Not to burst anyone’s bubble, but active investing might not really be everyone’s perfect cup of tea. Or is passive investing the way to go? In some instances, we might be better off leaving our investment decisions to a professional. But when is this the case?
WHEN IS HANDING IT OVER TO THE PROFESSIONALS THE BETTER OPTION?
Of the many reasons, we feel that the most straightforward of the lot is simply due to a lack of interest. We believe in doing what you love in life. For most things, we all need a certain level of interest to keep the fire burning and active investing is no exception. Therefore, for those without an interest in investing, it may be best to leave it to the professionals.
Another constraint is time, or rather the lack of it. Although investing is simple, it is not easy. And investing does take time away from your usual activities. For those who lack the time, delegating the work to a professional might be the way to go.
Lastly and most importantly, a key factor is when one lacks the ability to control their temperament. A successful investor must be able to control their emotions and remain composed even when the rest of the market behaves irrationally. Warren Buffett once said that investing is not about a guy with an IQ of 160 beating a guy with an IQ of 130. Even Newton got caught in the South Sea bubble. Simply put, investing is about being able to stay level headed about your investment decision and not to be influenced by the irrationality of the herd. Unfortunately for many, temperament is not something that can be can be easily cultivated. And for investors faced with challenges in the area of emotional control, considering professional management might be a good alternative for them.
WHAT DO WE LOOK OUT FOR WHEN ENGAGING PROFESSIONALS?
Choosing the right professional to handle your investment is a challenge on its own. Many studies have shown that on average, most professional mutual fund managers failed to outperform a passive index fund. Therefore, some suggest that it may be best for passive investors to just invest in passive index funds. By buying the market, you would never ever underperform that respective market. Even Warren Buffett himself has advised us on this subject. He has openly mentioned that the choice of investment for the bulk of his liquid estate after his passing will be placed into a low-cost index fund.
However, for investors who want to go with actively managed funds, choosing a good fund is important.
Three key considerations in your search include understanding the fund’s:
1. Investment Mandate and Strategy
2. Track Record
3. Fee Structure
1. Investment Mandate and Strategy
With so many investment strategies out there and with funds getting more ‘creative’ by the day, you have to know what you are investing in. It is important to choose a fund with an investment mandate that it simple to understand and most importantly, one that you believe in. Be wary of investment strategies that appear to be too complicated.
As a rule of thumb, if you are unable to understand how the fund plans to make money or what you are investing in even after reading it 3 times, it might be best to give the fund a pass. With so many choices in the fund management world, there will be something in line that fits your investment objectives. It is just not worth it to invest in something that you do not feel comfortable with.
2. Track Record
When looking at a fund, it is a good idea to take stock of the fund’s performance history. Although past performance is not an indication of future performance, it would provide us with a base to work from. Furthermore, this gives us a chance to check if the performance makes sense. For example we take into consideration a fund with an investment mandate of being solely invested in the Singapore market. If this fund returned 10% in a particular year while its benchmark, the Singapore Straits Times Index dropped 20% during the same time, it might be worth your while to dig deeper.
This boils down to the simple reasoning of mean reversion. On the average, a fund’s return should not vary too much from its average if you not doing things too differently. In the event of an outperformance, it pays for one to delve deeper into the details to find out the reason behind their success. When a fund outperforms their benchmark over an extended period of time, we can come to two conclusions:-
– They are doing something good
– They are doing something bad
Bernard Madoff, the perpetrator of one of the largest Ponzi scheme in history, was the poster child of the latter.
A Ponzi scheme uses the ‘investment’ of new investors to pay off earlier investors. New money is disguised as profits to pay off the high returns promised to the earlier investors. Basically your ‘investment’ is recycled as ‘dividends” to earlier ‘investors’. Once there is no new ‘investment’, this whole house of cards comes tumbling down. Madoff’s operations worked by promising his investors with a consistent growth of above 10% every year regardless of the volatility of the market. A good rule of thumb is to be wary of someone ‘guaranteeing’ you double digit returns. Investors blinded by the allure of consistently high returns completely disregarded the possibility that things might be too good to be true.
To us, what’s amazing wasn’t the collapse. But rather Madoff’s ability to carry on while at the same time being recognised as a distinguished member of the Wall Street community. Not only was Bernie Madoff the former Chairman of NASDAQ – one the world’s largest exchange, he was also a well-known philanthropist. The story of Bernard Madoff should act as a reminder for all of us. If it looks too good to be true, well it most likely is.
3. Fee structure
Another important aspect of choosing the right fund manager would be to look at the fund’s fee structure. Most mutual funds work on a fixed yearly management fee while hedge funds typically charged a flat management fee plus a performance fee based on the fund’s performance. When reviewing the past performance of the fund, it is important to check if it is presented net of all fees for an apples-to-apples comparison.
Some funds with high fee structure might be very damaging to an investor’s return. The more they take, the less you make.
THE ART OF CHOOSING
Evaluating a fund is by itself an investment skill. Not only will learning to be a better investor improve your financial position in the future, it can also improve your ability to be a better judge of characters and also impact many of your other major life choices.
And after all this talk, if you are still interested in investing in funds, you might want to check out SGX listed iFAST Corporation Ltd’s website Fundsupermart.com for more information!
They have over 1,000 funds offered by more than 80 leading fund managers the likes of Aberdeen, Henderson, East Spring, Legg Mason. Here’s a sample layout of Aberdeen Singapore Equity Fund with the Fund info, Annual reports and factsheet all in one stop.
LOOKING TO INDEXES
At the end of the day, if you are interested in index funds, here are two to get you started:
Submit your email address for important market updates and FREE case studies! We will only provide you with information relevant to value investing. You can unsubscribe at any time. Your contact details will be safeguarded The information provided is for general information purposes only and is not intended to be any investment or financial advice. All views and opinions articulated in the article were expressed in Value Invest Asia’s personal capacity and do not in any way represent those of his employer and other related entities.
Disclosure: As at 5 Sep 2016, Mun Hong is not a Shareholder of the above mentioned Companies.