The better way to choose funds

Question: There are a lot of investment choices nowadays. Apart from mutual funds, there are also unit investment trust funds, variable unit-linked insurance and now exchange-traded funds. Can you provide a guide on how to choose the best one?—posted on PFA’s “ask a friend, ask Efren” service at www.personalfinance.ph

Answer: The immediate basis for choosing funds would be investment returns.  But that is by no means the only basis for choosing which funds to invest in.  Here are some tips for you:

1. Compare durians to durians. While it may be obvious that you should not be comparing a fund invested in stocks with one that is invested in bonds, comparing equity funds to other equity funds should also not be that automatic.  This applies to any other comparison with the same asset class of funds. In particular, you should not compare the performance of an index fund with that of one that is actively traded.

2. Include the fees in return computations.  Funds will have different fees. Fees that you pay for buying into a fund can be called entry fee, sales fee or front-end load. Fees that you pay in selling a fund can be called exit fee, redemption fee or back-end load.  At least include the entry fees in computing for returns.  You may not need to include the exit fees as these normally go down to zero if you stay long enough in a fund.  With some funds, exit fees go away after a short six months. Some funds have zero entry or exit fees. Funds that do not have any such fees are called no-load funds.

3. Ask for risk-adjusted returns. Investment return has an identical twin, risk.  They are identical in that the higher the potential investment return is, the higher the potential risk. Also, the higher the historical investment return, the higher the risk that the fund took in getting those returns. There are three indices that can be used to measure risk-adjusted investment returns.  These are Jensen, Treynor and Sharpe indexes. Rather than make your nose bleed, just ask for the risk-adjusted investment return of the fund you are considering.  Make sure the funds provide you with the same indices over the period of performance that you are reviewing.

4. Compare investment performance with internal benchmarks.  Some funds will have unique investment objectives that will require the construction of internal benchmarks to gauge their performance.  Ask for such a comparison while also understanding the logic behind the construction of the benchmark.

5. Ask about the investment process.  You should not and need not run after the fund with the best investment performance. It is very difficult for a fund to stay best performing for an extended period of time.  What is important is to see whether a fund’s investment process is institutionalized or not.  A fund that relies heavily on just its fund manager, even if returns are stellar, faces management risk since that fund manager can resign, get sick or be called from this life early.

6. Ease of adding investments. Informed investing should not be a one-time exercise. You will need to do periodic investing to achieve your financial goals in a more affordable fashion. So ask also about the ease with which to do repeat investing.  Some funds make it a no-brainer by doing automatic monthly debits against your savings account with them.  Some offer the flexibility of “sweeping” or debiting your savings account at any time the balance meets the minimum investment lot for your chosen fund.

7. Know the other charges.  Some funds offer sweeteners like hospital income benefit, term insurance and others. Be sure you know what these costs are and how they impact investment returns.  Other funds are subject to many taxes and licenses depending on the nature of the fund (e.g. corporation vs mere product).  Such charges can weigh down returns or increase a fund’s risk-taking so that its return can be at par with those that do not have such expense burdens.  The complete disclosure on such other charges may be found in the prospectus for mutual funds and exchange traded funds, plan rules for unit investment trust funds and proposals for variable unit-linked insurance.

8. Match your return goals with risk preference.  Most important of all, you will need to match you target investment returns and risk preference with the estimated returns of the funds your choosing as tempered by the risks they are taking.  And once you have chosen a fund, be sure to review its performance periodically, like every quarter to determine if the fund is allowing you to be on track with your goals and risk preference.  Ideally, you should review your investment plan every two years.

If you want to learn more about investments in particular and personal finance in general, please visit www.personalfinance.ph. The site has many free useful resources. You may also attend the EnRich™ personal finance training happening on March 22,  9 a.m. to 5 p.m. at Gloria Maris, Gateway Mall, Cubao, Quezon City. Details for EnRich™ may be found in the website.

(Efren Ll. Cruz is a Registered Financial Planner of RFP Philippines, personal finance coach, seasoned investment adviser and bestselling author. Questions about the article may be sent by SMS to 09175050709 or e-mailed to [email protected]. To learn more about the RFP program, attend a FREE orientation on April 3, 2014, 7pm at the PSE Center. E-mail [email protected] or text <name><e-mail><RFP> at 09173464126 to register.)