How do Malaysian unit trust (UT) fund investors decide when to invest and how do they select the funds? Very often it is based on past performance.
UT fund promoters are also happy to go along. After a period of market upswing, and when funds have attractive returns for one, three or five years returns, many use this to sell the funds. You can easily see advertisements in the newspapers and magazines that show consumers that their funds have double digit positive returns.
I have also seen sales promotion booths of unit trust companies in local shopping mall displaying buntings showing attractive fund performance returns, giving the consumers the impression that they will continue to get such returns in the future when they invest.
I was given the impression that perhaps only Malaysian UT investors have such fund purchasing behaviour due to the overzealous selling and marketing tactics here.
Apparently I was wrong in my conclusions. I was surprised when the book ‘Market Sense and Nonsense’ by Jack D Schwager (John Wiley & Sons, Inc 2013) mentioned that when the stock market had been rising, investor buying interest would increase. Conversely, after a period of market decline, investors would be more prone to liquidate than invest. This book’s author further remarked that the strong relationship between market returns and investor net flows into equity mutual funds (similar to unit trust as we know it here) was clearly evident in a research conducted using Standard & Poor’s (S&P) index in the US market.
Looks like such investors’ behaviour is quite universal irrespective of where they are from – advanced market like US or a not-yet-mature market like Malaysia.
The book also illustrated in details the various research studies conducted that showed that past performance was an unreliable indicator of whether the UT fund would perform in future.
In fact it said that investors who selected UT funds based on highest past returns – a common approach – would end up indirectly investing in the sectors or markets that had realised the highest past returns in recent years.
The obvious question to ask is: Does the best performing sector or market (funds that invest in the sector or market) continue to perform better in the future year?
Personally I have asked this cheeky question to some friends: Will you buy the 4D number that has just won the first prize in the previous draw? So far, all of them said no.
Of course 4D is a chance game where probability theory says that all the numbers have the equal chance to be drawn as a winner again in the next draw. That shows that sometimes people make illogical decisions.
Why do past high-returns sectors perform so poorly?
Coming back to the investing book that I quoted above, it continued to ask another critical question: Who do past high-return sectors and strategy styles perform so poorly?
One of the possible explanations is that there is a change of fundamentals. Typical a sector or strategy used by a UT fund will do particularly well because of a prevailing highly favourable fundamental environment. There is no reason to assume that the conditions that provided strength in the past will remain prevalent in the future.
For example, consumer stocks will fare poorly during recessions. Unless recession conditions are expected to extend into the future, this past performance is not only irrelevant but also misleading in regard to future potential returns.
Another explanation in the book was equally interesting – emotional price distortions. Strong bull markets attracted speculative buying that could cause prices to move well beyond equilibrium level. In this context, the sectors and markets with the highest past returns were exactly the ones most likely to be excessively priced and hence most vulnerable to retracement.
The above definitely sounded familiar especially to those UT investors who invested in UT funds before the 2008 financial crisis and got caught by the subsequent rapid market decline.
Sometimes it is good to listen.
Lee Khee Chuan ChFC,CFP,CLU,FLMI,BA.(S’pore) is a Bank Negara & Securities Commission-licenced financial adviser representative (CMSRL/B1602/2011) and Director, Advisory & Practice Management of Standard Financial Planner Sdn Bhd (SFP). Contact Lee at 016-888 1038 to know more about how multi-unit trust companies and funds platforms through independent financial adviser (IFA) firm can benefit retail investors.