Thursday 28 Mar 2024
By
main news image
This article first appeared in The Edge Malaysia Weekly, on November 7 - 13, 2016.

 

According to Lars Kroijer, author and former hedge fund manager, a combination of global equities ETFs and investment-grade government bonds is all investors need for better long-term returns.
 

The global low-yield environment is making it tough for investors to plan their next move, especially when often-used strategies such as individual stock-picking and actively managed unit trust funds are no longer producing the desired returns. 

Lars Kroijer, author of Money Mavericks: Confession of a Hedge Fund Manager and Investing Demystified: How to Invest without Speculation and Sleepless Nights, offers investors a strategy that can generate better returns in the long term while giving them peace of mind. His advice: buy into global equities for potentially higher returns and government bonds to hedge against the investment risks. 

Global equities, he says, have generated a return of 4.5% in US dollar terms over the last 100 years. But the key to unlocking the returns, he adds, is choosing a vehicle that comes with the lowest fees, such as an exchange-traded fund (ETF), as every penny saved contributes to future returns. “Small returns compounded over time can make a huge difference in an investor’s portfolio,” he points out.

Government bonds, meanwhile, act as a hedge against the risks and volatility of global equities. Kroijer says investors should look for investment-grade securities that can provide a steady stream of income that is slightly above the inflation rate over the years if held to maturity.

“It would be suicidal to only buy into a global equities ETF and the market collapses. That is why you should diversify into bonds such as US Treasury Bills, which have almost no risk,” he says.

“If you are worried about the future, you should buy more bonds. But if you have a longer-term horizon, you can allocate as much to equities as you can afford if things are not great in the near term.”

Kroijer has the same investing philosophy as John Bogle, a renowned investor and founder of the Vanguard Group, who says, “If you can’t beat the market, be the market”. 

“If you [don’t have access to the tools needed to] beat the market or pick the best mutual funds, invest in global equity index funds and almost risk-free government bonds. That is all you have to do, and you will do better than most men in the street,” he says. 

Investors who want to take higher risk could allocate 75% of their portfolio to global equities ETFs and 25% to government bonds while those who are more conservative could do the opposite. The combined returns, says Kroijer, would be much higher than if you invested in individual stocks using your own research or in actively managed unit trust funds. 

According to Bloomberg data, the 10-year US and Malaysian government bonds provided a return of 1.86% and 3.59% respectively as at Oct 31. By comparison, the Vanguard Total World Stock ETF saw a return of 1.64% and 50.82% over the past one and five years respectively. The iShares MSCI World ETF saw a return of 1.03% and 55.78% during the corresponding periods. 

In Singapore, the db x-trackers MSCI World Index UCITS ETF saw a return of 0.43% and 51.14% in the past one and five years as at Oct 31. This compares with the FBM KLCI ETF, which saw a return of 3.84% and 25.87% during the corresponding periods. 

 

Why global equities ETFs?

Kroijer, who used to run his own hedge fund, is still on the board of several hedge funds in the UK and other countries. He says his experience on Wall Street has shaped his straightforward investment approach. 

“It is kind of funny. Many have asked me why a hedge fund manager like me would write a book telling people to buy index funds and government bonds. [I tell them that] I know how unlikely an investor is able to beat the market. I have been in the industry and I have seen it closely.”

Having been in the financial industry for more than 15 years and a fund manager for six, Kroijer knows that retail investors have little advantage over financial experts such as fund managers, investment bankers and analysts. “These people have access to information, analytical tools, research, trading patterns and technology. The general investor would not be able to get his hands on all of these things. As a general investor, what are the chances of you doing your own research and beating the market?” he says. 

Kroijer says investors should buy into global equities ETFs and not play the speculation game by trying to pick stocks that will beat the market. They should also avoid buying a single country or regional ETF based on macroeconomic trends. 

“It is extremely hard to predict what will happen next. And it is equally hard to know if the individual securities or markets have already been priced in. For instance, there is an Indian company growing fast and a UK one growing slowly. Both companies made US$1 million last year. Now, the Indian company is trading at US$300 a share while the UK one is trading at US$100 a share. Which is cheaper? It is very hard to know,” he notes. 

