This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on July 4 - 10, 2016.
While plain vanilla funds have been at the core of investors’ portfolios, there are growing concerns that alternative strategies are slowly taking market share from the often inexpensive index tracking funds.
Earlier this year, Detlef Glow, Thomson Reuters’ head of Europe, the Middle East and Africa research, made it a point to highlight that this has happened in the fund management space, where managers are extending their investment universe or increasing the flexibility of their funds by taking short positions and investing outside their focus markets.
Fund managers have increasingly been introducing alternative funds that use an array of complex investment strategies. An example of this are strategies that are meant to shelter clients against market volatility, which try to minimise losses by anticipating whether stocks will rise or fall. These funds tend to have short track records and obscure trading strategies, which make them harder to comprehend.
The heightening complexity is also seen in the exchange-traded fund (ETF) space, Glow says in the Lipper Alpha
Insight newsletter. Transparency is one of the key attributes in the ETF space, but the emergence of offerings such as strategic beta ETFs — a catch-all term referring to rules-based strategies that aim to deliver better risk-adjusted returns than traditional market capitalisation-weighted indices — has made it harder for market participants to understand exactly what these funds are doing, he points out.
To an extent, the increasing level of complexities makes it harder for investors and other market participants to comprehend and navigate. However, experts beg to differ, insisting that there will always be room for plain vanilla funds and that they are as dominant as ever.
Plain vanilla is a term that signifies the most basic or standard version of a financial strategy. In Morningstar’s definition, traditional long-only funds — which buy into securities such as stocks, bonds or both — are considered relatively plain vanilla.
According to Germaine Share, senior manager and research analyst with Morningstar Investment Management Asia, strategic beta products represent a middle ground in the active-to-passive spectrum — deviating from a traditional strictly passive market portfolio, but doing so in a rules-based, transparent and relatively low-cost manner.
From a funds point of view, Share is sanguine about the place of plain vanilla offerings in the marketplace. “We do not think the time for investing in long-only funds is over. As a portfolio of various securities, funds offer a diversified exposure to a certain market, which helps mitigate risks,” she says.
“From a global perspective, these plain vanilla products have been growing faster than the broader ETF market and attracted new cash flows. In general, these strategic beta ETFs help fill the gap between active-to-passive investment styles and offer a lower fee option to those active funds that might have posed index-like strategies. That said, good active managers will likely remain favoured by investors. In addition, funds are managed by professional and experienced investment teams, which have expertise in the region and have the ability to deliver above-market returns.”
According to Monem A Salam, president of Saturna Sdn Bhd (a unit of Saturna Capital, which runs the biggest shariah-compliant share fund in the US), funds have become more complex in terms of investments over the years, but not necessarily in terms of structure.
“Fund managers want to differentiate themselves, so they are offering new products. Funds are getting more complex to satisfy customer needs, but more complex does not
necessarily mean higher returns, whether it is risk adjusted or not,” he says.
“A well-allocated portfolio for investors will always have, at its core, plain vanilla funds. More complex investment strategies and products should always be left in our asset allocation as outliers.”
Monem says the growing middle class in Asean has contributed to the growing appetite for plain vanilla strategies. “The one good thing that these funds have over newer complex funds is a track record. It is important to have a clearer picture of what to expect. Many complex funds have not been through a complete cycle of bull and bear markets.
“The retail unit trust industry will always start by offering plain vanilla products and then move on to more complex ones. That is because the complex products need higher investment minimums and take longer for investors to understand.”
Share says Morningstar’s analytics shows that Malaysia’s fund market continues to be dominated by long-only funds, with more complicated strategies such as hedge funds not so common.
Equity funds have dominated the market in the past five years, accounting for more than 70% of the market as at end-January. Fixed-income funds account for about 16% of the market, with allocation funds following closely at about 10%.
“In terms of Morningstar categories, Malaysia’s large-cap (shariah) funds have gained the most interest with RM3.84 billion of inflows over the past year, followed by Asia-Pacific ex-Japan equity funds, which saw RM2.07 billion of inflows. Conversely, balanced funds experienced the most outflows, losing RM1.04 billion,” says Share.
“In terms of the long-only universe, most funds launched in 2015 were equity funds with a regional (Asean or Asia-Pacific ex-Japan) or global mandate. There were a couple of new dividend-focused strategies, which have been popular in the cross-border markets, such as Hong Kong, as well. In terms of bond funds, all three new bond funds introduced last year focus on Asian high yield.”
As far as the Malaysian ETF market is concerned, Share says the offerings are fairly straightforward with seven equity ETFs based on Malaysia, China and Asean stocks as well as shariah-compliant products and a bond ETF.
“The latest addition was the MyETF Thomson Reuters Asia-Pacific Ex-Japan Islamic Agribusiness (0826EA, listed in December 2015), offering exposure to stocks in Asia-Pacific that are primarily engaged in the upstream agricultural production activities,” she adds.