Invest because of good performance

We will take a more serious study of this equity fund and make some investment criteria for decision making.

This particular fund is PSMALLCAP. However the principles and approach used are the same for other equity funds.

Typically, a fund agent will show the following good performance to impress the potential investors.- since the launch of the fund in 13th June, 2000, i.e. 4.5 years ago, the fund has produced a positive return of 65.87%. This sounds impressive especially when comparison is made with the KLCI over the same period that only produces 4.82%, worse than that of bank saving interest.

Fund agent will use this as a convincing evidence to get customers to invest. There are some serious flawed thinking which we will discuss in further details. First we take a look at the behavior of this fund performance with KLCI for comparison.

From the shapes of the graphs, we notice that patterns between PSMALLCAP and KLCI are similar. You don't get KLCI down drastically and Fund goes up sky-high. They rise the fall are in similar fashion except a better managed fund rises faster or drop less compared with KLCI.

If you have invested in this fund since launch, is this a fund with good return?

With 65.87% return, it is equivalent to 13% return per year after minus the fund commission / charges. Not too bad an investment. But a big question needs to be addressed, will the market in the future continue with this same rate of return or momentum? If not, will it bring about negative return after more years of investment? This is a relevant question as most investors had experienced high return and turned to negative during the economic crisis some years ago!.

Hence as a 4.5 year-investor, your real profit of 13% per year is when you sell the fund and take the cash Now! Otherwise, you are at the mercy of the market forces, which may either bring about higher return or losses.

It is naive to use the argument that past good performance will bring about similar good performance.

The fund return is 57.93% and the KLCI is 35.42%. The fund agent will emphases more the previous comparison of 65.87% for fund and 4.82% for KLCI in the 4.5 years time frame, but less on this 3 year time frame. But we should intelligently conclude that different timeframes give different returns, and we should not be manipulated to take a particular timeframe to prove a particular point.

Figure 2

- 3 years period

Now we take a closer look on the 3 year return, i.e. 57.93%, which is equivalent to 17% per year return after deducting the commission and charges. Wow, 17% per year return in 3 years is better than the previous 13% per year after 4.5 years.

It seems that shorter term investment (3 years in this case) is better than long term (4.5 years) investment, contrary to the prevalent belief of longer term investment is the way to go.

Similar question like above is to be posed: do you want to take the higher profit now or wait - for better or for worse!? Surely you need other criteria and analysis to make such a decision.

What if you were the investor in this fund only 9 months ago?

Figure 3

- 9 months.

The fund return is 2.24%, which is actually negative after deducting the commission / charges, and KLCI is 2.27%, more than the fund return. You will actually see that the patterns of both fund and KLCI are similar. You will also notice that after you purchased the fund 9 months ago, and within the next few months, your return can be negative -8 to -15% (with commission included). If the market declines from now onward, your could have losses.

With the above, do you think you have sufficient data and logic to decide on fresh investment or continues with the past investment? Certainly NOT!? But many investors will act using the earlier logic of good past performance as the basis. This is very un-wise.

What if I show you another investment instrument that gives 6.79% return instead of 2.24% in the same 9-month period?

The return for this particular investment instrument is 6.79% or 6.54% after deducting the charges / cost. This is much better the the equity fund in this period of time.

What then are the learning points for sound investment?

Summary of Investment Learning points

Using only past performance data for investment decision is a foolish act.
Actual investment profit or performance is highly dependent on the timeframe of consideration and realization of the profit to cash in equity market, which goes up and down in certain patterns and trends.
What could be good paper gain (profit) can evaporate fast in different timeframe.
"Long term investment" strategy may not bring about higher profit, it can be high loss.
Good investor will use different investment instrument for different timeframe to maximum consistent positive profit
Certain knowledge and skills are required to determine timing of investment for good positive return, not with blind faith on long term investment and diversification.

The above investment criteria and strategies are employed by this QuaSyLaTic in his investment management services to clients (see performance report) and taught in his internet tuition class