Kroijer says investors have always made the mistake of seeing their investments as separate from the economy of the country they are living in. This has led to a lack of diversification, which could result in a disaster during a market downturn. 

“For instance, what will happen if equity markets around the world go down by 50%? It means a lot of companies will go bankrupt and you may lose your job. That is why you should allocate more of your investments to high-quality government bonds if you are worried about the future,” he says.

“The global equities index fund will provide you with diversification, compared with a single country ETF. For instance, if you only buy into the Malaysian index and it goes down by 50%, you will take a hit in your portfolio. But the global equities index fund as a whole may be unaffected.”

Currently, there aren’t any global equity ETFs on Bursa Malaysia. But local investors can access them via overseas brokerage accounts. 

Investors could look at the db x-trackers MSCI World Index UCITS ETF, which is listed on the Singapore Exchange, or the Infinity Global Stock Index Fund, which feeds into the Vanguard Global Stock Index Fund. The latter tracks the MSCI World Free Index, which comprises a basket of 1,600 stocks. 

Investors could also look into the Vanguard Total World Stock ETF and iShares MSCI World Equity ETF, which are listed on the New York Stock Exchange. 

As local investors do not have direct access to Malaysian government bonds, their only option is to buy into a local bond fund. According to The Edge-Thomson Reuters Lipper Fund Table, conventional bond funds saw an average return of 5.76% and 13.75% in the past one and five years respectively as at Oct 21 while Islamic bond funds saw an average return of 5.93% and 23.08% respectively.

Note that the returns take into account the annual management fee, but not the sales charge for bond funds, which ranges from 0% to 2%. 

 

Most unit trust funds underperform the market

Kroijer points out that most unit trust funds have underperformed the market in the last decade. “Almost 90% of the equity mutual funds globally have underperformed the market in the past 10 years (net of fees), based on numerous studies and reports. While some fund managers were able to beat the market, they still underperformed after deducting the fees (which include the sales charge and annual management fee),” he says.

According to the S&P Dow Jones Indices’ semi-annual report published in September, the S&P Indices Versus Active (Spiva) scorecard shows that as at June, 87.5% of the actively managed equity funds in the US underperformed its benchmark in the past decade. The Spiva Europe Scoreboard, which measures the performance of actively managed European equity funds, says 96% of the European funds underperformed their benchmark over a 10-year period as at the end of last year. According to the scorecard, European actively managed emerging market equity funds also suffered the same fate. 

“There is a widely held belief that active portfolio management can be most effective in less efficient markets, such as emerging market equities, as these markets can provide managers the opportunities to exploit perceived mispricing. However, this view is not substantiated by our research as active funds underperformed their benchmarks in all time horizons, with 96% of funds underperforming the 10-year period,” says the report. 

The fees imposed on investors are the main reason these funds underperformed the market, says Kroijer. Throughout his career, he has seen many investors pay huge amounts of fees to fund managers only to see their funds underperform the markets. 

He says this is especially true in the hedge fund industry. “It was very hard to distinguish between the hedge funds that created value and those that did not when the markets consistently went up during those years. It was only during the huge declines of 2008/09 that many hedge fund managers found out that they had only been taking a long position on the market without adding much value. 

“Of course, some of them made a huge amount of money by providing a little more value-add [but that did not justify the fees]. No wonder there were a lot of angry investors.”

Kroijer says hedge funds usually charge investors a 2% annual management fee and 20% of the total net profit. While the charges of unit trust funds are much lower than hedge funds, it is still not good enough as 9 out of 10 funds underperform the market net of fees, he points out. 

 

Equity crowdfunding not yet a meaningful asset class

Amid the current low-yield, low-interest-rate environment, alternative assets have been gaining traction among investors in search of higher returns. Equity crowdfunding is one of them as it allows the general investor to invest in start-ups and small and medium enterprises with little upfront cost.

Lars Kroijer, the founder of London-based AlliedCrowds, a platform that helps developing countries gain access to alternative financing such as crowdfunding, cautions investors to be aware of the risks they undertake by investing in equity crowdfunding platforms. “The returns of equity crowdfunding have not been that good. There are also very few figures to suggest that it has a great success. I would caution people who expect to make a lot of money out of it. It is like buying a lottery ticket.

