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INVESTMENTS
Beware of Hot Funds - The Slow and Steady Way to Build a Better Portfolio
Recently many funds in Asia have been given better than average returns since the Asian crisis.
It appears that many investors are enjoying these returns and are demanding higher returns to either make up their previous loses or believe that they can make a quick buck. Well, I want to remind investor that ‘High Returns also means High Risks’. Investor need to take stock of their expectations and ask the question of whether they are comfortable with the risks associated with their current portfolio. As an adviser I have always told my client over the last 12 years;
‘…that my job as an adviser is not to get you the highest returns but to help you achieve a decent consistent returns with regards to the risk that you wish to take and the goals that you have set.’
This means that purchasing the best performing funds may not be the best choice. In a study at the University of Virginia by Ronald Wilcox a marketing professor fund that most investor place twice as much emphasis on past returns then any other factor. Investors must be reminded that past returns is no guarantee for future returns. Most performance figures as shown as 1-6 month average or 1-5 year averages. All these performance figures show is what happened in the past and my not necessary be indicator for the future.
A US study by the Brandes Institute which is a research division of the Brandes Investment Partners found that funds that are consistently placed in the 43rd percentile (beating 57% of similar funds) would have moved into the top quarter after only five years. This result was conducted by looking at the results of many of the big funds from 1992 to 2003. However, the sad reality is that no funds will beat 57% of its peers consistently.
What this means is that moderate results could become great results over a period of time. The reason for this is that it is better to have a funds that is more consistent than a funds that is ranked 1 st this year, last next year and in the middle in the 3 rd year. However, when a fund is sold based on performance it tends to attract a lot of investors and the fund then may find it hard to obtain all the right type of stock or assets immediately. This would mean that the funds will a more consistent inflow could catch up in terms of it relative performance.
We have seen many recent examples where investors have investor based on the hottest funds or sector, Asian boom and technology boom immediate come to mind. The other side of this story is the Asian crisis and technology bubble burst. Chasing the hot fund or sector can get investors into a lot hot water. Currently many investors are looking to invest into the energy sector as oil price reaches records highs. The only problem in buying into this sector at the moment is that the investors may have missed the boat and have brought the investment at the high price. Buying into energy is good for the speculator who has a high risk appetite but most investors should invest for the medium to long term.
Another aspect that most investor neglect is to understand is the fund managers’ objective. Just because the fund is an Asian Fund, this information doesn’t tell you anything. This name of the fund doesn’t tell you where the investment is mainly situated like an overweight in China or Indonesia. The title also doesn’t explain is the fund manager is only looking for value, top down, big cap, or small cap stocks, etc. Understanding the fund managers’ process will also give you the information needed to reduce the risk of the investment.
As the best performing fund may not tell you that all the investments were placed in medium to small capital stocks that carries a high level of risk. While middle ranks funds may have a process to look at the value of the stock or specifically target stock that pay good dividend. These funds may not be sexy but they may have a lower risk rating for their investment process.
Therefore to avoid or minimizing building an investment portfolio based on hot or average performance figures follow this check list:
- Understand that the "average" return can be inflated by a short hot streak. The best way to see if there is a short hot streak is to look at how a fund performed over time. Examining the performance graph since the inception of the fund can help.
- Look for a fund that has a yearly ranking usually in the top half and don’t necessarily look for the top fund. Consistency is the name of the game.
- Read the fund prospectus and report to see if you can understand what the fund manager’s objective.
- Finally good fund managers will own up to their mistakes. They will tell the good, warn investors if they have concerns and tell them what their strategy will be during uncertain times.
- Investors should be consistent with their investment strategies and have a plan. Investing into a hot fund or sector for less than 12 months is not a plan.
Remember the race between the tortoise and the hare. The hare may be fast but he soon ran out or steam while the slow and steady tortoise won the race.
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