Asked on 08 Oct 2019
I’ve read many books and articles saying most funds underperform as compared to indexes so I’m a bit apprehensive?
Contrary to popular belief: There is still a use for UTs.
In a market where market information is transparent and fluid (example: S&P 500): It has indeed been proven that most funds underperform compared to indexes.
However, in markets where information may not be so readily available or where passive funds do not provide reliable tracking of the index you are looking at, active management might be a better venue.
Certain UTs also allows access to instruments not normally accessible to retail investors like us.
Once again my recommendation is not to overgeneralize the UTs vs ETFs comparison but instead look at the specific instrument you are aiming to invest in and your purpose for investing in that particular instrument.
I usually dislike answering questions this way but it would be best to speak with a Financial Advisor that distributes Unit Trusts for advice on using UTs for portfolio construction.
What I do want to say is that about 80+% of active funds tend to underperform their benchmark indices over a 15 year period, yes, but passive index ETFs 100% underperform. Because they just try to track the index, minus fees, and that's what you get.
Before going into the product, spend some time figuring out your overall portfolio asset allocation and your desired exposures to different asset classes, geographies, and industries. UTs are just tools to help you achieve the exposure you want in your portfolio.
After that then look at the either a UT or similar ETF to give you that exposure you want.
Hi Anonymous, I happened to have chanced upon this while seeing someone responding to one of my answers from years ago.
It's natural to be apprehensive as most Unit Trusts are actively managed and by extension, charge a much heftier fee, which certainly affects investment returns.
The problem with your current sources on many books and articles is that they typically come back to the same piece of research, which is SPIVA - or the Standard and Poor Indices and Active. This is a comparison to show funds that underperform compared to indices.
There are many viable criticisms for this line of study, but much of it was covered briefly by Samuel below. Most of the categories are not only effiicient-market based, but they are also wrongly compared: as this article will highlight - where if you feel MOST actively managed funds underperform their benchmarks: ALL passive investing underperforms their benchmarks. All.
For the most part, as an investment specialist I'd love to help you out if you're still looking for opportunities, especially during this time of Covid where the market is much lower from its previous highs.
When financial consultants proclaimed that passive index ETFs 100% underperform the market, it always seems to me that they are trying to find an excuse as to why active funds underperformed the benchmarks/markets. Of course, passive underperform because it is not in their nature to outperform the market.
The objective of passive investing is for the fund to track the benchmark efficiently.
If you are going with the active route, there are cheaper ways to get active exposure. For example, actively managed / smart-beta ETFs. They generally cost cheaper than an actively managed mutual fund. (Note that a unit trust is a form of mutual fund).
And as you have pointed out, it is true that most active funds underperform. The probability of a financial consultant picking winning active funds consistently over the long run is very very slim, which is just as good as the probability of active managers picking winning stocks.
As retail investors, you are better off with picking passive ETFs to form the bulk of your portfolio if you are not willing to spend a lot of time researching on individual stocks. No harm allocating 5 to 10 per cent of your portfolio to active funds if you are so inclined.
Anyway, I am starting a financial blog. Do check it out.