“Equity crowdfunding is hugely over-hyped. The size of its capital is only 0.1% of the size of venture capital. It is so tiny and not really a meaningful alternative investment to anyone at this point of time. There has been a lot of thought put into it, but very little action has been done. Just like high-school dating, all thoughts but no actions.”

Unlike venture capital funds, where the fund managers are actively involved in growing the business of the companies, equity crowdfunding investors have no say in the companies they invest in, says Kroijer. Whether equity crowdfunding will become a meaningful asset class in the future remains to be seen, he adds. 

For it to really gain traction, what it really needs now is a success story. “We need to have some success stories for equity crowdfunding to take off. And we need more data and statistics to show that it has been a good deal. It might happen in the future,” he says.

 

Hedge Fund Specialist

Lars Kroijer, who has a Master of Business Administration (MBA) from Harvard Business School specialising in hedge fund investments, decided to start his own fund after working for three years with hedge fund firm HBK Investments. 

The Holte Capital Fund, which he launched, is described as a “very conservative” fund that generated an average return of 8% annually, regardless of the market conditions. It gained traction a few years after its launch as investors, who were still reeling from the dotcom bust, were keen to invest in it, says Kroijer. 

At its peak, the fund’s assets under management grew to US$1 billion over a six-year period, he says. The fund closed in 2008 just before the global financial crisis and the returns were paid out to the investors. 

 

Asian investors can afford a more active approach, say local experts

Local industry players believe that investors can adopt a more active investing approach and get returns in the longer term. 

Bryan Zeng, general manager of FA Advisory Sdn Bhd, says there are still a number of unit trust funds that have outperformed the benchmark index over the longer term. “In this part of the world, investors could adopt a more active investment approach and have a view on the country’s economy and which sectors will benefit from it. Then, they can make a decision and buy into unit trust funds that have good fund managers with a solid track record. Investors can also adopt the value investing approach by investing in companies with good fundamentals. Individual investors can outperform the market if they are diligent enough to conduct their research.” 

He adds that adopting a passive investing strategy alone may not be the best option for investors. What is suitable for investors in developed countries may not be suitable for those in emerging markets, which includes most of the countries in Asia. 

Zeng says this is because emerging markets are not as efficient as developed markets such as the US and Europe. Emerging markets will take some time to reach the stage of developed markets. “That is why you see a lot of ETFs being listed in developed markets but there aren’t as many in most of the emerging markets.”

He also says while almost 90% of the actively managed funds in developed countries fail to outperform the markets, it should not be the case in Asia.

Danny Wong, CEO of Areca Capital Sdn Bhd, says the long-term outperformance of actively managed funds in Malaysia and other emerging markets is not uncommon. “There are still a number of actively managed funds that generate about 50% returns over a five-year period, and the 5% sales charge and annual management fee are not a big problem from a long-term perspective.”

He also says while 9 out of 10 fund managers in developed countries underperformed the markets (which include the emerging markets), this is not the case in parts of Asia. “I think fund managers in developed countries underperformed the indices of emerging markets because they tend to invest using a top-down approach as they are global fund managers. They tend to look at the economic growth of emerging markets, followed by sectors and filter them down to individual companies. However, we need an in-depth bottom-up approach to find gems in this part of the world.”

According to The Edge-Thomson Reuters Lipper Fund Table, the funds in the Equity Malaysia category generated an average return of 2.98%, 7.1% and 42.46% over the one, three and five-year period as at Oct 21. Also, 15 out of 65 funds saw a return of more than 50% in the last five years. 

Funds in the Equity Malaysia Islamic category generated an average return of 0.57%, 6.01% and 38.93% during the corresponding periods. Eight out of 58 funds saw a return of more than 50% in the last five years. 

Instead of passively investing in global equities ETFs, Wong suggests that investors look at dividend funds. “Global growth may not be great moving forward and the upside of global equities ETFs may be limited. I would suggest investing in dividend funds that invest in solid companies and provide steady returns over the years,” he says.

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's AppStore and Androids' Google Play.

      Print
      Text Size
      Share