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O ver the last decade an increasing number of investors have turned to unit trust funds to save for their retirement and other financial goals as it is a good way for the little investors to get a piece of the market. Instead of spending all their free time buried in financial reports, all investors had to do was buy a unit trust fund and they would be set on their way to financial freedom. As a result, what was once just an obscure financial instrument is now very much a part of our daily lives.

However, many would have found out by now that investing in unit trust funds is really not as simple as throwing your money at the first sales agent who solicits your business. Although in theory investing in unit trust funds is an excellent idea, in reality they may not necessarily deliver all the time. While unit trust funds can offer the advantages of diversification and professional management, it should be noted that as with other investment alternatives, investing in unit trusts involves risk. Whether you have invested in unit trusts or are thinking of joining the bandwagon, it would be useful to be aware of the common mistakes investors make while investing in unit trusts.

By Daud Yunus

Myth 1: Performance is Not All

While fund rankings and ratings often emphasize how well a fund has performed in the past, the fact is a fund’s past performance at a point in time is really not as important as you might think. Looking at past performance may mean you end up investing in funds that have already made big gains, not funds that are positioned to make profits in the future.

Table 1 shows how investors make the mistake of ignoring funds that did not perform well the previous year. Funds that did not make it to the top quartile in 2004 were able to significantly improve their ranking in 2005 with most making it to the top quartile. Whilst the table only shows two funds in each category with the greatest step up in ranking, there were a large number of funds that were able to improve their rankings within a year.

This is because different asset classes perform differently to changing market conditions. It is rare for an asset class to repeat last year’s performance, be it over or under performance. Sometimes too the fund manager who built the track record you are looking at may no longer be managing the fund. If the manager has changed, then the past record of the fund is no longer valid.

Many forget the mandatory fine print: “past performance does not guarantee future performance” – what it really means is performance is just an indicator. If you narrow your focus too much on historical numbers you could miss out on the funds with real potential. Remember too that the table shows the ranking as at a particular point in time. The picture may not look the same if a different time period was selected or if you look at cumulative performance. An added danger about over emphasis on performance is that it puts pressure on fund managers to keep up with their performance. This could result in fund managers taking on extra risk to pursue higher returns, which in turn, expose the fund

Table 1 : Performance is not all

Equity

Equity

Equity Index

Equity Index

Equity SmallCap

Equity SmallCap

Balanced

Balanced

Bond

Bond

Islamic Balanced

Islamic Balanced

Islamic Equity

Islamic Equity

Islamic Equity

Islamic Bond

Islamic Bond

Category

Avenue EquityEXTRA

Kenanga Growth

Public Index

OSK-UOB KLCI Tracker

MAAKL Progress

AUTB Progress

TA Income Fund

Pacific Income

CIMB-Principal Steady Return Bond

AmBond Fund

Affin: Dana Islamiah Affin

KL City Dana Imbang

Kenanga Syariah Growth

Mayban Dana Yakin

TA Islamic

AmBon Islam

BIMB-ASBI Dana Bon Islam

Fund Name

4.48%

0.91%

6.89%

9.85%

-5.01%

-8.86%

2.72%

4.18%

6.16%

5.64%

-3.43%

-6.39%

1.92%

-5.52%

-5.83%

7.08%

6.72%

2004

3

13

2

1

2

3

6

4

8

12

5

9

2

11

12

3

5

Rank

6.04%

3.58%

13.28%

14.77%

1.82%

2.51%

2.52%

8.33%

4.43%

0.71%

0.25%

-0.35%

2.57%

-3.90%

0.90%

-0.63%

5.20%

2005

35

40

8

5

6

5

22

14

22

24

10

12

19

23

20

7

6

Rank

Source: Normandy Research

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and the investor to more risk.

To avoid this, fund investors should consider current market conditions, the fund manager and the fund objectives rather than look at one-time performance. Examine the consistency of returns over three to five years against a benchmark index and other funds in the category. Track how the fund performed during the good and bad phases of the stock and bond markets. After returns, look at a fund’s investment style and see how it fits your risk-return profile. The fund prospectus will show its investment objective, how it would be achieved, and the risk-return positioning.

