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Asian markets – ETFs or active funds?

As I was travelling to work the other day, I had the opportunity of over-hearing a couple of fellow passengers describing their mixed fortunes from investing in Asian stock markets. What struck me, from the tone of the conversation, was just how different their experiences were in terms of the returns achieved on their money.

Date: Jun 14, 2011          Author: Stewart Aldcroft

Keywords: ETFs, Active management

As I was travelling to work the other day, I had the opportunity of over-hearing a couple of fellow passengers describing their mixed fortunes from investing in Asian stock markets. What struck me, from the tone of the conversation, was just how different their experiences were in terms of the returns achieved on their money.

Passenger 1 – I shall call him “Wong” – explained that his adviser had managed to get him to invest in the award-winning fund of XYZ Asset Management three years ago ( in early 2008). This was just before the global financial crisis (GFC). Timing was really poor, as in September that year stock markets around the globe collapsed, as did Lehman Brothers, and some other major financial companies and banks almost disappeared as well.

Wong made the point that his adviser kept telling him at the time of the GFC: “Stick with it, the markets are not so bad. Your fund manager has won lots of awards for good performance, so he will be sure to make money in the long term.”

Unfortunately, a little while later, the adviser then told him: “I’m sorry to tell you, but the manager of the fund has just left to start his own hedge fund. The company is appointing a new person to run the fund. By the way, the new fund manager has said he wants to make a change to the style adopted, and will try to be less aggressive in selecting stocks, given the market conditions.”

Passenger 2 – I will call him “Brian” – listened carefully to what he was being told by his friend. He then asked: “How did your fund perform in the last three years, with both the GFC and the changes that were made?”

Wong said: “Actually, I don’t think I’ve done too well. Last month the annual statement came in and it said that I have still not made a profit. Maybe it takes a bit longer for the new manager to get his strategy working properly.”

Brian then asked: “Do you know how much it has cost you to not make any money?”

Wong replied: “Yes, my adviser told me that he earned a fee for selling me the fund three years ago, of around 5%, and then the fund managers charge a fee each year of about 1.75%, so I guess in total it has cost me over 10% of the amount I invested over three years.”

Brian at this point was beginning to feel very smug. “I don’t like to upset you so early in the morning, but I thought you might like to know there are alternative choices. If you had bought the ABC Asian ETF at the same time as the XYZ Asian Fund you would have not only had a better return on investment, but also it would have cost you a lot less.”

"How come?” Wong asked.

Brian told him: “Exchange traded funds (ETFs) also invest directly into the same stock markets that mutual funds invest in, but instead of having an individual fund manager making stock selections and providing management, it only tries to match the return of the stock market index. It’s also cheaper, because you don’t need to pay any front end fees and the annual costs are also quite small.”

"But,” said Wong, “only trying to match the index doesn’t sound very exciting.”

Replied Brian: “No it’s not. But as most funds seem to underperform their index benchmarks, an index-based fund like an ETF will often do better. And what’s more, it will only cost you 2% over three years instead of 10%.”

Asked Wong: “But isn’t it difficult to invest into ETFs?”

"Not really,” said Brian. “If you have a securities account already with your bank or stockbroker, they can buy an ETF immediately for you.”

"But I don’t like to try new things,” Wong said. “I always end up making mistakes.”

Brian laughed: “But if you have already invested into stocks on the market and funds, then there is nothing new in ETFs. They have all the benefits of funds, with the liquidity and simplicity of a stock. In fact, your securities account is probably already set up to include ETFs. Why don’t you ask your bank?”

There is nothing new in this story about the difference between ETFs and mutual funds. It has been the same for quite a long time now, but the only real issue is getting started on using them.

For many people, doing something for the first time can often be like going into the unknown. Fortunately, with ETFs that’s not the case, as this illustration clearly shows.

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