1. Introduction
A
mutual fund is a type of financial vehicle made up of a pool of money collected
from many investors to invest in securities like
stocks, bonds, money market instruments, and other assets. Mutual funds are
operated by professional money managers, who allocate the fund's assets and
attempt to produce capital gains or income for the fund's investors. A mutual
fund's portfolio is structured and maintained to match the investment
objectives stated in its prospectus.
Mutual
funds give small or individual investors access to professionally managed
portfolios of equities, bonds, and other securities. Each shareholder,
therefore, participates proportionally in the gains or losses of the fund.
Mutual funds invest in a vast number of securities, and performance is usually
tracked as the change in the total market cap of the fund—derived by the
aggregating performance of the underlying investments.
·
A mutual
fund is a type of investment vehicle consisting of a portfolio of stocks,
bonds, or other securities.
·
Mutual funds
give small or individual investors access to diversified, professionally
managed portfolios at a low price.
·
Mutual funds
are divided into several kinds of categories, representing the kinds of
securities they invest in, their investment objectives, and the type of returns
they seek.
·
Mutual funds
charge annual fees (called expense ratios)
and, in some cases, commissions, which can affect their overall returns.
·
The
overwhelming majority of money in employer-sponsored retirement plans goes into
mutual funds.
Source: Mutual Fund
Definition (investopedia.com) - https://www.investopedia.com/terms/m/mutualfund.asp
With a small amount of money invested in a
mutual fund, we have diversified our investment in many stocks held within the
fund. Fund manager usually buys and sells stocks regularly to make profits to
its fund investors. A mutual fund is actively managed by a fund manager(s)
unless it is an index or ETF fund, which is invested in a fixed basket of
stocks as in their disclosure.
The fund’s annual fee is also called Management
Expense Ratio (MER), which is calculated on the total value of a
fund. Even if the fund performance or
return was negative, fund manager still collects annual fee based on the
remaining value of the fund. The MER is different by each fund investment.
Many outperformed fund charged higher MER. We shouldn’t pay only attention to
the MER as our main focus on fund investment, but we should view “historical
performance”, returns in the past 10 years or longer to determine its style and
risks.
2. How fund
units are calculated?
Mutual
funds pool money from the investing public and use that money to buy other
securities, usually stocks and bonds. The value of the mutual fund company
depends on the performance of the securities it decides to buy. So, when you
buy a unit or share of a mutual fund, you are buying the performance of its
portfolio or, more precisely, a part of the portfolio's value. Investing in a
share of a mutual fund is different from investing in shares of stock. Unlike
stock, mutual fund shares do not give its holders any voting rights. A share of
a mutual fund represents investments in many different stocks (or other
securities) instead of just one holding.
That's
why the price of a mutual fund share is referred to as the net asset value
(NAV) per share, sometimes expressed as NAVPS. A fund's NAV is derived by
dividing the total value of the securities in the portfolio by the total amount
of shares outstanding. Outstanding shares are those held by all shareholders,
institutional investors, and company officers or insiders. Mutual fund shares
can typically be purchased or redeemed as needed at the fund's current NAV,
which—unlike a stock price—doesn't fluctuate during market hours, but it is
settled at the end of each trading day. Ergo, the price of a mutual fund is
also updated when the NAVPS is settled.
Source: Mutual Fund
Definition (investopedia.com) - https://www.investopedia.com/terms/m/mutualfund.asp
Usually each mutual fund will calculate its unit value several
times per week for current unit holder as well as unit price for new investors.
Let’s consider an example as follows for a mutual fund’s unit price
·
Fund holds stocks of 100 companies (in the
market the average of stocks held by a mutual fund is 100).
·
Value of fund is calculated by adding market
values of those 100 stocks and dividing by the number of fund units.
·
Assuming that each stock has market share
price of $1 and fund holds 10,000 shares of each stock.
·
The market value of fund is $1 * 10,000
shares * 100 stocks = $1M
·
Assuming that the fund currently has issued
100,000 units to existing shareholders
·
Fund’s unit price is $1M / 100,000 units =
$10/unit
If the fund manager calculates its unit price every Wednesday and
we deposit $10,000 to this fund on the preceding Monday. The fund manager would
wait until Wednesday to determine how many units, we would get.
