You will compare one active fund's long-run return after fees with its stated benchmark and an index fund alternative.
Wei Ling has written her conditions for an active fund in lesson 6.3, When an active fee might be worth paying. Now she tests the fund she has held for three years. She is a little nervous, because she likes the fund and the people who sold it, and she would rather not find out that she has been overpaying. This exercise gives her, and you, a straight answer about one fund's record so far.
You will compare one active fund's long-run return after fees with its stated benchmark and with an index fund alternative. Wei Ling's Asia equity fund is the worked example, with every figure made up for the example.
Open the fund's latest factsheet and find the performance table. Take the returns for the longest periods shown, usually five and ten years, and since launch. Prefer annualised figures, the average yearly return, over cumulative ones, the total over the whole period, because annualised figures can be compared directly with yearly costs.
Check the basis, as lesson 1.3, Find the facts in a fund's three key documents, explained. Most factsheets show returns NAV to NAV, which means after the fund's running costs but before any sales charge. If you paid a sales charge, your own return was lower. Note which basis your figures use.
Wei Ling's factsheet shows a ten-year annualised return of 5.1% NAV to NAV, and 6.3% for the benchmark over the same period.
Before you trust the comparison, check that the benchmark matches what the fund holds. Compare the fund's country and sector breakdown on the factsheet with the benchmark's, which you can find on the index provider's website. A fund holding mostly Asian technology and banks, benchmarked against a broad Asia ex-Japan index, is a fair match. A fund benchmarked against a narrower or weaker index, or against cash, is not.
Also check whether the benchmark has changed. Some funds switch benchmarks over their lives, and the factsheet may show the current one against the whole history. The prospectus or annual report usually records any change.
Wei Ling's benchmark is an Asia ex-Japan equity index, and her fund's top holdings and country weights look broadly like it. She accepts it as fair.
The benchmark is an index, and an index has no costs. You cannot buy it. So add a third column: an index fund, or ETF, tracking the same or a similar index, with its own return after its own costs over the same period. You can find its returns on its own factsheet.
In Wei Ling's example, an index fund tracking a similar Asia ex-Japan index returned 6.0% a year over ten years after its costs. Its expense ratio is 0.30%.
On S$10,000 over ten years, the difference becomes concrete. At 5.1% a year, =FV(5.1%, 10, 0, -10000) gives S$16,444.75. At 6.0%, =FV(6%, 10, 0, -10000) gives S$17,908.48. The index fund would have left her about S$1,464 better off, before counting her sales charges, which would widen the gap.
Now the number that tells you what the active fund has to do in future. Subtract the index fund's yearly cost from the active fund's. Wei Ling's fund has an expense ratio of 1.75%, from module 2, and the index fund 0.30%. The gap is 1.45 percentage points a year.
That means the active manager must beat the index by about 1.45% a year before costs, every year on average, just to match the index fund after costs. Beating the index by 1% before costs would still leave her behind. Add the yearly effect of any sales charge, spread over her holding period as in lesson 2.4, List every charge on one fund, and the hurdle rises further.
Write this hurdle down. It is the clearest single number for judging whether the fund's past record is good enough, and whether you expect it to be good enough in future.
Wei Ling's test sheet has three columns, the fund, its benchmark and the index fund, with rows for five- and ten-year annualised returns, return basis, yearly cost, the dollar outcome on S$10,000 over ten years, and the yearly outperformance the fund needs to cover its extra cost. Underneath is a short verdict.
Her verdict: over ten years, the fund trailed both its benchmark and a comparable index fund after costs, and it would need to beat the index by about 1.45% a year before costs just to draw level. It has not done that so far. She notes that this is a verdict on the past, not a forecast, and that the decision about what to do next is hers. Your own test sheet and verdict come next, in the activity below.
Complete the active fund test sheet and write a two-sentence verdict on whether the fund has earned its fee so far.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).