Why There is NO Unit Trusts ( Mutual Fund ) in My Portfolio

I guess most investors also having experience of buying a unit trusts (aka mutual fund) or maybe having unit trust in their portfolio at a certain point of their investing life. 

Depending on the situation, some may have bitter experience and few lucky one may have made money from their investment in unit trusts.

Quoted below from Investopedia :

What is a 'Mutual Fund' :

A mutual fund is an investment vehicle made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets. Mutual funds are operated by money managers, who invest the fund's capital and attempt to produce capital gains and income for the fund's investors. A mutual fund's portfolio is structured and maintained to match the investment objectives stated in its prospectus.

BREAKING DOWN 'Mutual Fund'

One of the main advantages of mutual funds are they give small investors access to professionally managed, diversified portfolios of equities, bonds and other securities. Each shareholder, therefore, participates proportionally in the gain or loss of the fund. Mutual funds invest in a wide amount of securities, and performance is usually tracked as the change in the total market cap of the fund, derived by an aggregating performance of the underlying investments.

Mutual fund units, or shares, can typically be purchased or redeemed as needed at the fund's current net asset value (NAV) per share, which is sometimes expressed as NAVPS. A fund's NAV is derived by dividing the total value of the securities in the portfolio by the total amount of shares outstanding.

Things like “ professionally managed, diversification “ often being cited as a benefit of investing in unit trusts,, BUT …. What about cost and their performance?

Fees Associated With Mutual Funds

When an investor purchase shares in a mutual fund, he has usually assessed a fee known as an expense ratio. A fund's expense ratio is the summation of its advisory fee or management fee and its administrative costs. Additionally, these fees can be assessed on the front-end or back-end, known as a "load" of a mutual fund. When a mutual fund has a front-end load, fees are assessed at the time of the initial purchase. For a back-end load, mutual fund fees are assessed when an investor sells his shares.

Sometimes, however, an investment company offers a no-load mutual fund, which is a fund sold without a commission or sales charge. These funds are distributed directly by an investment company rather than through a secondary party. To learn more about mutual funds, read How to Pick a Good Mutual Fund and Investopedia's Mutual Fund Basics Tutorial.

How Fees erode our return .. even with 1 or 2 % point,,, huge impact in the long run!

Passive vs active fund performance in 2014  ( if you are lucky, you might be in the group of 15% )

image credit to GolmanSach.com

How about fund performance from Europe? Well, almost the same,  below link from FT.com :

86% of active equity funds underperform!

More money is moving into passive funds 

image credit to Morningstar.com

Below links from a few famous financial bloggers would give you a very good insight and understanding on pro and con of investing in unit trust :

The stuff that could make all the difference in your Mutual Funds: by TACOMOB

How Paying 1% In Investment Fees Could Mean Giving Up To 1/3 Of Your Wealth: by Budget Babe

 Why Investing In Mutual Funds or Unit Trusts May Not Be A Good Idea? : by BIGfatpurse

No discussion on unit trust ( mutual fund ) is complete without knowing what is " survivorship bias ".

What is 'Survivorship Bias '

Survivorship bias is the tendency for mutual funds with poor performance to be dropped by mutual fund companies, generally because of poor results or low asset accumulation. This phenomenon, which is widespread in the fund industry results in an overestimation of the past returns of mutual funds.

Also known as "survivor bias".

BREAKING DOWN 'Survivorship Bias '

For example, a mutual fund company's selection of funds today will include only those that have been successful in the past. Many losing funds are closed and merged into other funds to hide poor performance. This is an important issue to take into account when analyzing past performance.

Those funds that your banker/insurance agents / financial planner ( commission base ) show you were those left after many funds been closed or merged. As such, this may not represent the true performance of the fund manager or trust investment company.

My Experience :

Well, I do not belong to that 15 % of betting the market by selecting the right unit trusts to invest at the right time.

In my early days of investing, I have invested in one of the unit trust recommended by bank staff ( that was about 16 years ago while I was still learn how to invest ).  Being influenced by some of the books and article on the benefit of investing in a unit trust ( again the same highlight of managed by professional, diversification and nice past performance chart etc … ), I have put some money into the so-called “ balanced fund “.

The result was quite obvious that …. turned out to be a bad investment with double-digit loss.

One of the thing that really pissed me off was that, in reading through their annual report, I found out that the fund was having more than 120 % of the portfolio turned over ratio p.a.

Concept explained: Fund Turnover Ratio ( by Investopedia )

What is the 'Turnover Ratio'

The turnover ratio is the percentage of a mutual fund or other investment's holdings that have been replaced in a given year, which varies by the type of mutual fund, its investment objective and/or the portfolio manager's investing style. 

For example, a stock index fund will have a low turnover rate, but a bond fund will have high turnover because active trading is an inherent quality of a bond investments; likewise, an aggressive small-cap growth stock fund will generally experience higher turnover than a large-cap value stock fund. Also, the more portfolio turnover in a fund, the more likely it will generate short-term capital gains, which are taxable at an investor's ordinary-income rate.

BREAKING DOWN 'Turnover Ratio'

Actively managed mutual funds with a low turnover ratio show a buy and hold strategy. For example, a mutual fund investing in 100 stocks and replacing 50 stocks during one year has a turnover ratio of 50%. However, because the average turnover rate of managed mutual funds is approximately 85%, nearly all of the funds’ holdings are being turned over annually. Some funds hold their stock for less than twelve months, meaning their turnover ratios exceed 100%.

Importance of Knowing Turnover Ratio

Knowing the historical turnover of a mutual fund helps an investor determine the fund’s expected performance in the future. Some funds such as bond funds and small-cap stock funds have naturally high turnover ratios. High turnover results in increased costs for the fund and decreased returns for shareholders due to shareholders paying spreads and commissions when buying and selling stocks.

 In addition, funds with higher turnover ratios distribute yearly capital gains on which shareholders pay taxes, which lowers shareholders’ returns. In contrast, low turnover results in decreased costs for the fund and increased returns for shareholders. Also, funds with lower turnover ratios distribute fewer capital gains on which shareholders pay taxes. Therefore, investors are advised to choose mutual funds with turnover ratios under 50% or index funds with turnover no greater than 5%.

With such an exceptionally high turn over ratio, I might conclude that the so-called “professional fund manager” might have picked all the wrong stocks at first, hence required him to replace it more than once in annual the basis or maybe he is “playing golf “ with his broker (from brokerage firm he used to trade ) at one of the prestige golf clubs.

This great book may explain: Where Are the Customers’ Yachts? by Fred Schwed

This book was written almost 76 years ago where the story still very much valid and also it been written in funny and entertaining ways.

How about you? how many % of unit trust you have in your portfolio? and are you the lucky 15% who managed to make money by investing in a unit trust?

Cheers!

Quote Of The Day :

 “For one thing, customers have an unfortunate habit of asking about the financial future. Now, if you do someone the single honour of asking him a difficult question, you may be assured that you will get a detailed answer. Rarely will it be the most difficult of all answers – “I don’t know.” From the book “Where Are the Customers’ Yachts