You are here
Which fund should you invest in?
FUNDS are an increasingly popular investment instrument. At UOB Private Bank, for instance, the amount which our clients have invested in funds rose more than 100 per cent in 2017 from the previous year. Their popularity stems from the exposure they offer to investors to a wide range of markets, asset classes and strategies, and their usefulness in diversifying a portfolio.
Given the wide selection of funds available, how should an investor choose one that will meet their investment goals?
- Understand the fund strategy and be prepared to stay invested over the long term.
Choose fund strategies that you understand. For example, there are funds that invest with a bias towards growth and technology companies, which may appeal to investors who see the technology sector outperforming over the next few years.
We also advise clients to hold a fund investment for at least three to five years so that they can ride out changing or challenging market cycles.
- Look at the returns yielded since the fund's inception date.
We advise investors to look at a fund's full return history. If you are presented with returns from a cherry-picked time period, such as a specific year without any explanation on why that year was used, ask for more information on the history of the fund.
And when comparing returns between funds, use a common time period to ensure you are comparing the performance of funds in the same market conditions.
- Know your fund's Total Expense Ratio (TER).
Many fund factsheets show only the fund's management fee structure. But you should be looking at the TER, which shows the amount required to cover the fund's total annual operating expenses.
This is expressed as a percentage of the fund's average net assets and can include various operational costs such as administrative, compliance, distribution, management, marketing, shareholder services and record-keeping fees. Consult your financial adviser if you are unable to find it.
- Appreciate the differences between index funds, alternative investment funds and liquid alternatives.
Index funds seek to replicate an index, such as the S&P 500, rather than try to beat a benchmark. As index funds are often traded on stock exchanges, they are commonly known as Index Exchange Traded Funds (ETFs).
When evaluating an index fund, you should always consider the total costs of holding the fund, such as its expense ratio, bid/ask spread and tracking difference.
The tracking difference is the difference in return between the ETF and its underlying index over a given time period. The tracking difference can be caused by a wide range of factors including rebalancing costs, management fees, cash drag, securities lending and tax treatment of the underlying income in the fund.
Another factor is the use of an optimisation strategy, where the fund comprises a representative sample of the index, instead of all the securities that make up the index.
The bid/ask spread is the difference between the price a buyer is willing to pay for an asset and the price a seller is willing to accept for it.
Liquidity of the index ETF is also important, so select ETFs from large, established index fund providers. Beware of niche index strategies as these funds may have higher expense ratios, lower liquidity and higher volatility. For instance, broad-based indices such as the S&P 500 and Topix are generally less volatile than say a niche index strategy fund such as a specific commodities-focused index.
Alternative investment funds include non-traditional strategies such as hedge funds, private equity, real estate, managed futures, commodities and derivative contracts. They are more complex and much more difficult to evaluate as reliable performance data and peer comparisons are often unavailable to the public.
When considering such funds, find out what and how a specific alternative investment contributes to your portfolio. For instance, does the fund have a lower correlation to the broader markets, such as the stock markets, or reduce the overall volatility of your portfolio? How does it enhance portfolio returns? Does the investment have a strong track record of generating returns over market cycles? Are there hidden risks, such as excessive leverage, that are being used to generate attractive returns? Are the redemption terms of the fund supported by the liquidity of the underlying portfolio investments?
Ensure that you have adequate answers to all these questions before investing or seek the help of a professional financial adviser.
Liquid alternatives are mutual funds or unit trusts that use alternative investing strategies similar to those used by hedge funds, but with higher liquidity. There are now more liquid alternatives emerging from other asset classes such as private real estate, private infrastructure, private debt and private equity.
Looking ahead, we see opportunity in liquid alternatives as they are constructed to provide investors with the benefits of a traditional alternative investment yet remove some of the main disadvantages including long investment lock-up periods. For instance, some liquid hedge fund strategies offer daily liquidity and some liquid private market investments have monthly liquidity.
The main attraction of a liquid alternative over a traditional alternative investment is its lower investment minimum and better liquidity. But some investors may still prefer traditional alternative investments as they feel liquid alternatives do not offer full diversification benefits or the full upside potential of the traditional fund. Again, we advise you to understand the trade-offs and to choose the instrument that is better aligned to your long-term investment objectives.
- The writer is head of Managed Product Solutions, UOB Private Bank