If the above unit price ($10/unit in the example) was calculated
on Wednesday after our deposit on earlier Monday, we will get $10,000 deposit /
$10 = 1,000 fund units on Wednesday.
We should record the purchased unit price as well as sold unit
price for reporting capital gain or loss in annual income taxes.
3. Return on
investment in a mutual fund
Investors
typically earn a return from a mutual fund in three ways:
·
Income is
earned from dividends on stocks and interest on bonds held in the fund's
portfolio. A fund pays out nearly all of the income it receives over the year
to fund owners in the form of a distribution. Funds often give investors a
choice either to receive a check for distributions or to reinvest the earnings
and get more shares.
·
If the fund
sells securities that have increased in price, the fund has a capital gain.
Most funds also pass on these gains to investors in a distribution.
·
If fund
holdings increase in price but are not sold by the fund manager, the fund's
shares increase in price. You can then sell your mutual fund shares for a profit
in the market.
Source: Mutual Fund
Definition (investopedia.com) - https://www.investopedia.com/terms/m/mutualfund.asp
We will have to report distribution in addition to capital
gain/loss (if sold your units) from a mutual fund in our annual income taxes.
Most of mutual fund record distribution as dividends. Usually mutual fund
companies sent report (T5 form in Canada) to each unit holder by year end, thus
we would get information to report annual income tax correctly.
4. Sales/commission
fees or load mutual fund
Many mutual funds charged sale or commission fees in addition to
annual MER. We should verify if a fund has Front End (FE), Deferred Sale Charge
(DSC), or No Load fee before investing our money.
A load
mutual fund charges you a sales charge or commission for the shares purchased.
This charge could be a percentage of the amount you are investing in, or it can
be a flat fee, depending on the mutual fund provider.
For example,
if you invested $1,000 into a 5% load mutual fund, you would actually be
investing only $950, with the remaining $50 going to the company as a
commission. The fee goes to compensate a sales intermediary, such as a broker,
financial planner, or investment advisor, for his time and expertise in
selecting an appropriate fund for the investor. There are different types of
load an investor may encounter.
Front-end
load, also called Class A shares, is a single charge paid by the investor when
they purchase shares of the fund.
Back-end
load, or Class B shares, charge a one-time fee paid when you redeem or sell,
your mutual fund shares.
Level load
funds, also known as Class C shares, are yearly charges and will be a fixed
percentage taken from the fund's assets.
Loads are
only one of the fees which may impact the investor of a mutual fund. Some loads
will be paid from the assets of the mutual fund and will reduce the returns
that will be distributed to the investor.
Source: Load vs. No-load Mutual
Fund: What's the Difference? (investopedia.com) - https://www.investopedia.com/ask/answers/125.asp
Front-end
load (FE) is the charge or
deduction of our total investment at the beginning of investment into the fund.
For example, $10,000 invested in 5% of a FE fund would mean “only $9500 will be
used to buy fund units. $500 was deducted as sale or commission fee.”
Deferred
Sale Charge (DSC) or Back-end load: is the amount or
percentage of charge applied to the total amount of our redemption
(withdrawals) from a fund. Many funds reduce the DSC charge over years of
shares holding. For example, a DSC fund would charge 7% in 1st year,
6% in 2nd year, 5% in 3rd year, 4% in 4th
year, 3% in 5th year, and no charges after 5 years.
·
Following this example, we may have invested
$10,000 in the fund, which grew to $20,000 during year 3.
·
We decided to withdraw $5,000 of the fund in
3rd year. The fund would charge 5% DSC to the $5,000, i.e. $5,000 *
0.05 = $250. We remained with $4,750.
·
The remaining investment in the fund was left
with $15,000 after withdrawal.
No
Load fund does not have sale charge or commission fee, but it usually
charges higher MER to fund holders. Sometimes No Load fund requires investors
to hold funds for a minimum period of time, e.g. 3 months, to avoid charges.
5. Types of
mutual fund
Order of risks and returns are increasing for the following funds:
Money Market Fund -> Bond Fund -> Fixed Income Fund
-> Balanced Fund -> Dividend Fund -> Equity fund -> Specialty Fund.
For example, Specialty Fund may produce spectacular return to investors, but it
may also drop significantly in a short time frame.
