It looks like someone else has also done a review of the unit trust industry (published on the same day as my review no less) and this is none other than Tong Kooi Ong, owner of The Edge newspapers, who gave the thumbs down to balanced funds in Malaysia and Singapore. This is inspiring me to also take a stab at the mammoth task of objectively assessing balanced funds sometime in the future.
I’ve admired TKO for a long time since he started The Edge business newspaper decades ago which is THE go-to business newspaper in Malaysia. The page-3 commentary on the weekly Edge reminds of the “leaders” section of The Economist but for Malaysia.
There was, however, a paragraph in the article which confused me a little:
“If you recall, I’ve discussed at length the risks posed by passive funds in their indiscriminate purchase of stocks chosen to replicate the index without regard for the actual facts or performance of a company. Their best feature — low fees — is also their Achilles heel. These risks will only grow as liquidity gradually reverses when the central bank steps back on stimulus”, Tong wrote.
I’m not sure what this means but is Tong saying “passive funds run the risk of underperforming”?
Underperforming what? He can’t be referring to active funds which he just dissed, so I’m assuming he is concerned about passive funds, which are based on indices, underperforming the market.
But hang on. Many passive funds’ indices are also market indices. Therefore following this line of logic and paraphrasing further, is Tong saying “the market runs the risk of underperforming the market”?
Which is why I’m confused.
People buy into passive index funds not only because they are low-cost but because people accept that market returns are good enough and that expensive active managers do a poor job of beating the market.
When compared to the market, a well-replicated index fund will just give market returns, so there is little chance of an under- or outperformance save for tracking errors.
Tong also goes on to propose an answer for this apparent passive fund quandary:
“What would be a good strategy to minimise both fees and risks?
Specifically, can a simple robo investing strategy that picks stocks based on valuation or fundamental variables do better than actively managed funds that are staffed with well qualified professional managers and analysts?”
Actually, these stock-picking funds already exist in the form of the so-called smart beta ETFs which buy stocks according to a selection of parameters like value, balance sheet quality, momentum etc. But these funds may not come cheap as the algorithms still have to be paid for.
More importantly, we don’t know what investors’ flavour of the day is going to be, whether it’s value one day and momentum the next. The Wall Street Journal recently wrote about a recent study which highlighted that value lost out to momentum as a strategy in the tech era. So much for fundamental analysis.
We are also missing the very important asset allocation decision. Simply tweaking your split of safe to risky assets as a way to boost risk-returns may be better than looking into flavour-of-the-day strategies.
Eg. Say your current asset allocation is 60% stock index fund and 40% bond index fund. You now want higher risk-returns: you should first consider maybe a 70-30 stocks to bonds before a smart-beta strategy.