The Business Times, Friday 31 October, 2003

Investment planning myths

JOSEPH CHONG compiles a list of some of the potential misconceptions and euphemisms to look out for when buying investment products

ALMOST every major equity market on earth is on the uptrend. Given the synchronised monetary stimulus by G-3 central banks, this is not surprising. We had forecast the current state of equity markets in an article in BT on May 14 ('A longer-term view'). Essentially, G-3 central bankers are 'manufacturing' money for us to spend. This spending party will only end when excess global productive capacity is used up. The consequence of this will probably be a liquidity-driven equity bull market until then.

If history is our guide, it is highly likely that increasing numbers of retail investors, the protection afforded by the Financial Adviser's Act notwithstanding, will be 'sold' into the bull market as it progresses - just as many were sold by the historical performance of bond funds as the bond market climaxed some months ago, and high-tech stocks in late 1999.

We have compiled a non-exhaustive list of some potential misconceptions, myths and euphemisms to be aware of when an investment salesperson is trying to earn a commission from you:

Buy for the long term

This is normally justification for the 5 per cent front-load charged by those compensated on a sales-commission only basis. The argument is that if you hold the fund for 10 years, it is less than 0.5 per cent per annum. Most of the time if your fund pops up 10 per cent, the same salesperson will find another justification to switch you to another fund. An 'adviser' who is paid only when you buy something is inherently conflicted. This is because selling and holding are two other active and important decisions in the investment process.

Suggested solution: Look for advisers who charge no front-loads but whose compensation is on an on-going basis and tied to the value of your assets.

Buy and hold, do not time market

Most fund managers claim to be bottom-up stock pickers who buy and hold their picks and do not time the market. Hence, as an investor in their funds, one should do likewise. This is a myth. The exercise of asset re-allocation itself is market timing. We know of very few fund managers who do not employ technical analysis to time their entrance and exits. A fund manager who trades regularly tends to be treated well by his broker, be it in soft dollar rebates or other benefits. A fund investor who times his entry and exit into funds is commercially disadvantageous for the fund manager.

Suggested solution: Market time if you know how to. Alternatively, get an adviser experienced in asset allocation and technical analysis.

Regular savings plans

Most fund managers would encourage you to take up a regular savings plan with them. We believe one ought to save and invest regularly into the capital markets consistent with one's investment risk profile. However, signing up for a regular savings plan (RSP) with just one fund from one asset class is not the way. This is because the success of different fund management approaches varies with the economic cycle. Growth funds will tend to outperform in a reflationary environment such as the current one, but you might want to avoid equities altogether in a deflationary cycle.

Suggested solution: If you need to sign up for RSPs, do so with a spread of core funds consistent with your risk profile. Alternatively, once a level of cash savings is reached, review your portfolio with a view to investing the cash.

Fund manager views

Unit trust fund managers regularly espouse asset allocation views. Very often, this is done on a quarterly basis or in conjunction with a product launch. Unfortunately, fund managers are product manufacturers (who have to sell enough of their product or they will lose money) and are thus potentially conflicted in giving objective advice. Fund managers appear to favour regions or sectors where they have the skill sets or need to support teams covering those areas. For example, we have never heard a primarily Asian, European or US fund manager being blatantly negative on Asia, Europe or the US respectively. Another problem with investment product launches is that, unfortunately, the best time to market a fund is probably the worst time to invest in it and vice versa; almost every fund manager was launching a tech fund in 1999.

Suggested solution: Take fund manager views with a pinch of salt especially at fund launches. Go into their website and check where their assets are gathered and what their expertise is. Or, check with an unaffiliated adviser.

Sophisticated investor

According to our securities laws, someone having above a certain net worth or income could be classified as a sophisticated or accredited investor. This means someone selling an investment or life insurance product to such a person need not comply with certain disclosure requirements - requirements that would apply for all other cases. The logic is that as a rich person, you would know how to assess the virtue of a product even if things are hidden from you.

Unfortunately, most clients do not know that they have the choice of such protection. Because it is not required, no one tells them. This is probably why structured product sales are so popular among the high net worth - pricing is bundled and a breakdown of charges is not needed!

Suggested solution: Even if you qualify, insist on being unsophisticated. Ignore the flattery of being a sophisticated investor. Insist on the protection and requirements of the FAA and the Securities and Futures Act.

Importance of low expense ratios

Expense ratios of funds sold here are expressed fairly accurately - up to two decimal places. Unless the expense ratios are out of whack, we generally assign little importance to them because expense ratios do not necessarily express the management cost accurately. This is because, in Singapore, fund managers are permitted to receive soft dollar rebates from stockbrokers. These are rebates from trading commissions paid for by fund owners that, strangely enough, are permitted to be rebated back to the fund manager and not fund owners. These are disclosed as essentially one-liners in prospectuses but little more.

To make matters worse fund managers with affiliated stockbroking firms often have internal arrangements to generate a certain amount of business for the stockbroker. In short, comparing expense ratios as things stand is a meaningless exercise.

Suggested solution: Ignore expense ratios as a selection parameter for the time being.