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To Invest In Exchange Traded Funds or Unit Trusts?

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The top performing Singapore-focused unit trusts in the ten years to end January 2013 were Nikko AM Shenton Thrift and Aberdeen SP Singapore Equity.

According to research firm Morningstar, the former registered an annualised return of 13.9 per cent, while the latter managed 13.2 per cent a year during that period. Based on those return numbers, a $150,000 invested in Shenton Thrift back in 2003 would have grown to about $550,000 as of end January 2013. Aberdeen would have grown the same amount to about $520,000.

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These are admirable results. But remember, 2003 was the year when the US military launched its “shock and awe” campaign against Saddam Hussein’s Iraqi forces. As if that was not enough, here in this part of the world, we also had to grapple with the fears and panic surrounding the Severe Acute Respiratory Syndrome epidemic. Most would find 2003 to be a difficult time to invest in the market. As such, asset prices were severely depressed. But as it turns out time and again, the most difficult times are the best times to invest.
For comparison, just how did the Straits Times Index do during that same period relative to the top unit trusts?

Pretty similar! A $150,000 invested in the index would have grown to $536,000 for a return of 13.6 per cent a year. The assumptions are that dividends were reinvested back into the index and no transaction costs are taken into account.

The Best Unit Trusts Failed To Beat The Market

Here’s how Morningstar calculates the total returns of the unit trusts. It takes the change in monthly net asset value (NAV) – with all income and capital-gains distributions during that month reinvested – and divide that by the starting NAV.
Morningstar does not adjust total returns of the funds for sales charges, such as front-end loads, deferred loads, redemption fees and bid-offer spread when dividends are reinvested. If one were to include all the above transaction costs or charges, the return for an investor in either fund would be lower than the reported number.

In other words, after taking into account transaction costs, even the very best unit trusts in Singapore failed to give its investors a return that matched the market return! Just on the reported returns alone, without factoring in investors’ transaction costs, most unit trusts struggle to beat the market index because of the fees which are charged to the funds annually. The annual report net expense ratio of the Aberdeen Singapore fund was 1.67 per cent, while Nikko Shenton Thrift’s was lower at 0.83 per cent, according to Morningstar’s 2013 report. This difference in fees is probably one reason why Nikko’s performance is better than Aberdeen’s.

Expense Ratios Make a Huge Difference

Expense ratios are fees charged to the fund to pay for the fund managers’ salaries, the fund management company’s operating expenses which include their swanky offices, and the running costs of the funds such as broker commissions, custodian and fund administration fees, among other things.

The higher the expense ratio, the more difficult it is for a fund to outperform its benchmark. Unless the fund manager is able to consistently generate returns that exceed the benchmark by enough to cover the annual fund expense ratio, investors are generally better off by simply buying into the lower cost index funds.

The above article is written by Teh Hooi Ling, Head of Research at Aggregate Asset Management. Aggregate Asset Management is the manager of Aggregate Value Fund, a no management fee Asia equities fund.

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