Myth 2: Cheap is Better

The lower the unit price the better the investment. Many investors have the misconception that unit trust funds with low unit price are better because they get to own more number of units for the same amount of investment.

The fact is the performance of a fund does not depend on the fund’s price. Performance depends strictly on how the underlying assets held by the fund perform. A fund priced at RM2 per unit is no more expensive than a fund priced at 50 sen, especially if the minimum investment amount for the two funds is RM1,000 and they both invest in the same stock market. That means if you invest RM1,000 in either fund, you will have RM1,000 worth of stocks.

How can a fund priced at RM2 a unit be considered cheap? Assuming that the fund has RM10 million worth of stocks and each unit is RM1. The stocks the fund holds perform very well and doubles. The fund is now worth RM20 million and each unit is priced at RM2 assuming nobody buys or sells the fund. If the fund manager decides to sell off RM10 million worth of the stocks as those stocks have risen to their fair value and replaces them with RM 10 million worth of undervalued stocks. The remaining RM10 million worth of stocks the manager holds because these stocks still have upside potential. The fund now with RM20 million worth of stocks and each unit is still RM2 would not be expensive

since each unit is part of a portfolio of good undervalued stocks that have the potential to appreciate much further. Investors should never look at the fund price and judge if a fund is cheap or expensive. Price really does not matter.

Myth 3: All Unit Trust Funds are Risky

In general, unit trust funds carry much lower risk than stocks. This is primarily due to diversification. With stocks, the worry is that the company you are investing in goes bankrupt. With unit trust funds, there is little chance of the fund going bankrupt since unit trust funds typically hold more than 50 companies, all of the companies that it holds would have to go bankrupt for the fund to collapse.

The fact is all investments carry some leve l o f risk and every investment has advantages and disadvantages. If you expect your investments to make returns for you then you can expect that you may lose some or all of the money you invest because the securities go up and down in value. Even dividend or interest payments fluctuate as market conditions change.

To avoid this, investors should always hold a basket of securities to diversify the risks. The trick is to match the risk profile of your investment to your own risk appetite. Remember that features that matter to one investor may not be important to you. Whether any particular feature is an advantage for you will depend on your own unique circumstances. The real danger is not whether unit trusts are risky but investing without understanding the risks involved.

Myth 4: Unit Trust Funds Are Too Expensive

It is important to understand the

structure of a unit trust fund to appreciate how expenses are charged. There are several entities involved in a mutual fund, like the Trustees, asset management companies (AMCs) and the unit trust management companies (UTMCs). The last two are the most important elements in the context of our discussion. The UTMC launches the unit trust fund schemes. Quite often the AMC and the UTMC could be two distinct entities and have distinct revenue streams and expenses.

As is evident from the Table, the expenses of UTMCs typically comprise of fund management expenses, trustee fees, tax and audit fees among other expenses. These are expenses the fund incurs on an annual basis to operate the unit trust fund.

This is over and above the entry fee, which is a one-time fee of between five to six percent. The entry fee is usually a distribution expense that the UTMC passes on to your unit trust agent.

The fact is, if an investor were to try to invest like a unit trust fund it would cost an individual much more. Investing RM10,000 in a unit trust fund would cost an investor RM760 assuming entry fee of 6 percent and recurring fees of 1.6 percent.

An investor investing with the same sum of RM10,000 directly in the stock market would incur fees of RM788 for a portfolio of 30 stocks and RM 1,308 for a portfolio of RM50 stocks. That is assuming you do not trade actively.

