Which equity funds are better, mutual funds or UITFs?

Question: I want to invest in pooled funds that are into Philippine stocks. Which of the two would be better for me, mutual funds or unit investment trust funds (UITFs)?

Answer: To answer your question, we need to do a two-part analysis. First, we need to look at the historical performance of Philippine equity-invested mutual funds (MFs) and UITFs. The source of the analysis is My PF App 2023 of the Personal Finance Advisers. Understand that performance review includes not just looking at actual annual compounded returns but also such returns versus a benchmark and risk measures. Also, let us do three periods of returns as the investment scenario varies over time: five, 10 and 15-year performance all as of the year 2022.

For the benchmark, let us use the Philippine Stock Exchange index (PSEi) Total Return index (TRI) as such a benchmark considers the reinvestment of dividends on top of price changes, the same as pooled funds. The PSEi considers only price changes. In fact, the PSEi TRI outperformed the PSEi by 1.72, 1.92 and 2.60 percentage points for the five, 10-, and 15-year periods, respectively.

For measures of risk, let us use the Sharpe ratio, Treynor ratio and Jensen’s alpha. Sharpe ratio is the difference over time between an investment’s return in excess of a risk-free rate (e.g. one-year Treasury Bill) divided by the standard deviation of the investment’s returns over the same period. In essence, the ratio measures return per unit of risk; the higher the Sharpe ratio, the better.

Treynor ratio is like the Sharpe ratio in terms of numerator but uses the investment’s volatility versus a benchmark, with such volatility called beta as the denominator. The higher the Treynor ratio, the better.

And without going through its dizzying formula, Jensen’s alpha is a risk-adjusted performance measure that computes the excess return of an investment over what it should have earned based on the capital asset pricing model. Its alpha ideally should be zero or higher.

15-year period

There were 20 MFs and UITFs that had data over the last 15 years. The period was marked by a huge recovery from the Global Financial Crisis of 2008. In fact, this period included the longest bull run in the history of the Philippine stock market after the unification of the previous two stock exchanges, the Manila and Makati stock exchanges.

Only one pooled fund, a UITF, outperformed the PSEi TRI’s 6.65-percent per annum return. That same UITF also had the only positive Jensen’s alpha. In terms of Sharpe ratio, only two MFs were in the top five list, with the rest being UITFs. And in terms of the Treynor ratio, there was only one MF in the top five.

10-year period

There were 26 MFs and UITFs in the 10-year review. The period pretty much took away the impact of the recovery from the Global Financial Crisis of 2008, with the PSEi TRI posting an annual compounded return of only 3.14 percent.

In this period, none of the pooled funds outperformed the PSEi TRI. No pooled fund also had at least a zero Jensen’s alpha. In terms of Sharpe ratio, three MFs were in the top five list. And in terms of the Treynor ratio, there was only one MF in the top five. Interestingly, in both top lists, an MF was on top.

Five-year period

There were 59 MFs and UITFs in the five-year review. The period was dominated by the impact of COVID-19, with the PSEi TRI posting an annual compounded return of only negative 3.44 percent.

In this period, seven pooled funds, all of which were UITFs, outperformed the PSEi TRI and with only one of them having a positive return (i.e. the same UITF was the only one with a positive Jensen’s alpha). In terms of Sharpe ratio, three MFs were in the top 5 list. And in terms of the Treynor ratio, the top 5 list was dominated by UITFs. Finally, in both top five lists, the UITF with the lone positive return was on top.

When it comes to tracking errors of equity index funds, the longer the period, the wider the tracking error becomes. Tracking error simply measures how far off the return of an investment is versus its benchmark.

The second and more important part of the analysis deals with you.

You need to figure out what you need to earn based on the future value of your financial goals compared with what you have to start with and what you can periodically add. Performance rankings will vary with the ever-changing investing landscape. What is important is to find that fund that can meet your return demands over the long-run as balanced by your risk preference.

And do not forget that there are also equity-invested single premium variable unit-linked insurance policies that not only invest for you but also provide you with life insurance coverage.

I wish you a fruitful and stress-free investing experience. INQ

Send questions via “Ask a Friend, Ask Efren” free service at www.personalfinance.ph.

Efren Ll. Cruz is a registered financial planner and director of RFP Philippines, seasoned investment adviser, bestselling author of personal finance books and a YAMAN Coach. Email [email protected]. Attend the 99th RFP Program this January 2023. E-mail [email protected] or text 09176248110.