of dividends since 2012. How much returns should I expect from the equity fund to beat FDs and the EPF? Here’s some mental maths:
If I placed RM 1,000 in a fixed deposit account, I would receive RM 1,030 upon its maturity. Instead, if I choose to buy units of an equity fund, I would incur RM 50 in sales charges (5% of my capital) and thus, leaving my initial capital to be RM 950. To match my returns with fixed deposit, I would need to earn RM 80 in my first year from the equity fund. This equates to a return of 8.42% from RM 950 of initial capital.
What about the EPF? If the EPF pays out 5.7% in dividends for 2017, then, my EPF should increase to RM 1,057 from every RM 1,000 I have in my EPF account. This means, I would need to earn RM 107 in my first year from the equity fund to match my returns from the EPF. This equates to a return of 11.26% from RM 950 of initial capital.
This means, the equity fund needs to generate more than 8.42% and 11.26% in returns to beat returns from FDs and the EPF respectively. We haven’t even factored in the annual management & trustee fees applicable to these funds.
#2: On Fund’s Performance
Tan: ‘The performance of this fund is good. It has made, on average, 8% a year in returns since its inception in 2013.’
How are returns from unit trust measured? It is based on the net asset value (NAV) appreciation of a unit trust fund over a specific period of time. It is a measure of capital growth over cash returns. As such, returns are dependent on the NAV fluctuation of a unit trust fund and thus, are not guaranteed.
What is less mentioned is the term, ‘Fund Volatility Factor (FVF)’. It is often measured based on returns over the last 3 years. For instance, if you opened a fixed deposit account and received annual interests of 3%, 3%, and 3% over the last 3 years, then, the FVF is 0%. This means, the returns are not volatile.
If you find a fund where the FVF is 10%, this means, the returns may deviate by +/- 10%. If the fund’s average returns is 8%, future returns could fluctuate between -2% to 18%. Thus, high FVF funds have greater uncertainties of future returns than low FVF funds as they are more volatile. This explains, perhaps, why you may experience inconsistent returns from your investment in a unit trust fund.
#3: Am I buying a Trading Fund?
Tan: ‘The objective of investing in an equity fund is to achieve mid-to-long term capital appreciation. Unit trust is a long-term investment and not for short-term gains.’
I believe, there are many sincere people who buy units of unit trust funds as they believe that they are investing. In my opinion, some were being grossly misled.
Here’s another term that is less mentioned. It’s called, ‘Portfolio Turnover Ratio (PTR)’. PTR is a simple way to tell us whether a fund is an investment fund or a trading fund.
For instance, let’s use a IGB Reit as an example. It is a Reit that derives rental income from Midvalley Megamall and the Gardens Mall. Since its inception, it never bought or sold any investment properties. As such, IGB Reit’s PTR is zero as there is no change in the composition of its investment portfolio.
If you find a fund where the PTR is high, this means, the fund manager has been active in buying and selling investment securities. If a fund’s PTR is consistently high, this means, it is a fund that is active in trading and have lesser tendency of holding onto an investment. In most cases, you may find high PTR funds in most equity or aggressive funds.
Tan: ‘Of course, I must tell you beforehand that returns are not guaranteed.’
Pardon me for writing this. While there are many consultants who possess great customers’ services, ultimately, I believe the priority of all consultants is to make their respective principals rich first over sincere investors like you and me. Let me elaborate.
For a start, the rich invests differently from others. Their focus is on cash flow which are recurring and predictable. Meanwhile, many others choose to focus on capital gains which are non-recurring and unpredictable. Let us assess unit trust investment from the viewpoints of both buyers and sellers.
For sellers, they derive consistent multiple streams of income from your investments in unit trust. They include sales charges, management fees, trustee fees, switching fees and other fees applicable. They make money in both good and bad times as they continue to derive income from investors regardless of the performance of their funds.
For buyers, you incur multiple streams of fees for investing in unit trust in exchange of an opportunity to realise a gain from selling off units at a price higher than your purchase cost. In good times, you may stand to gain if the fund’s NAV goes up. In bad times, you may lose if the fund’s NAV drops. In this case, who’s got the upper hand? I’ll rest my case.
#5: I’m a Risky Investor?
Ian: ‘Well Tan, I invested in stocks.’
Tan: ‘So, you are an aggressive investor. I think, you can take high risks. After all, stock investors are high risk takers.’
Ian: ‘Ehm… Not exactly, bro. I’m actually quite conservative.’
I suppose, there is a misconception of who stock investors are, their nature and what they actually do. I believe, stock investors are branded as high risk takers as many do not know the difference between speculators, traders and investors. Here’s the key difference.
In most cases, stock investors are conservative by nature. Before investing, they want to know what they are investing into, how their money is being used, what their returns are, how potential risks are mitigated, and more importantly, can the price of the investment be reduced further. This is why stock investors need official documents such as annual reports, quarterly reports, press releases, and investors’ presentations to assess a stock deal.
It is not the same as unit trust where most people buy units, not knowing how their money is being managed, and hope that the units somehow will appreciate in prices. Knowing adds certainty. To stock investors, investing without knowledge is very risky. Thus, if a unit trust consultant fails to explain how my money is going to be invested, then, I reckon that the investment is very risky.
Here are some guidelines:
– Find funds that have lower sales charges.
– Ask for the funds’ FVF & PTR.
– Ask for the funds’ distribution policy.
– Benchmark performance against FDs and the EPF
– Don’t be lured or oversold by ‘Best-Performing Funds’.
– Check out Conservative Funds. Don’t dismiss them.
– Ask how your money would be invested. Where does it go?