Hopeton Morrison, Contributor
MUTUAL FUNDS represent the investment of choice for many of today's new and savvy investors. All over the world it is an investment product that has attracted many because of its promise of bright, aggressive, professional money managers who engage in expert selection of securities for the fund.
Within the last couple of years the Jamaican marketplace has seen a plethora of funds all registered outside Jamaica but marketed by Jamaican financial institutions. First it was NCB Capital Markets that introduced a number of select equity funds from its parent AIC, headed by Michael Lee Chin
This was followed by JMMB's Select Index Fund which is registered in the Cayman Islands but charts the movement of the 15 most liquid stocks on the Jamaican Stock Exchange. The Grace Caribbean Fixed Income Fund (a fully owned subsidiary of Grace, Kennedy & Co. Ltd) was next and this was invested in US-dollar fixed income instruments of Caribbean countries. Grace is licensed to administer up to 10 mutual funds and the Grace Fund targets initial investment of US$10,000 per investor so you would need to be fairly liquid to invest here.
SCOTIABANK MUTUAL FUNDS
In April 2003 Scotiabank Jamaica introduced its own Scotiabank Mutual Funds which invest solely in international (mostly North American) securities. The five funds are: Scotiabank Money Market Fund; Scotiabank US Dollar Bond Fund; Scotiabank US Growth Fund; Scotiabank Global Growth Fund and Scotiabank Canadian Growth Fund.
All over the world today, mutual funds have become the investment instrument of choice. In the United States for example, US$100 billion was invested in these funds in 1980. This leaped to US$1.6 trillion in 1993 and increased some fourfold in early 2003 to US$6.3 trillion.
A question frequently asked is whether mutual funds and unit trusts are one and the same. Often the terms are used interchangeably here in Jamaica but there are a couple of technical differences between them.
First of all, unit trusts hold securities to maturity with the trust expected to dissolve when most of these securities have matured. Unit trusts should have a fixed termination date but in Jamaica and in some other jurisdictions the practice is for these funds to reinvent themselves on maturity and therefore to carry on indefinitely.
A second difference is that mutual funds are actively managed portfolios and for this the fund charges a fee. On the other hand unit trusts are bought on a 'Buy' price and sold on a 'Sell' price. The difference between the two becomes the broker's commission and is also used to cover the overhead expenses of the trust.
SCHEMES
Both types of schemes are defined as 'Collective Investment Schemes'. These schemes are usually more suitable for the small investor because of their relatively low expense, their liquidity (which means that buyers and sellers can either purchase or dispose of their units quite easily) and their diversification into a mix of securities resulting in them sometimes referred to as 'balanced funds'.
Both unit trusts and mutual funds pool money from many investors which accounts for the term collective investment scheme. This pool in turn creates considerably greater buying power for the smallest investor in the pool than he would have under normal conditions. Currently there are 10 unit trust funds now administered in Jamaica (see table below).
But there is a downside to these collective investment schemes. In recent times mutual funds have been caught in a turmoil associated with unethical practices. Two of the most common of these practices have been Front Running and Portfolio Pumping. Front Running occurs where portfolio managers purchase shares for themselves and follow this up by buying copious amounts of the same shares for the fund that they manage. The effect of this of course is that the market responds by pricing up the stock thus pricing up also the manager's own holdings.
The practice of Portfolio Pumping occurs where fund managers on the day when the reports on the fund comes due attempt to manipulate the market by buying up large amounts of a security already held in an attempt to drive up the value of the fund and aiming to put a very positive spin on quarterly or half yearly returns.
Mutual funds and unit trusts are fairly decent investment tools but there are some precautions that you need to take a few of which are outlined below:
First you may be paying a premium for purchasing and keeping a mutual fund. Fund prospectuses outline the schedule of fees and expenses of the funds that they are describing. A three per cent annual fee means that $3 is taken out of every $100 that you have invested.
OVERLOOK
These fees are unfortunately usually overlooked by many investors who do not understand the long-term cumulative effect of them especially when these are combined with "loads". Basically funds are classified as load funds or no-load funds. Another name for a load is commission which is a one-time fee. This is levied in addition to the annual management fee which varies anywhere from less than one per cent to five per cent or more. Even a two per cent annual management fee is a very big deal as over time it takes out an enormous portion of your returns. Loads are sometimes taken as soon as you buy into the fund (known as a front end load) or when you sell (called a back end load).
So then you might think that the way to go is with a no-load fund. But these sometimes compensate for the lack of loads by charging a bigger management fee. Forbes magazine in its 2004 Mutual Fund Guide (February 2, 2004) identifies the average charge in the U.S. market for domestic equity funds at 1.5 per cent which it describes as tolerable but advises investors to find funds that charge one per cent or less. It is generally felt also that index funds carry the lowest expense ratios for the clear reason that these funds require less active management than the others. Essentially the fund manager is buying into a particular index such as is the case locally where the JMMB Select buys into the 15 most liquid Jamaican blue chips. After that the manager simply tries to keep up with the index.
One important statistic is that funds with lower expense ratios generally perform better than those with higher expense ratios and the reason here is that the latter has to literally play catch up to match the returns of those with a lower expense ratio.
ISSUE OF FEES
On this issue of fees, you are advised against just looking at the actual expense ratio in isolation. For example, let us say a fund is advertising an expense ratio of three per cent. The ratio then becomes a function of what you reasonably expect the returns to be after one year. So for example if a fund has returned 35 per cent in a year the true expense is 8.5 per cent (three divided by 35).
A critical consideration is the question of past performance as a measure of fund performance going forward. Well, the jury is in. And past performance does not predict future returns.
You have to be very careful how you analyse this past performance thing. We don't have the data on the local mutual funds available at this time but information on the past performance of the local unit trust funds is published twice weekly in the financial press. And the last 12 months have been another red letter year locally for equities.
CURSORY LOOK
You will find it instructive to take a less than cursory look at the performance of the 10 local Unit Trust Funds specifically the equity-based funds which are BARITA's Capital Growth Fund, DB&G's Premium Growth Fund, JUT's Income & Growth and Capital Growth funds, and SIGMA's Equity Fund (See table below). We have also worked out the broker's commission for purchasing units in these funds based on the difference between what the fund pays when a unit is purchased from a client and then resold to another client as a function of the price paid by the new purchaser.
In conclusion then look out for the following when purchasing mutual funds/unit trust funds:
Seek out funds with no-loads and that settle for low fees.
Read the fund prospectus. Chances are you spent years investing in your career, family, education, enterprise and so on. Why then do you have a problem spending an hour or two reading through a prospectus before investing this money that you have toiled so hard to accumulate?
Be wary of fads. All the research in personal finance supports this notion that investors tend to move with a herd mentality. Be a Contrarian. Research shows that the independent thinking investor knows that fads invariably flop. Remember the dot.com binge and how many investors were hurt when that bubble was busted?
Above all, remember that past performance is no predictor of future returns.
Hopeton Morrison is general manager of St. Thomas Cooperative Credit Union Ltd. and lecturer in the School of Business Administration at the University of Technology. Please send comments and questions to: hmorrison@stccu.com
