In the previous article I have mentioned that even though unit trust can be a profitable investment, there are still many investors who had not benefited from it (maybe even had losses) probably due to the lack of knowledge and having received wrong/bad advices.
“…there is a world of difference between good advice and advice that sounds good.” Jason Zwieg
We will now take a careful look at five of these most prevalent (good sounding) beliefs concerning unit trusts.
Myth No 1 : A low entry price for unit trust means a far better chance of enjoying capital gains
Usually investors are more interested with the unit trust priced at 25 cents per unit compared to the one priced a ringgit per unit. This is because they assume that the lower price per unit means that it has the potential to go higher.
But this is really just a myth!
The unit trust performance is not dependent on whether the offered price per unit is high or low. For example, let’s look at Fund A with the initial offering price of RM0.25/unit and Fund B offered at RM1/unit.
Say if you start investing with RM5000 in both of the unit trusts, you will have 20000 units in Fund A and 5000 units in Fund B.
Let’s assume that both funds A and B are investing only in the shares of Petronas Dagangan Berhad, so their profit or loss depend only on the performance of Petronas Dagangan shares. Will Petronas Dagangan profit performance depends on whether the unit trust’s price is RM0.25/unit or RM1/unit?
Of course not.
A lower or higher price per unit will not affect the performance of Petronas Dagangan or any company on the Malaysian Stock Market. A low price per unit will also not influence the oil price nor management efficiency.
Findings from my search on the Morningstar have proven that a lower price per unit does not mean a better performance or vice versa. You have to look at the return in 1, 3 or 10 years to measure the fund performance, not at the offered price per unit value.
Another way of looking at it is to assume that you own a fixed proportion of a fund. Now, let us say that portion is represented by 10 units of a 100-unit fund: you own 10% of the whole pie.
Or you could just as easily own 1 million units of a 10 million-unit fund; again you own 10% of the fund. In both cases, your slice of the total fund asset value pie is the same. Clearly, growth or contraction rates will be identical regardless how the fund is sliced.
The only truthful conclusion that can be drawn from this analysis – of the relative attractiveness of high and low priced unit trusts – is that unit price makes no difference, whatsoever, to long term gains.
Myth No 2 :New fund always outperform the old
This myth is a little related to the first myth, supposing that the price per unit in a new fund is still cheap and and can go higher.
Actually there is no clear relation between unit trust age and its performance. A new unit trust can just outperform the old, and vice versa.
For example Public Ittikal, which was launched in 1997 has a higher return than Public Islamic Optimal Growth which was launched in 2008.
There are also cases where new unit trusts are doing better than older unit trusts. Thus there is no conclusion that newly launched unit trusts will always be doing better than the older ones.
Future unit trust performance will be determined by the stock market condition which nobody can exactly predict.
For example, when a new unit trust is launched, it will take some time to invest all of its fund in the stock market. This is different with old unit trust which have fully invested its fund.
In the climate where stock prices are going up, then the old unit trust will outperform the new because it has all its fund has been invested whereas the new unit trust will underperform because it still has a lot in cash. For example, if only 50% of the fund’s cash has been invested in the stock market, then when the stock market experience a 10% increase this unit trust will only get a 5% increase.
Compared to an old unit trust with all the cash already invested in the stock market, which will fully benefit from stock price increase at anytime.
The same applies if the stock market crashes. A new unit trust will then outperform the old because only some of its cash is already in the stock market compared to an old unit trust.
Being old or new is not the primary determinant of good or bad performance. The main criterion for fund selection is how competent (or not) the fund manager is. In other words, being old or new neither guarantees success nor precludes failure.
Myth No 3: Smaller funds always outperform bigger ones.
The bigger the fund becomes, the larger a proportion of the overall market it constitutes. And that mean that if a fund has too much money and too many holdings, any significant purchase it makes is going to cause ‘slippage’. Meaning the fund manager’s buying and selling activity alone will be influential enough to cause a price movement that hurts fund performance.