(The Recurring Expenses Table has been sourced fromthe Prospectus of an existing UTMC)

Table 2 : Typical UTMC recurring expenses

Expense

Fund management feesTrustee FeesAudit Fees

Tax Agent’s FeeAdministration

Other Expenses

Total Recurring Expenses

% of net assets

1.50%0.07%

0.004%0.002%0.024%0.03%

1.606%

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With unit trust funds, you are essentially hiring a professional manager at an especially inexpensive price to do the work for you. The fees pay for the benefit of having a competent fund manager, who takes time, effort and expertise to research stocks and sectors to pick the best 30 to 50 stocks and buys and sells them for you. Of course this additional fee should be followed by out performance of the benchmark index and even peers. The good news is that there are quite a number of unit trust funds that have generated good performance results over three to five

years against the benchmark index and their peers.

Investing is serious business that is best approached with a methodical approach. Unit trust funds allow for that and investors should try to benefit from them. While you can choose to do it yourself by spending all your time researching, analysing and trading stocks, history tells us that not many individuals have been successful doing it on their own. If you lack the time or expertise to invest directly then why take the risk of making the wrong decisions.

Remember that fees are not necessarily the first criterion for assessing a unit trust fund. Asset management is not a free service and good fund managers deserve to be compensated for their services. If you know exactly what you are paying for and you think it represents value for money then, is the price you pay really that expensive? At the end of the day, being a successful

investor is about making the most prudent investment decisions.

Myth 5: Unit Trust is for Speculation and Short-Term

Many investors tend to treat unit trusts like stocks moving in and out of funds, either in an attempt to time the market or to “take profits” when the price has gone up. One of the greatest roadblocks to successful long-term investing is impatience. Impatient investors are no different to those impatient drivers on our roads. They are always mindful of

what lane they are in and how other lanes are doing compared to theirs. They watch for every little opening and swing from lane to cut in front of someone else to get any slight advantage for themselves. While they may indeed save a few minutes, they don’t realise that the process is extremely dangerous and annoys everyone around them. Translate this to investment terms and you have investors who take on too much risk in return for uncertain gains. The fact is many forget that unit trusts are long-term investments. If you are not prepared to hold on to you unit trust investments for at least three years or more you are playing a loser’s game. Impatient investors also make easy prey. In their quest to chase returns, they can be lured to change lanes, and change lanes again rarely giving their investment or strategy enough time to perform adequately. Not only is switching in and out of funds costly, it has been proven over that investors

are incapable of timing the market or identifying major bull or bear markets. For those who spend too much time watching the market and your fellow investors like a hawk, you would do much better spending time looking for investment opportunities over the next five to 10 years.

Pa t i en t i nves to r s who make investments and stick with them for may look very boring but they are more likely to sleep well along the way and be able to devote their attention to other things in life.

Investing in unit trust funds need not be that difficult. Before you invest, be sure to read a fund's prospectus and shareholder reports to learn about its investment strategy and the potential risks. Funds with higher rates of return may take risks that are beyond your comfort level and are probably inconsistent with your financial goals. Another fundamental rule is to diversify your investment portfolio. Unless you can predict

the future, you have to be prepared for it. The way to prepare for it is to accept the fact that you don’t know what part of the economy and what part of the markets are going to be attractive. It could be stocks or bonds or short-term or long-term investments – hence the need to diversify. Last but not least, always have a plan for your money. Each time you decide on an investment strategy, whether you are planning for retirement or some other purpose, ask yourself:

• How much to put in this plan and • For how long to hold this plan

This will give you a good sense for whether your plan is working out or not, and when to get out and when to hold.

Daud Yunus, is the Group Managing Director of Normandy Advisory Services Sdn. Bhd., a licensed Investment Advisor and Fund Manager.

Table 3

Total Investment

Diversification Counters

Average Size of Investment

Brokerage (0.7% or RM12 minimum)

Clearing Fee

Stamp Duty

Total Charges per Trade

Total Buy & Sell Charge per Investment

Total No.of Investments

Total Buy & Sell Charges

Total Buy & Sell Charges as % of Total Investment

RM10,000

30

RM333

Charges (RM)

12.00

0.13

1.00

13.13

26.27

30

788.00

7.88%

RM10,000

50

RM200

Charges (RM)

12.00

0.08

1.00

13.08

26.16

50

1,308.00

13.08%

Source: Normandy Research

UT