What You See Is What You Get? I

Whenever someone makes an investment, being it in equities, mutual fund (unit trust), real estate and so forth, his objective is to maximize his Return On Investment (ROI). In Mutual Fund, a conventional belief of its return is around 12% per annum. An outcome of the investment return will varied depends on different strategies employed by the investors. Bear in mind that in mutual fund investment, there are 2 typical charges, ie: Sales Load which hover around 5 to 6.5% and Annual Management Fee at 1.5%. Whenever we look at the table of the mutual fund, there would be 3 columns, which are Offer Price (OP), Bid Price (BP) and Net Asset Value (NAV). The difference between OP and BP constitute Sales Load. To make a picture clearer, let’s show you an example.

John invested $ 10,000 in Fund KSA on 2nd January 2006 at OP of $1. With this, he will have 9,350 units of the fund (Note: 6.5% Sales Load). After a year, Fund KSA OP is at $ 1.20. At a glance, it shows a return of 20% per annum. Quite impressive with this return rate. If he sold all of his 9,350 units, he will get $ 10,333 (9,350 * $ 1.10517). Instead of the 20% return, he only manages to get the return rate of 3.33% of his original investment. Playing magic, huh? Sometimes, what you see is NOT what you get….

Fund of Fund(s) (FOF)

Finally….after been in the market for quite of time in western world, especially US, it reaches to Malaysia, a relatively new market of fund management -- Fund of Fund(s). News clip of FOF, click here.

What’s Fund of Fund(s) (FOF) is all about? FOF is a fund invested its money into another mutual fund, in contrast to the conventional way, where mutual fund invests directly in equities, commodities, currencies, bond and so forth. When its conventional peers need to stretch their head to find out the best investment opportunities, FOF need not do so. What FOF needs to do is to find out the best mutual fund and invest on it.

What’s the benefits could investors gain from FOF? If we link a relationship between investment products (equities, commodities, currencies, real estate….etc) and investors similar to manufacturer and end user, then mutual fund (unit trust) role is like a retailer. When the products passing on from one level to another level, there is a cost of conducting business. That’s why mutual fund charges its investors sales load (5 – 6.5% of initial investment value), annual management fee (1.5% of NAV) and so forth. What happen if there is another level on top of retailer, ie: distributor? Put it an example, how much you pay for your airline ticket if you book directly from the internet compare to the one you buy from an airline agent?

Besides creating extra cost of business which is ultimately passing on to its end user, I see no value in the perspective of investors for creating another level. Of course, if you are a promoter or interested parties of these funds, there is another story.

Capital Guaranteed Fund II

In Malaysia, typically fund will charge 5- 6.5% of fund’s Net Asset Value (NAV) as sales load. That means $100 you invested, only $95 - $93.5 is invested for you by fund managers. The remaining $5 - $6.5 is paid to their sales force and admin fee. Thus, by investing in the fund with same amount compared to the one, John who does it by his own, to achieve same result after a year, say 10% return of $100 investment, you need not 10% return but roughly 16% return! Table illustrates the scenario:

John $100 $110 10% annual return
You $95 $110 16% annual return

It likes a 100m race where John starts at 0m but you start at -5m and assuming both of you have similar accelerating power, who will be the winner is no doubt in question.

Second part of income generated for fund management is through management fee. In Malaysia, typical rate is 1.5% NAV per annum. Putting DUT Fund as an example, with RM 300 million at the beginning of the year, assuming there is 0% return at the end of the year, its NAV will be RM 285 million (RM 300 million – (RM 300 million * 5%)). Thus, its first year management fee would be RM 4.275 million. What’s the management fee for the remaining 2 years? RM 4.21 million and RM 4.15 million. Total management fee for entire 3 years is RM 12.64 million. Good business, isn’t it? At least for the fund management. What’s investors get after 3 years maturity? From RM 300 million at the beginning of the fund launching, investors left with RM 272.36 million (RM 300 million – RM 12.64 million – RM 15 million).

