$$ analysts: Tread carefully on mutual funds

Ram Ramesh, Caribbean Money Market Brokers (CMMB) CEO, is advising investors to carefully examine rates quoted by mutual funds managers and understand the true nature of their claims, before taking the plunge.

The performance measurement for mutual funds in TT is a controversial area, he feels. He said it is not immediately apparent whether the performance figures reported by the funds are gross or net of the management fees usually charged by these funds. Additionally, he noted that while in absolute terms a mutual fund might have posted impressive results, it is important to compare this performance against how the market as a whole performed during the same period.

Ramesh said due to the inherent lack of liquidity in the stock market many equity funds in Trinidad and Tobago tend to hold significant positions in fixed income instruments. “This renders evaluation of the fund performance against benchmark difficult, if not impossible. One has to construct a custom benchmark based on the average asset allocation during the period,” he said.

He said in the case of the Income and Growth funds, the funds are likely to have significant investments in fixed income instruments to provide the income component. “If one were to build a composite benchmark of fixed income and equity investments in TT, these funds are likely to have significantly out-performed the benchmarks as interest rates were low in 2002.” However, he said, whether this excess return is significant depends on the risk that the fund assumed in generating this return and how close the fund’s composition is to the benchmark. “A rising tide lifts all ships. Therefore one should carefully examine whether the fund performance was due to general market conditions or to specific manager performance,” he said.

Investors, he said, need to look at the long-term performance of a fund not just last year’s performance. “A particular fund might have performed extraordinarily well in one year but poorly in other years.” He believes that one has to view the performance of a fund for an extended period of time, preferably five to ten years, but certainly not less than three years. He said advertisements appearing on a fund’s performance should be required to have this data. Ramesh said this is why the Association for Investment Management and Research (AIMR) recently published guidelines for advertising as part of its Global Investment Performance Standards (GIPS).

GIPS are a set of global standards being proposed by AIMR to promote ethical standards for investment management firms to follow when presenting performance results. The standards aim to provide greater uniformity and comparability among investment management firms. Ramesh said even when a fund out-performs its benchmark, one has to examine what risks the funds took in order to produce the high return. He suggested that for this purpose, investors can use a measure known as “The Sharpe Ratio” that helps compute the amount of return generated by the fund for each additional unit of excess risk taken over a risk free rate.

The CMMB CEO said in TT, the standard of performance reporting has to be raised in order to allow investors to make informed and fair decisions and comparisons. These standards need to include disclosure on composition of the funds by asset class, comparison against benchmark returns, information on whether returns quoted are net or gross of fees, and returns information for at least three, he said.

He said last year was characterised by a period of low interest rates combined with high liquidity due to general lack of investment opportunities. “The trend suggests that this condition will continue into 2003, therefore one can expect mutual funds and other investment managers to compete for investments by quoting attractive returns based on their past performance,” he warned.

Peter Clarke, managing director, West Indies Stockbrokers Ltd (WISE) shared some of Ramesh’s views. He said investors have to be careful and  understand that the previous and historical performance of mutual funds is no guarantee of future performance. He said investors have to be even more careful when investing in equity funds and looking at their past performances. “Equity funds tend to perform in line with the stock market which goes up and down. It has good years and bad years.”

Clarke said 2002 was a particularly good year, but reiterated that investors have to exercise caution if they are investing in mutual funds and expecting the same returns as last year. “The point is, mutual funds, especially equities carry more risk than money market funds, and with that in mind, investors need to think carefully before they act.” He said it will be dangerous to assume that beacuse a fund returned 25 percent in one year, that it can do the same again in another year. “Equities are different from money market funds in that they carry more risk and can do better than money market funds when the stock market performs well.”