WHENEVER we are approached by a unit trust consultant or financial planner about an investment product, our next question will revolve something about the returns: “What is the expected return or past record of returns?”
We could probably be reading through a fund factsheet and our focus goes straight to the performance chart and its past one year, three year and five year returns.
Don’t get us wrong for it is only natural that returns will be the crucial element when deciding to invest.
The point of our article would be to showcase the different context in which returns can be better evaluated.
Judging from past returns
Although we are all familiar with the term ‘past performance is no guarantee for future performance’, past performances can be a useful indicator in evaluating a fund.
Past performance gives us a window to the past to gauge if the investing formula implemented by the fund is something that has worked, and how successful has it been – as long as certain crucial factors has remained constant throughout such as the strategy or investment team.
If the fund employs a bottom-up investing style in Asia, an intensive amount of research would be needed considering the number of investible companies in the region.
Hence, if the fund shows a long track record of outperformance, it means its investing strategy has been proven to work.
Returns relative to the benchmark
You may be ecstatic to know that the fund you have invested in have returned 15% for the year.
But what if the benchmark of your particular fund has increased by 30%. Putting the returns of the fund in perspective, relative to its benchmark, it has actually underperformed by 50%!
Find out why that has happened. Was it because of the mandate of the fund or certain styles employed?
For example, the performance of a dividend-oriented equity fund will typically lag behind those of growth-styled funds during bullish markets.
What is the ‘x’ amount of risk taken to achieve ’y’ returns A fund may have stood out having achieved a higher set of returns.
But have you ever wondered how much risk has been taken in order to achieve the generated returns?
Were the high returns only made possibly through taking excessive amounts of risk? Performance measurement ratios like the Sharpe Ratio is one of those commonly used to valuate risk-adjusted return.
When comparing between funds, opt for a like-to-like or apples to apples comparison – for example between bond funds investing locally.
If both funds achieved 5% returns, the one with a higher Sharpe Ratio should be preferred. Remember to ensure variables are the same before making the direct comparison, i.e. the frequency of period used, length of time period, risk free rate chosen, etc.
Conclusion
A fund’s return should not be judged in isolation. Compare it with the broader market or its peers. Find out how much risk has been taken to produce those returns. – Aug 1, 2021.
Danny Wong Teck Meng, CFP is the Chief Executive Officer of Areca Capital Sdn Bhd and a Certified Member of FPAM.
The views expressed are solely of the author and do not necessarily reflect those of Focus Malaysia.