The bigger the unit trust fund size, the more cash the fund manager will have to invest. And any big scale purchase can also influence stock price movement. For example the EPF which has a big fund size, any buying or selling by EPF will be of interest to other investors.
From my survey on the Morningstar website, most unit trusts with bigger funds are performing better than the ones with smaller size funds.
This shows that bigger unit trusts have better chances to outperform the smaller ones. Economic of scale for example, favour bigger unit trust funds.
Another factor that I can think of is the level of diversification, where bigger unit trusts can better diversify its investments.
Over the shorter, 1-year period especially in bullish time, the small funds outperformed the big one, but some of big funds did do better than some of the small one.
This is due to the fact that small funds offer little diversification. Meaning, if you risk a significant portion of your fund on a few potential high-flyers, then when the stocks take off, your entire fund will fly. If the stocks took a dive, you entire fund will crash. So low diversification strategy adopted in certain small fund is a double-edged sword.
However ‘over-diversification’ can also lead to an average performing unit trust. Meaning that it just goes up and down according to market flow. For example if the KLCI goes up 10%, the unit trust will also go up 10%. Similarly when the KLCI goes down.
These finding suggest that small funds tend to outperform big ones in bull markets yet underperform them in bears. Since stock market is so volatile, with bears and bulls constantly jostling for ascendancy, the lack of defensiveness is a character trait within small equity funds that should not be ignored
Myth No 4: The higher the ‘dividend’ the better
This is the most prevalent and the biggest myth!
Unit trust dividend is not the same like the dividend in stocks or ASB. That’s why the term ‘distribution’ is more correct for unit trust. In Bahasa Melayu it is called ‘pengagihan’.
Unit trust dividend is nothing more than a return of a portion of the fund.
For example, the price of Unit Trust A on 15 October 2015 is RM1.20. Then on 16 October 2015, a 20 cents distribution is announced. If Ahmad had 10,000 unit in Unit Trust A, how much is Ahmad’s investment on 16 October 2015?
Many had the assumption that Ahmad’s return on 16 October is 20%. Actually no.
What happens on 16 October is, Ahmad gets a distribution of:
RM0.20/unit x 10000 unit = RM 2000,
Whereas the price of Unit Trust A on 16 October is RM1.00. So Ahmad’s investment balance in Unit Trust A on 16 October is:
RM1.00/unit x 10000 unit = RM10,000
Added with the RM2000 dividend it will be RM12,000
Thus no difference with Ahmad’s total amount on 15 October, the day before distribution which is at:
RM1.20/unit x 10000 unit = RM12,000
If this is the case, what’s the point/advantage of investing in unit trust?
Let’s remember that we do not know how much was the price per unit at the time when Ahmad started investing. Maybe he bought Unit Trust A at RM0.80/unit. Then his initial investment amount was only:
RM0.80/unit x 10000 = RM8,000
As compared to the investment amount on 15 or 16 October, which is RM12,000.
In this example, the return of investment is RM4,000 or 50%.
As such, dividend amount is not a reflection of the attractiveness of a fund, nor a predictor of great future performance.
Myth No 5: Good to buy Unit Trust a day before dividend payout
This is very much related to the previous myth.
Using the same example above, Nabil invested on 15 October 2015 by buying 10,000 unit Unit Trust A.
So the value of his initial investment is:
RM1.20/unit x 10,000 = RM12,000.
The next day, he received RM2000 in dividend/distribution.
Should Nabil take out/withdraw the RM2000 and go buy an ipad or book tickets to Perth, Australia?
Please don’t! Haha… That RM2000 is not his investment profit, but his own money being returned through distribution!
That’s why the advice to buy unit trust before distribution is a very expensive myth to believe in.
As an investor, one must be wise in receiving/considering free advice. Free advice is aplenty in FB and also from friends. Do not be influenced by the various names like wealth planner, financial advisor and the likes.
I urge you to continue to develop your ability to exercise intelligent skepticism. I hope I’ve shown you how.
Let me know if you need more explanation about unit trust investment.
Elias Abllah, Personal Finance