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Published December 8, 2007  |
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Choosing funds that outperform markets
Compared to selected Asian funds, S'pore funds appear to have the best record
By
TEH HOOI LING
I STILL have some unit trusts I bought many years ago. And earlier this year, I received reports from these asset management firms. Each firm, of course, would have a range of funds under management. I flipped through the reports and what struck me was that funds that underperformed their indices appeared to significantly outnumber those that outperformed.
Since then I've been meaning to do a more detailed study to satisfy my curiosity as to what percentage of funds actually outpace their benchmark indices. And finally, I got hold of some data from Morningstar recently. There are now more than 700 Singapore-registered unit trusts - about the same as the number of companies listed on the Singapore Exchange. Due to time constraints and the difficulty in ascertaining the different benchmarks, I've limited my analysis to just country funds. And more specifically, country funds in Asia. The countries I looked at included Singapore, Taiwan, Malaysia, Korea and Indonesia. And among these countries, it appears that managers who run the Singapore funds have the best record - at least when measured against the Straits Times Index (STI). In the year to Oct 31, 2007, six of the 10 funds I looked at here outperformed the STI. The best performer was Fidelity Funds Singapore A. Over a slightly longer horizon of three years, 40 per cent outperformed the STI and since 2002, half of the funds outperformed the market index. The average return of the 10 funds over one year was 0.75 of a percentage point above the STI's 46.1 per cent. However, for annualised returns over three and five years, the average of the 10 funds trailed the STI by 0.92 and 1.28 percentage points respectively. But it has to be noted that Morningstar's returns are calculated on a bid-to-bid basis. In other words, sales charges are not included. Take these charges - which can be as high as 5 per cent - into consideration, and we find that fewer funds actually outperformed the STI. As mentioned, managers of Singapore funds have the best record relative to the STI. In other markets, fund managers fared worse. In Malaysia, two of the four funds I looked at outperformed the Kuala Lumpur Composite Index. Over three- and five-year spans, only one managed to do that. And the average return of the four funds - Aberdeen, DBS, Fidelity and Lion Capital - trailed the KLCI over the one-, three- and five-year periods. Only Lion Capital managed to consistently beat the index in these three time frames. In Korea, only two out of five funds managed to outdo the Kospi over the past one and three years. And only one managed that over the past five years. In Indonesia and Taiwan, not one fund registered in Singapore managed to beat the respective market indices. Mutual funds have become the investment vehicle of choice for many investors who do not have time to do their own stock analysis. But investors face a complex array of choices among hundreds or even thousands of mutual funds with different objectives, risk and performance. Actively managed mutual funds still dominate the number of funds and dollar value of assets. Performance Just as with stocks, investors in funds often use past performance as a primary selection criterion. Some recent studies that point to the strong positive performance-flow relation are Sirri and Tufano (1998), Del Guericio and Tkac (2002) and Nanda, Wang and Zheng (2004). But as the required disclaimer goes, past performance is no guarantee of future performance. Jain and Wu (2000) examined 294 mutual funds that advertised in Barron's or Money magazine. They found that while the pre-advertisement performance of these funds was significantly higher than that of the benchmarks, there was no superior performance in the post-advertisement period. Yet the advertised funds attracted significantly more money than a control group of funds. However, another group of scholars document that some winners experience a pattern of repeated relative performance over various horizons. Despite these findings, the literature is ambiguous about whether mutual fund returns are predictable. Thus, the usefulness of past performance as a selection criterion is limited because of the volatility of investment returns, Haslem and Baker said in their paper on an empirical analysis of retail S&P 500 Index Funds with diverse expense ratios. On the other hand, they noted that Malhotra and McLeod (1997) found fund expenses to be one of the few predictable aspects of investing, but one that investors often fail to consider when selecting a fund. 'A long-standing debate exists about whether a fund's performance is due to management quality, other fund attributes or just luck,' Haslem and Baker wrote. 'One strand of the finance literature finds that managers of actively managed funds have some stock-picking talent.' For example, studies by Grinblatt and Titman (1989, 1993), Grinblatt, Titman and Wermers (1995), Daniel, Grinblatt, Titman and Wermers (1997) and Frank, Poterba, Shackelford and Shoven (2004) found that mutual funds tend to select stocks that outperform a broad market index and outperform passive benchmarks of stocks with similar characteristics. These studies base their analyses on the gross returns of the portfolio holdings of mutual funds and typically do not account for transaction costs or expenses. Wermers (2000) analysed the performance of US equity mutual funds from 1975 to 1994. His analysis showed that mutual fund managers hold stocks that beat the market portfolio by almost enough to cover their expenses and transaction costs. Kacperczyk, Sialm and Zheng (2005) found that funds with concentrated portfolios perform better than funds with diversified portfolios. This evidence lends support to the value of active fund management. Another strand of the empirical literature produces disparate results. Evidence from Jensen (1968), Malkiel (1995), Gruber (1996) and Carhart (1997), among others, shows that actively managed funds, on average, underperform benchmark portfolios with equivalent risk by a statistically and economically significant margin. Their conclusion is that after accounting for expenses and transaction costs, active managers, on average, destroy value. Predictability Carhart (1997) found that common factors in stock returns and investment expenses explain almost all of the predictability in mutual fund returns. He reported a significantly negative relation between performance and expense ratios, portfolio turnover and load fees. An implication of the underperformance of most actively managed funds is that investors would be better off in low-cost passively managed index funds, said Haslem and Baker. Indeed, if one only has a less than 40 per cent chance of outperforming the market index by buying into an actively managed fund, and the best fund succeeded in beating the market index by 2.5 percentage points a year over a three-year period before transaction costs, then perhaps simply buying an exchange traded fund (ETF) may not be that bad an alternative. But the problem with an ETF is that its price is available every second, every minute of the day. This may cause investors to be short-term in their outlook as they are tempted to trade in and out in response to the daily gyrations of the market. But as many great investors have demonstrated, it is those who take a long-term view who enjoy the big returns. The writer is a CFA charterholder. She can be reached at hooiling@sph.com.sg | |||||||||