A
Money Market Fund is a kind of mutual fund
that invests in highly liquid, near-term instruments. These instruments include
cash, cash
equivalent securities, and high-credit-rating, debt-based securities
with a short-term maturity (such as U.S. Treasuries). Money market funds are
intended to offer investors high liquidity with a very low level of risk. Money
market funds are also called money market mutual funds.
Source: Money
Market Fund Definition (investopedia.com) - https://www.investopedia.com/terms/m/money-marketfund.asp#what-is-a-money-market-fund
Money Market Fund usually offers guarantee of initial capital
investment, i.e. no capital loss. They distribute interest income monthly,
which is often below the inflation rate. We tend to park our cash in Money
Market Fund while waiting for opportunity to invest in equity market or stocks.
Currently many banks have closed new entry into their money market fund and
moved to Money Market ETF. However
this creates a risk of losing initial capital if our sold price was lower than
the purchased price of ETF shares. Because little interest portion of the ETF
could not compensate the capital loss, holding cash without interest could be a
better option in this case.
A
Bond Fund is simply a mutual fund that invests solely in bonds. For many
investors, a bond fund is a more efficient way of investing in bonds than
buying individual bond securities. Unlike individual bond securities, bond
funds do not have a maturity date for the repayment of principal, so the
principal amount invested may fluctuate from time to time.
A
bond fund, also referred to as a debt fund, is a pooled investment vehicle that
invests primarily in bonds (government, municipal, corporate, convertible) and
other debt instruments, such as mortgage-backed securities (MBS). The primary
goal of a bond fund is often that of generating monthly income for investors.
A
bond fund invests primarily in a portfolio of fixed-income securities.
Bond
funds provide instant diversification for investors for a low required minimum
investment.
Due
to the inverse relationship between interest rates
and bond prices, a long-term bond has greater interest rate risk than a
short-term bond.
Source:
Bond Fund Definition
(investopedia.com) - https://www.investopedia.com/terms/b/bondfund.asp
Because the price of bond coupon is inversely proportion to the
interest rate, we must pay attention to the interest rate trend set by central
bank, because we may lose initial capital even though original interest payment
to each coupon was the same. Bond fund’s unit price may slightly be different,
because fund managers actively trade bond coupons on the market.
Bond Fund could be
High Yield Bond Fund invested in higher yield and riskier bond coupons. High
Graded Bond Fund invested in high quality bond coupons with lower yields and
risks.
Bond coupon rates paid to investors are usually higher than
inflation rates.
A company issued bond coupons could declared bankruptcy OR bond
coupons may go down because interest rate goes up. This could result in capital
loss to investors. Therefore Bond Fund is
riskier than Money Market Fund.
Fixed-income
securities are easily traded through a broker and are also available in mutual
funds and exchange-traded funds. Mutual funds and
ETFs contain a blend of many securities in their funds so that investors can
buy into many types of bonds or equities.
A
fixed-income security is an investment that provides a return in the form of
fixed periodic interest payments and the eventual return of principal at
maturity. Unlike variable-income securities, where payments change based on
some underlying measure—such as short-term interest rates—the payments of a
fixed-income security are known in advance.
Fixed-Income
security provides investors with a stream of fixed periodic interest payments
and the eventual return of principal upon its maturity.
Bonds
are the most common type of fixed-income security, but others include CDs,
money markets, and preferred shares.
Not
all bonds are created equal. In other words, different bonds have different
terms as well as credit ratings assigned to them based on the financial
viability of the issuer.
The
U.S. Treasury guarantees government fixed-income securities, making these very
low risk, but also relatively low-return investments.
Source:
Fixed-Income
Security Definition (investopedia.com) - https://www.investopedia.com/terms/f/fixed-incomesecurity.asp
Fixed Income
Fund is similar to Bond Fund, because they mainly invested in bonds.
However Fixed Income Fund has a small portion of portfolio invested in equity
(mostly preferred shares), so it may fluctuate
more as compared to a Bond Fund due to changing stock prices in the fund on
the market. This is why Fixed Income Fund
is riskier than Bond Fund.
A Balanced Fund is a mutual fund that typically
contains a component of stocks and bonds. A mutual fund is a basket of
securities in which investors can purchase.
Typically,
balanced funds stick to a fixed asset allocation of stocks and bonds, such as
70% stocks and 30% bonds. Bonds are debt instruments that usually pay
a stable, fixed rate of return.
