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High fees may eat into returns on unit trusts

Investing legend Warren Buffett's (above) personal preference is to put 10 per cent of his cash in short-term government bonds and 90 per cent in a very low-cost S&P 500 index fund.
Investing legend Warren Buffett's (above) personal preference is to put 10 per cent of his cash in short-term government bonds and 90 per cent in a very low-cost S&P 500 index fund.PHOTO: AGENCE FRANCE-PRESSE

I recently wrote about the various investment products, such as unit trusts, retail bonds, single shares and fixed deposits, that are available to beginner or novice investors starting with, say, $20,000 in capital.

In response, many readers have pointed out that unit trusts may not be the best deal, and they asked about another option - exchange-traded funds (ETFs).

One reader said that for someone new to investing, it should be noted that unit trusts carry relatively high fees and charges.

These costs can be as high as 10 per cent of the total investment and are recurring costs that eat into your investment, regardless of how it performs.

Another reader agreed, saying that actively managed funds are expensive to buy, sell and hold.

He said: "Over time, this adds up significantly and returns are seriously depleted by fees."

PAY FOR WHAT YOU GET

In the long run, the market has shown that it's quite common for some unit trusts to underperform the index. Why pay so much in fees when they don't perform as well?

MR ONG LEAN WAN, Wen Consulting principal consultant , on one of the disadvantages of investing in unit trusts

He also says he has no qualms about paying for performance, but added: "Yet we all know that actively managed funds seldom - especially after fees - perform as well as their benchmark."

Still, some readers took a different slant. One said management fees are for a fund manager's expertise, so "it's crucial for an investor to identify, be comfortable and trust a fund house's investment style".

Another reader said: "There are fees involved but relative to the value and returns, these fees are sometimes quite low."

Experts have pointed out that if the fund is held for say 10 years, then the fees spread over the decade, are relatively low. Investors should not be trading in and out of funds but should hold them for the long-term, these experts say.

That reader also agreed with advice that an investor should avoid spreading a small investment sum, such as $20,000, over a large number of stocks as the dealing costs would be too high, and that wealthier investors can still use these now-relatively-cheap baskets to get the same job done.

Experts say that ETFs are becoming more popular and are a relatively recent phenomenon.

Your money tracks the value of various asset classes and indices through ETFs.

For instance, an ETF might track the value of a stock market index, like the Straits Times Index (STI), or a commodity such as gold. As the name suggests, these instruments are traded on stock markets just like stocks.

Wen Consulting principal consultant Ong Lean Wan says the biggest advantage of ETFs is the lower cost, compared with unit trusts.

But he notes that Singapore-listed ETFs are not as cheap compared with United States ETFs, which also offer greater variety.

ETFs can also be traded anytime during trading hours and at a price of your choice, adds Mr Ong, while unit trusts use forward pricing, so you have to wait until the end of the day for a valuation before selling them.

"In the long run, the market has shown that it's quite common for some unit trusts to underperform the index. Why pay so much in fees when they don't perform as well?"

Investing legend Warren Buffett said in his 2014 Berkshire Hathaway shareholder letter: "My advice to the trustee (of his estate) couldn't be more simple: Put 10 per cent of the cash in short-term government bonds and 90 per cent in a very low-cost S&P 500 index fund. (I suggest Vanguard's.)

"I believe the trust's long-term results from this policy will be superior to those attained by most investors - whether pension funds, institutions or individuals - who employ high-fee managers."

However, in his latest investment outlook, bond investing guru Bill Gross cautioned investors, saying that mutual funds, hedge funds and ETFs are the most vulnerable when liquidity becomes scarce.

He noted that over the past few years, global markets have benefited from trillions of dollars of liquidity from loose monetary policies by the Federal Reserve and major central banks.

He raised the flag on sharp price moves in certain markets should that liquidity begin to dry up.

In any case, always research and do your own homework before jumping into any investment.

A version of this article appeared in the print edition of The Sunday Times on August 09, 2015, with the headline 'High fees may eat into returns on unit trusts'. Print Edition | Subscribe