Unit Trusts (a.k.a. mutual funds), bonds and treasury products. These are just some investing options banks and other institutional investors offer their clients. But before you buy into any of these, let’s look closely into the bank’s offer.
“Traders and salesmen would boast about ‘ripping the face off’ their clients — structuring and selling complicated deals that clients did not understand but that generated huge profits for the bank that was brokering the trade.”
13 Bankers: The Wall Street Takeover and the Next Financial Meltdown, by Simon Johnson & James Kwak.
When I log into my online banking account these days, I can get a lot done from my dashboard. I can transfer money locally and globally. I can settle utility bills, pay my taxes and even pay parking fines. I can take out insurance, apply for loans or credit cards.
It’s very convenient. I appreciate anything that helps me avoid having to go to a bank branch in person.
But it’s not just the day-to-day conveniences that online banking offers me. My bank also helpfully offers me an increasing array of ways for me to “invest” my money.
In the screenshot below, you’ll see the Investments tab of my online banking dashboard.
You might see this and think of words like ‘choice’, ‘variety’… or even ‘convenience’.
But I think you should treat this section, especially the parts I’ve highlighted in red, a bit like a museum. First, because that’s where a lot of the stuff on offer here belongs. Second, because you should look, but not touch. And third, because if you do touch what you see here, it’s likely to be very expensive for you. (You’re probably better off buying cheap markets.)
Below, I’ll tell you why one particular relic here is so toxic to your financial health.
Unit trusts (or investing in mutual funds)
The ever-so-helpful Q&A provided by my bank on unit trusts says the following [my comments added in red]:
Q: What are unit trusts? How can I benefit from unit trusts investment?
A: Unit trusts (or mutual funds) give investors the opportunity to diversify even a small investment in securities, bonds, currencies and commodities in markets around the world. [So do ETFs, at a fraction of the cost.] This is achieved by combining the resources of many investors into one large fund which can be spread over a number of different investments and over a wide geographical area. [This sentence is nonsensical financial jargon gibberish, it makes no sense.]
Unit trusts have a number of benefits:
- Spreading the risk. You spread your investment across a diverse portfolio. This is usually safer than investing in a single share. [Portfolio diversification has nothing whatsoever to do with unit trusts.] Of course, levels of risk and return also vary among different funds. [I would hope so.]
- Professional management. Fund managers spend their working lives researching and managing investments. [Just because someone spends a lifetime managing money, it doesn’t necessarily make them good at it.] It would be very difficult for an individual to have an in-depth knowledge of markets around the world. With a unit trust, their expertise is working for you. [Well, technically, it’s your money that’s working for them.]
- Access to worldwide markets. Your money can be invested in overseas markets, which may not be easily accessible by individuals. [You don’t need a unit trust to invest in overseas markets. There are roughly a thousand ETFs listed in the U.S. and Hong Kong giving you exposure to every possible geographic market imaginable.]
- Economies of scale. With a large number of investors contributing to a single fund, operating costs and commissions can be amortised. Individual investors thus pay lower fees. [It is difficult to respond to this assertion without resorting to profanity. Discussed further down.]
- Liquidity. You can buy and sell unit trusts on any dealing day (except on public holidays in the countries to which your fund is linked).[This is a dangerously misleading comment. Liquidity doesn’t just mean the ability to buy and sell. It’s the price of liquidity that matters. This is best represented by the bid-ask spread – that is, how much more you pay to buy a security than you receive from selling it.]
So far, so good. We’ve been briefed on all the ‘benefits’ of unit trusts. But surely there must be some risks?
Q: What are the risks of investing in unit trusts?In general, investors are exposed to the following risks when investing in unit trusts and investors should refer to the individual product offering document for further details and risks involved.
- Investment Risk – Unit trusts are NOT equivalent to time deposits. [If you were unclear that a mutual fund isn’t a time deposit then perhaps this is not an investment you should be considering in the first place.] They are investment products and some may involve derivatives. [Wait, what?] Investment involves risks. [Again, if you were not aware of this fact, maybe you shouldn’t be looking at unit trusts.] Past performance is no guide to future performance of the funds. Value of the investments can fluctuate and is not guaranteed.
- Credit risk – For funds investing in bonds, bonds are subject to the risk of the issuer defaulting on its obligations. It should also be noted that credit ratings assigned by credit rating agencies do not guarantee the creditworthiness of the issuer. [Finally, a genuinely sensible observation.]
- Liquidity risk – There is a risk that investments made by a unit trust may become less liquid in response to unfavourable market developments or market sentiment. [Wait, didn’t you just cite liquidity as one of the benefits of unit trusts?]
- Currency risk – If the fund’s assets and income are denominated in currencies other than the base currency of the fund, currency movement may affect the value of the fund’s share price. [The second sensible observation in here.]
Now that you’ve read the Q&A, you understand that a mutual fund is not a time deposit. And you realise that liquidity is both a benefit and risk. So let’s get on with choosing a unit trust.
You’re keen on some simple broad Asian equity exposure, so you browse the list of mutual funds and you come across the [BANK NAME REMOVED] Asia Ex Japan Equity Fund.
It sounds pretty straightforward.
You take a look at the fund factsheet and notice that the fund was launched on the 1st of April 1993.
You disregard the fact that this US$288 million fund opened for business on April Fool’s day, and instead recall that “fund managers spend their working lives researching and managing investments”.
This fund has been running since ’93 so it must be a winner.
And with over a quarter of a billion dollars under management, it’s time to see how those ‘economies of scale’ are working out in terms of ‘lower fees’. You glance at the fact sheet again, shown below..
Hmmm… So, the bank/fund manager takes over 5 percent of your money for the privilege of managing your money (the ‘Initial charge’ or ‘Front load’).
Then they take another 1.5 percent of your money to ‘manage’ it for you. But don’t worry, “with a unit trust, their expertise is working for you,” just like a car mechanic.
You do the maths and realise the fund needs to rise by 6.75 percent in the next 12 months just for you to break even.
Perhaps you console yourself in the knowledge that at least you have liquidity, given that “you can buy and sell unit trusts on any dealing day”.
But sadly your consolation is short-lived when you realise that although you just bought the fund for US$56.04 the best ‘bid’ you have is US$53.10.
This is 5.4 percent below what you just paid for it, as you can see in the figure below.
If you are unclear on what it means to ‘have your face ripped off’, it’s getting sold an investment product like this.
These products are still marketed, a growing list of mutual funds still sit there being advertised by my bank. The logical conclusion therefore is that there are still people out there buying this junk.
Please, don’t be one of them.
The fund I looked at today is just one of hundreds. And it ‘manages’ over a quarter billion dollars of individual investors hard earned wealth.
P.S. At Stansberry Churchouse Research, our goal is to help you make your own investment decisions… and learn to avoid financial garbage like Unit Trusts. If you want recommendations that can make you money, rather than squander it, click here to learn more about The Churchouse Letter.