·
Balanced
funds are mutual funds that invest money across asset classes, including a mix
of low- to medium-risk stocks and bonds.
·
Balanced
funds invest with the goal of both income and capital appreciation.
·
Balanced
funds can benefit investors with a low risk tolerance, such as retirees, by
offering capital appreciation and income.
Source: Balanced Fund Definition
(investopedia.com) - https://www.investopedia.com/terms/b/balancedfund.asp
A Balanced Fund invests
in both equity (stock) and bonds.
Since its objective is also invested in stocks, thus high risk stocks could be
included in the portfolio. This is why Balance
Fund is riskier than Fixed Income Fund, but it could potential offer higher
rate of return.
Dividend Mutual Funds
are mutual funds that invest in stocks that pay dividends. If you invest in
these funds, you can reinvest the dividends into more shares. Or, you can use
the money as an income stream.
Some
dividend mutual funds focus on stocks that pay high dividends that represent a
large percentage of their stock price. That percentage is known as dividend
yield.
If
you own stocks of dividend-paying companies through a mutual fund, the
dividends will be paid to the fund. It will then pass them along to its investors.
Dividend
mutual funds tend to own shares of established companies. They often have a
long history of paying dividends. These stocks are often referred to as
blue-chip stocks; this used to be a high-value color of poker chips.
Source: Dividend
Mutual Funds: What Are They? (thebalance.com) - https://www.thebalance.com/what-are-dividend-mutual-funds-2466755
Since Dividend Fund invests mainly in dividend paying stocks,
it is riskier than Fixed Income Fund.
However it is less risky than Equity Fund, because many investors are
interested in getting regular dividend payment by the fund via dividends that
it received from stock investment. Because of its attractiveness to investors,
i.e. more stock buyers, the fund’s unit price was more stable, but it didn’t
mean that fund investors will not lose capital investment in the fund OR fund
unit price could also go down.
An
Equity Fund is a mutual fund that invests
principally in stocks. It can be actively or passively (index fund) managed.
Equity funds are also known as stock funds.
Stock
mutual funds are principally categorized according to company size, the
investment style of the holdings in the portfolio and geography.
Some
equity funds are also divided into those pursuing income or capital
appreciation or both. Income funds seek stocks that will pay dividends, usually
investing in equities of blue-chip companies. Other equity funds primarily seek
capital appreciation, or the objective that the stocks in the portfolio will go
up in share price.
There are many types of
Equity Funds in the market, e.g. Growth
Fund, Value Fund, etc. They even specify the region of selected stocks such
as North America Equity Fund, South America Equity Fund, Europe Equity Fund, Asia
Equity Fund, US Equity Fund, etc. However they are mainly invested in stocks in
hope of its share prices appreciated. If they sold holding shares resulted in
capital gains, then gains will be passed on to unit holders as distribution for
income tax declaration.
Growth Fund invested mainly in corporations, which have likely
increased in sales and earnings significantly. Those will make its share price
going up substantially. However its share price may also go down deeply if sale
or earnings targets were missed.
Value Fund invested mainly in stable corporations with predictable sales and earnings and its
share price was at relatively reasonable level. Those corporations’ share
prices fluctuate little [less volatile] as compared to stock prices in a Growth
Fund.
Stocks held in Equity Fund may not pay dividends to shareholders,
thus it less attractive to investors seeking regular payment, i.e. fewer
buyers. Therefore Equity Fund is riskier
than Dividend Fund.
Specialist
funds or Specialty Fund cover a broad range
of themes, including:
Energy -
including major oil & gas producers, like BP, Exxon Mobil and Royal Dutch Shell,
as well as much smaller exploration and production companies
Infrastructure
- these funds often invest in companies that own or operate infrastructure
projects such as roads, railways or airports, or those that supply utilities
like water or power
Resources -
funds that typically focus on companies that mine commodities, such as iron
ore, gold, copper or diamonds. They might also invest in areas such as energy
and agriculture
Agriculture
- provides exposure to companies that grow food such as corn, wheat or rice.
Some funds provide broader exposure by investing in companies in the food
production chain like fertiliser producers, distributors, or supermarkets
Technology -
funds focused on technology companies
Other areas
such as financials, healthcare, biotechnology, and even artificial intelligence
Fund.
