The Straits Times Index (SGX: ^STI) is one of the most widely followed stock market indices in Singapore and plays the role of a general barometer for the market. For investors who wish to invest in ‘the market’ itself, an easy option would be to invest in an index tracker that mimics the movement of the STI, such as the SPDR STI ETF (SGX: ES3) or the Nikko AM Singapore STI ETF (SGX: G3B).
Even though those index trackers will only be able to provide returns that are very close to the market, with no chance for the investor to actually beat the market, that’s actually an appealing factor when investors consider the risks of getting below-market returns when investing in actively-managed mutual funds (or unit trusts, as it’s more popularly known at home in Singapore).
And, the risk of underperformance, perhaps surprising to some, are much higher than you might think.
American mutual-fund powerhouse Vanguard did a study that showed that over a 20 year period ending 31 Dec 2010, 72% of mutual funds underperformed the S&P500 Index, a broad measure for the US stock market akin to the STI here.
While that’s a study conducted in the States, it wouldn’t be a stretch to extrapolate the low-odds of picking a unit trust that can do better than an index to the situation in Singapore.
For those that wonder why a large majority of actively-managed funds actually do worse than the market, a large part of the reason would probably stem from the annual expenses attached to them.
Morningstar compiled a report recently on investor’s experiences with funds around the globe and in our homeland Singapore, the average stock-based unit trust had an annual expense ratio of 1.94%. That’s a far cry from the annual expenses of 0.2% and 0.3% for the Nikko AM Singapore STI ETF and the SPDR STI ETF, respectively, according to the Singapore Exchange.
1.94% worth of annual expenses might seem tiny but let’s see how much a difference in expenses can actually hurt, if we use a hypothetical example of a $10,000 investment into a unit trust that is growing at 8% per annum before expenses.
The difference in actual returns that accrue to the investor is starkly different for a unit with a 0.3% annual expense ratio as compared to a unit trust charging 1.94% in expenses. For a 25 year holding period, that’s a difference between earning $53,543 as compared to $32,362!
And we have to remember that for a $10,000 investment growing at 8% per annum, the investment would actually be worth $68,485 at the end of 25 years. That seemingly small 1.94% in annual expenses has actually eaten up more than half of the investment’s returns. Does that seem small now?
In fact, for the unit trust that’s charging 1.94% in fees, it actually has to outperform its lower-cost peers (the ones charging 0.3%) by almost 1.8% per year in before-fee performance to be able to match up to the lower-cost unit trust’s returns.
And, that’s a tall order to achieve, considering that the fund managers of actively-managed funds have the propensity to pick losing stocks more often than winning ones. Talk about a double whammy!
Foolish Bottom Line
It would not be a gross exaggeration to say that there are new funds and investment-products unleashed onto you almost daily. There will be some winners out there among the entire universe of funds, unit trusts, and investment products. That’s for sure.
But, as an investor, it also pays to know if the odds are on your side in making a good-bet for a good-performing unit trust or fund (hint: it’s poor!). Those expenses are deadly – keep a close eye on them!
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chong Ser Jing doesn’t own shares in any companies mentioned.