You will wonder why investors left with RM 272.36 million while at the same time, the fund is guaranteed for its capital of RM 300 million? That’s the difference occurs when we are talking about PRESENT VALUE and FUTURE VALUE.


To find out PRESENT VALUE and FUTURE VALUE, click a link below:
Financial Calculator

Is Mutual Fund a Good Investment? II

People tend to think that their investment made in mutual fund is 100% of their money invested. This assumption is totally out of the reality. In real life, what you invest is lesser than the money you pour out. This means when you invest $10,000 in SDF fund, the money managed by fund manager for the investment purpose is not $10,000 but lesser. You would be amaze and ask if it is not $10,000 then how much is really for investment purpose?
People invest in mutual fund should be aware there are 2 different prices, ie: selling price and buying price similar to currencies exchange rate. The selling price of the fund is ALWAYS HIGHER than buying price. For example, selling price is $1 while buying price is $0.935. What is this means? That means fund management sold you the fund for $1/unit and if you decide to sell it back to them (providing there is no fluctuation of the prices), you only get back $0.935. Say, if you bought the fund for $10,000, then you will only get back $9,350. Where is the remaining $650? Evaporate in the air or taken by the Martians? Nope, that is the cost paid to the pretty or handsome guys who persuade you to invest in his fund, the fancy sales booth….etc. The difference of the prices is called Sales Load.

What’s the impact of Sales Load and management fee (note: mutual fund normally incurs 1.5% of NAV as yearly management fee) to your investment in the long run? It’s huge! Let me show you the example. There are 2 investors, namely, John and Tom. John invested his money amounting $10,000 in SDF mutual fund while Tom invested his money, same amount as John directly to equity market. Assuming both investments bring them same return rate, ie: 12% per annum. What’s the end result after 10, 20 or even 40 years?

Year 0 Year 10 Year 20 Year 30 Year 40
John: $10,000 $24,966 $66,665 $178,008 $475,315
Tom: $10,000 $31,059 $96,463 $299,599 $930,510

As from the table shown, the difference of investment result for John and Tom in term of percentage after 10, 20, 30 and 40 years are 24.41%, 44.70%, 68.31% and 95.77%. This means, although the return rate for both are same, ie:12% per annum but after deducting hidden cost by mutual fund, it brings a disastrous result to its investors. As you notice, the difference could be as huge as double after 40 years!

Please bear in mind that the calculation is based on consistent 12% per annum return rate. The difference could be further if in particular years, there are negative return rate. Remember that, mutual fund management fee is Asset Based Commission (ABC), which means no matter how’s the performance of the fund, 1.5% of the ENTIRE NET ASSET VALUE will still deducted from the fund. What do you think about your fund manager performance? Do you believe they are so superior that they could register consistent high, positive return rate for you in the long run, ie: 40 years? Or is it makes sense that they somehow might make some mistakes and bring negative return to the fund? How about switching from SDF fund to ASD fund, you might ask. It is truth that this is what people normally act if one fund does not perform, they will switch to another fund. My answer? Unless you are sure the fund you switch to is by high probability they are superior than others, otherwise, don’t do it. The reason? SALES LOAD.

Technorati Tags: Investment, Mutual Fund, Unit Trust, Asset Based Commission, Sales Load, Net Asset Value, NAV, Equity,

Is Mutual Fund a Good Investment? I

Before we jump into a conclusion, we should examine how’s Mutual Fund (known as Unit Trust in English Commonwealth countries) works.

Promoters and salesmen for the mutual funds are very friendly, some even hire only pretty ladies or handsome guys to lure the investors. This is not a bad thing since every one likes beautiful things and people. Everyone likes to be pleased. Remember when you shop in the jewelry shop, whatever you choose, you will be praised by the salesmen that your taste is very unique – that gives you an impression that you are the only one in the world, you are superior. Because of the feeling, it is naturally that you would pour out money to buy the jewelry. Whether the praise mentioned by the salesmen is truth or not is not important. After all, what lies in the salesmen mind is to sell you out the jewelry and earn the commission.