Source: Specialist
Fund Sector Performance and Review (hl.co.uk) - https://www.hl.co.uk/funds/research-and-news/fund-sectors/specialist
The Specialty
Fund mainly invested in a specific sector of economy, thus it is subjected
to the health of that sector. If the sector is doing well, stocks held in the
fund would go up quickly as well as the fund unit price and vice versa.
For example, energy fund invested in oil would enjoy growing in
share prices of oil companies when the oil price was going up, but it would
underperform or go down with the plunge of oil price.
Oil prices or gasoline prices are also seasonable as consuming of
gasoline is higher during summer months (travels by car and airplane during
vacation months). Natural gas’ consumption was peak during winter months for
heating houses.
This is why
Specialty Fund is riskier than Equity Fund because of
limited scope in investment choice. We should allocate a small portion of our
portfolio to this kind of fund, e.g. a maximum of 5%.
6. Risks to
mutual fund investment
Market
risk
The
risk that you will lose some or all of your principal. As markets fluctuate,
there is always a possibility that the mutual funds you hold might be caught in
a decline.
Inflation
risk
The
risk of losing purchasing power. If your mutual funds gain 5% in a year and the
cost of living goes up by 2%, you are left with a real return of only 3%.
Interest
rate risk
The
risk that rising interest rates will cause your mutual funds to decline in
value. When interest rates rise, bond prices decline and bond mutual funds may
also decline as a result.
Currency
risk
The
risk that a decline in the exchange rate will reduce your gains (or add to
losses). Even if the value of a foreign-currency-denominated fund goes up, a
decline in the foreign currency can reduce your returns when they are exchanged
back into Canadian dollars.
Credit
risk
The
risk that the issuer of a bond or other security won't have enough money to
make its interest payments or to redeem the bonds for face value when they are
due. Securities with a higher risk of default tend to pay higher returns.
Fortunately,
not every type of mutual fund is susceptible to every kind of risk. Equity
funds, for example, are subject to market risk but help protect against
inflation risk. Similarly, fixed-income funds are susceptible to interest-rate
risk but offer some protection against market risk. By diversifying, you can
reduce the impact of risk on your portfolio as a whole.
Source: Five
types of risk affecting mutual funds | BlueShore Financial - https://www.blueshorefinancial.com/ToolsAdvice/Articles/Investing/FiveTypesOfRiskAffectingMutualFunds/
Each fund manager has an objective to invest in financial market
instruments, i.e. equity fund would mainly focus on buy stocks and park a small
portion of fund in cash or short term vehicles such as treasury bills.
Therefore we must diversify our investment in several funds as a risk protection,
e.g. 50% in equity fund, 20% in dividend fund, and 30% in fixed income fund. We
will need to maintain that ratio by moving from a fund to the other fund
occasionally as a fund may outperform the other funds marginally as time goes
by.
7. Annualized
Returns
An
annualized rate of return is calculated as the equivalent annual return an
investor receives over a given period.
·
The
annualized rate of return is a process for determining investment returns on an
annual basis.
·
The rate of
return looks at gains or losses on investments over varying periods of time,
while the annualized rate looks at the returns on a yearly basis.
·
The
annualized rate of return is expressed as a percentage and is consistent over
the years that the investment has provided returns.
·
It differs
from the annual performance of an investment, which can vary considerably from
year-to-year.
Calculation
Using Annual Data
Calculating
the annualized performance of an investment or index using yearly data uses the
following data points:
P =
principal, or initial investment
G = gains or
losses
n = number
of years
AP =
annualized performance rate
AP = [((P +
G) / P)(1/ n)] - 1
Annualized
Rate of Return Examples
For
example, assume an investor invested $50,000 into a mutual fund and, four years
later, the investment is worth $75,000. This is a $25,000 gain in four years.
Thus, the annualized performance is:
AP
= (($50,000 + $25,000) / $50,000)(1/4) - 1
In
this example, the annualized performance is 10.67 percent.
A
$25,000 gain on a $50,000 investment over four years is a 50 percent return. It
is inaccurate to say the annualized return is 12.5 percent or 50 percent
divided by four because this does not take into effect compound interest. If
reversing the 10.67 percent result to compound over four years, the result is
exactly what is expected:
$75,000
= $50,000 x (1 + 10.67%)4
It
is important not to confuse annualized performance with annual performance. The
annualized performance is the rate at which an investment grows each year over
the period to arrive at the final valuation. In this example, a 10.67 percent
return each year for four years grows $50,000 to $75,000. But this says nothing
about the actual annual returns over the four-year period. Returns of 4.5
percent, 13.1 percent, 18.95 percent and 6.7 percent grow $50,000 into
approximately $75,000. Also, returns of 15 percent, -7.5 percent, 28 percent,
and 10.2 percent provide the same result.
Using
Days in the Calculation
AP = [((P +
G) / P)(365/ n)] - 1
Assume
from the previous example that the fund returned $25,000 over a 1,275-day
period. The annualized return is then:
AP
= [(($50,000 + $25,000) / $50,000)(365/1275)] - 1
The
annualized performance in this example is 12.31 percent.
Source: Annualized Rate
of Return Definition (investopedia.com) - https://www.investopedia.com/terms/a/annualized-rate.asp
8. Mutual fund
selection
There is no rule in selecting funds that suit our needs. Based on
historical data,
·
Most of stocks have upward trend over long
period of time, even though it occasionally performed poorly or in down turn
during trouble time such as recession or disaster periods such as dot com bust
in 2000, financial crisis from US housing bubbles in 2008, COVID-19 in April
2020. Most of stocks have recovered after disaster periods and reached new high
including major stock indices.
·
Bond funds or Fixed Income funds provided
steady income or distributions to investors. It also fluctuates a little as
compared to equity fund’s swings.
Therefore investors would need longer time in the market to invest
in equity funds, which are invested in stocks, in case we are entered a down
turn period. Good stocks will rebound to its high after a few months or years.
We should not invest our emergency fund in stock or bond markets.
A rule of thumb is to invest or park emergency fund, which is
equal to 3-6 months of expense, in saving accounts or money market fund, which
protect our capital as well as providing its liquidity.
Asset
allocation is a very important part of creating and balancing your investment
portfolio. After all, it is one of the main factors that lead to your overall
returns—even more than choosing individual stocks. Establishing an appropriate
asset mix of stocks, bonds, cash, and real estate in your portfolio is a
dynamic process. As such, the asset mix should reflect your goals at any point
in time.
·
Asset
allocation is very important to create and balance a portfolio.
·
All
strategies should use an asset mix that reflects your goals and should account
for your risk tolerance and length of investment time.
·
A strategic
asset allocation strategy sets targets and requires some rebalancing every now
and then.
·
Insured
asset allocation may be geared to investors who are risk-averse and who want
active portfolio management.
Source: Six
Asset Allocation Strategies That Work (investopedia.com) - https://www.investopedia.com/investing/6-asset-allocation-strategies-work/
There is no formula associated the investment age to specific
fund’s selection, but we could invest higher percentage of our portfolio in
equity funds and the remaining in fixed income fund in younger age. For
example, 70% in equity fund + 10% in dividend fund + 10% in balanced fund + 10%
in fixed income fund when we’re young. However we should be conservative as we’re
approaching retirement age. For example, 30% in equity + 20% in dividend fund +
20% in balanced fund + 30% in fixed income fund when we are above 55 years old.
We should keep or maintain the portfolio investment ratio constant
over time, i.e. market up or down. This way would help our portfolio perform
better.
·
During the high of stock market,
growth/equity fund would grow faster and go beyond its allocated percentage. We
should transfer some of our money in those growth/equity funds to fixed income,
balanced, dividends, or bond funds.
·
In contrast, the growth/equity funds are
poorly performed during recession, which lead to lower percentage in our
portfolio. This would be the time to transfer some of our money in fixed
income, balanced, dividends, or bond funds to growth/equity funds.
Most of us do not have time to monitor our investment portfolio
managed by a professional money manager, thus we should pay attention to
television news occasionally. For example, TV broadcasters are cheerfully
reported rosy news about stock indices hitting all time high or wonderful stock
performance. This is probably the time to transfer money from growth/equity
funds to fixed income, balanced, dividends, or bond funds. When people are
talking about recession, we should do the reverse, i.e. to transfer some of our
money in fixed income, balanced, dividends, or bond funds to growth/equity
funds. By doing this way, our portfolio should perform well with little time
spent.
Regardless of asset allocation, we should select good performance
funds to invest in by looking at its historical performance released to
investors, e.g. 10-year annualized returns, yearly performance (up/down
percentage), its bench mark against TSX or S&P 500, top 10 stocks holding
in the portfolio.