Business is business and for sure there is no free lunch in this world. Everything incurs cost. By setting up a fancy sales booth, hiring friendly yet pretty sales people, or even drives directly to your house or office to promote his funds all incurs cost, being it directly or indirectly. People naïvely think that it does not cost him single cent are doomed to be manipulated. While it is legal and makes sense that business needs to earn in order to sustain its operation, it is VITALLY important that the place you invest should at least protect your asset value for the first place and then enhancing its value for the later part. If the investment you made could not meet its first role of protecting its value, not mentioning of enhancing its value, it is worthwhile thinking of whether you make a sound investment or not. The case is worse if the investment you made not only does not protect its original value but bring you a negative value.

The problem lies in the mutual fund industry is its management fee is based on Asset Based Commission (ABC). That means no matter what’s the performance of the fund, being it good or bad, it will deduct 1.5% of the ENTIRE NET ASSET VALUE (NAV) of the fund. Put it an example, say Fund JKL NAV is $1 billion. Thus, at the end of the year, the fund manager will deduct 1.5% of NAV, that’s $15 million from the fund as management fee. Whether the fund performance is positive or negative is not the prime consideration. It is no wonder fund managers are looking for the biggest fund – the bigger the fund, the more they earn. This problem happens in almost every industry where the managers manage Others People Money (OPM) and this scenario is known as Owner-Agency Conflict.

How to prevent us from falling prey into this Owner-Agency Conflict? First of all, ask yourself what’s the objective of the investment you made? To please someone? Cannot resist because of pretty ladies or handsome guys persuasion? Or to create value to your asset? If the answer is the latter, then you need to choose carefully your fund manager. He should be the one whose his management fee should be Performance Based Commission (PBC) rather than Asset Based Commission (ABC). If his performance is poor, there is no reason he still receiving a handsome pay check. On the other hand, if he delivers, we should share some of our profits with him. Doesn’t it fairer?

Technorati Tags: Investment, Mutual Fund, Unit Trust, Asset Based Commission, Performance Based Commission, Net Asset Value, NAV, OPM, Owner-Agency Conflict

Conventional Wisdom III

3) Investment should leaves to professionals

We often been brainwashed by financial institutions and media that the investment should leaves to professionals. The reasons they give are:
i) Investment involves complicated things, such as charts, financial reports…etc that the ordinary people could not understand.
ii) Investment should have a long term perspective.
iii) Investment needs people who have financial background to deal with.
iv) Investment needs to be monitored day by day even minute by minute.
v) Market would be more stabilized when the investment is made by professionals and not retail investors.
….. and the list could go on and on.

While some reasons given are true, there are some reasons given LOOK TRUE but indeed are TOTALLY WRONG!! Put in an example: Investment needs to be monitored day by day even minute by minute. What are they mean? Are they mean you should sit in front of the screen to monitor the price changes all the times when the market open? (I am referring to the investment like equities, commodities, future or option market). When the price up, we chase it and when the price falls, we dump it like hell? Is this the practice of the so called professionals? The investment decision is driven by PRICE but not VALUE? There is no wonder Warren Buffett ever said: “There are too many people who knows everything about PRICE but nothing about VALUE.”

There are too many cases where the professionals that supposed to be forces of stability when market becomes panic, act the reverse – they are even worse than retail investors by creating more volatility. You would also notice that the investment decision of those professionals could be change in the shortest period. Today, they might buy ABC equity, tomorrow they can sell it, even at lost. This leaves me in puzzle -- The decision making could be change so rapid? Isn’t it an unsound decision? or there are hidden agenda underneath that we do not know?

Before we place our money to the professionals to manage, it’s very important to understand how’s the game works – where the interest of yours and your money managers. Are there any incentives for them to manipulate your money? How their income generates? By performance, asset value or other indicators? We should not fall prey into the trap of the predators waiting to “slaughter” you while at the same time you are assuming they are creating value for you. If this happens, that’s pity, isn’t it? And this happens days and nights…

Technorati Tags: Professional, Investment, Value, Net Asset Value, NAV, Price