Let’s take a look at the following examples:
|
2020 |
77.43% |
|
2019 |
14.01% |
|
2018 |
-11.09% |
|
2017 |
-23.24% |
|
2016 |
62.14% |
|
2015 |
1.19% |
|
2014 |
-1.67% |
|
2013 |
27.92% |
|
2012 |
15.24% |
|
2011 |
-2.39% |
Figure 1. Portfolio returns for each years from 2011 –
2020
By looking at figure 1, we can say that the fund manager could
capture some of good returns during the bull market during 2012-2019. It is not
a stable or consistent return as the fund up and down significantly, i.e. this
is a risky fund. However the fund did capture a gain of +77.43% in 2020 during
COVID-19 crisis as many other investors, so it’s good. If we could handle the
drop of -23.24% during a year and significant gains in other years, then we
could select this fund by looking at its bench mark below.
|
|
Year-to-date |
Last 12 months |
Last 3 Years |
Since Inception |
||
|
Your Portfolio |
|
15.62% |
146.08% |
32.88% |
14.56% |
|
|
CDN T-bills |
|
0.00% |
0.51% |
1.16% |
0.89% |
|
|
S&P/TSX Composite Index |
|
4.03% |
14.74% |
8.75% |
6.38% |
|
|
S&P 500 |
|
1.34% |
24.02% |
13.77% |
17.18% |
|
Figure 2. Bench
mark performance against TSX and S&P 500.
This fund annualized return is +14.56% for 10-year period, which
is good as compared to other equity funds in the market even though it didn’t
beat the S&P 500. Unless we wanted to invest in S&P 500, which carries
high multiple or PE, we can pick this fund.
Usually the MER had already deducted from historical returns
before publishing to investors. Therefore we should not pay attention about the
MER of a fund, but its investment style, 10-year annualized return as well as
its volatility, e.g. how deep it was plunged during recession, COVID-19 shut
down AND how long it took to recover to positive territory.
We can also look at the published top 10 stocks by portfolio
manager to evaluate his style and risk taken. For example,
·
Tesla was picked as top stock: means risky
·
Amazon was picked: means investing in
ecommerce and high flying stock
·
Bank of America was picked: means investment
in US finance sector
·
Unknown or penny stocks: means very risky
(could bankrupt)
·
Etc.
There is some strategy employed by fund managers, which called Windows Dressing. For example, they saw
Tesla shares appreciated 500% or more in a short time frame, so they would buy
Tesla shares as a top holding stock. This meant that they bought Tesla stock at
higher price, and may suffer significant loss, if Tesla stock was corrected
down. However they never mentioned when they did buy those top holding stocks
in disclosure. The only thing, which you should pay attention, was its past
returns. If they got 600% increase with Tesla shares, then its historical fund return
should be above +50%. A fund holds an average of 100 stocks, so a 600% could only
lift the whole portfolio to a certain level.
If we select specialty fund, we could switch them according to
seasons or favorable factors for its sectors in economy. However we should pay
attention to any fees or charges may be incurred by fund manager in case of
switching fund holdings.
9. Summary
Investment is not a fashion or a race to show our investment
portfolio outperformed others. We should not let other’s people spectacular
returns affecting our decisions in selecting funds to invest.
In brief, we should be very happy if our portfolio annualized
return was around +10% for the past 10 years. We shouldn’t allocate a large
portion of our portfolio in specialty funds or all in equity in order to beat
S&P 500 index or better than other people. This could result in significant
loss that we wouldn’t have time or expertise to recover.
We could also invest in mutual funds or ETF mimicking the stock
indices. Our portfolio would perform relatively well with little time spent to
manage it. Based on statistics, many money managers could not beat the record
set by the (USA) S&P 500 index.
Warren Buffet is a famous investor with exceptional return for his
investment in stock market as well as among wealthiest persons in the world. He
said that we should be fearful when people were greedy and vice versa. We
shouldn’t chase high flying stocks or funds, because the reverse trend could
come at any time.
We don’t have time to follow or expertise to understand stock
markets, because stocks have been traded by many billionaire investors around
the world including large size money managers. They are influential and could
set the trend of the stock market.
Play safe and be happy with reasonable returns.
Author: Vinh Nguyen at canvinh@gmail.com
written in June 2022.
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