“A low-cost index fund is the most sensible equity investment for the great majority of investors,”
Said Warren Buffet.
This bubbly-looking, cheery grandpa is not just any grandpa, but the most legendary investor of our time with a net worth of more than $80 billion. When someone as epic as he is makes a statement like that, maybe it’s worth listening to. Whatever that he’s talking about, I want some of that.
And in this case, an index funds.
Unfortunately, it turns out grandpa lives in the states and he is referring to the low-cost index funds available in America. Well, bummers. because I haven’t got the motivation to go about the painful process to unlock foreign stock trading abroad. So, I looked for the next best thing—Malaysia’s index fund.
I’ve sailed Seven Seas, hiked impossible mountains and fought deathly hallows in search of this “low-cost index fund”, but they prove to be rather elusive. Do we even have index funds in Malaysia? Or is it just a rainbow unicorn fantasy?
Today, I’m about to demystify this, Scooby-doo style.
Disclaimer: I am not a financial advisor. The advice here given is not financial advice even though my excitement might make it look like such. Please do your own due diligence prior to making any investment.
Does Index Fund Exist in Malaysia?
But if you asked big brother Google, chances are you’ll come across a lot of misleading information, and confusing jargons thrown around like…
- Mutual Funds
- Unit Trust
- Index Funds
Many sources that I’ve read like to use them interchangeably while they are in fact apples and, well, not apples. They are fundamentally different investment vehicles, with different fee structures that, ultimately, produce distinctly different portfolio returns. It’s sneaky, and tricky.
While we do have our own index funds in Malaysia, they aren’t exactly twin brothers with their US counterpart. In my humble opinion, the best way to understand them is to deconstruct the concept of index fund back to its core and build our understanding from ground up with our local perspective.
What is an Index?
Stock Market Index, or market index, is an aggregated performance of a collection of stocks.
I like to think of them as school report cards. Stock market index is like an exam score. It grades how well the stock market has been performing. Just like how we would have different subjects, a.k.a Mathematics, Physics, and Accounting, we have different stock market indexes that track different industries.
For example, the FTSE Bursa Malaysia Top 100 Index tracks the 100 largest market-cap companies listed on Malaysia’s stock market, therefore giving us a general feel of how well Malaysia’s economy is doing as a whole.
If we look at the FTSE Bursa Malaysia Palm Oil Plantation Index, which tracks the stock performance of palm oil companies, it tells us how performant the palm oil industry is in Malaysia.
The list goes on and you can refer to them on FTSE Bursa Malaysia Indices.
But these indices are just mathematical equations, not actual stocks. They are nothing but market data pulled from Malaysia’s stock market to be calculated as a benchmark that helps us make sense of the complicated market.
Index is not a financial product.
By that logic, we cannot invest directly in the stock market indices. If we want a portfolio that tracks the stock market indices, we need an index fund.
What is an Index Fund?
An index fund is a portfolio of stocks designed to closely match the constituents of a market index. It’s like ordering a single fruit salad. You only need to order one product (index fund) and the restaurant will serve you a variety of fruits, fresh greens, and just a little bit of everything based on their recipes (stock market index).
Similarly, if an index fund is designed based on an index that tracks the 100 largest market-cap companies, then the index fund would, ideally, buy into the same 100 stocks with the same weightings that exactly mirror the index.
As companies enter or leave the index, grow or shrink in market capitalization, the index fund manager will have to rebalance the portfolio accordingly to maintain the resemblance.
For that reason, the performance of an index fund should closely match the index itself.
Are Index Funds The Same As Mutual Funds or ETFs?
No, this is not a case of po-tae-to, po-tah-to.
Although most people have the general perception that mutual funds as actively-managed investments by high profile fund managers and all ETFs are exclusively passive investments, it’s inaccurate, to say the least.
While many popular mutual funds are indeed actively managed by fund managers and financial analysts, there are plenty of passively managed mutual funds that track a market index, which would fit into the category of an index fund.
Albeit uncommon, actively-managed ETFs exist too. They invest in stocks that do not belong in the market index to try and beat the market benchmark so we can’t just assume that all ETFs are index funds.
An index fund is not a mutual fund, nor an ETF.
The better, and perhaps more accurate comparisons are between investment styles (e.g., active vs passive) and investment vehicles (mutual funds vs exchange-traded funds).
In the most basic sense, there are two investment styles: (i) passive and (ii) active.
A passive investment style is an approach where investors attempt to maximize returns by minimizing the frequency of buying and selling. It’s a set it and forget it method. The idea is that despite the daily ups and downs, the market has historically shown an upward trend in the long term (like decades long). So instead of fighting the short term ambiguity and often irrational market, we let the market do its thing and build our wealth gradually.
On the other end of the spectrum, we have an active investment style. While passive investors avoid buying and selling, active investors’ favourite jam is to actively buy and sell. They optimize their returns by constantly monitoring the stock market and exploiting any profitable conditions. Usually, active investors can better generate short-term gains.
While the ongoing debate about which investment style is better has separated the world into two splits, my personal opinion is that both styles can and will help us achieve financial stability as long as we stick to the plan. The choice of our investment styles are very much like our preference for sports, they are just different means to the same goal. But that is another story for another day.
Right now, the main takeaway here is that an index fund is a type of passive investment.
We buy into a basket of stocks that the index tracks, and then hold it for the long term. We are not here to beat the market, we just want our portfolio to mimic the market trends and ultimately, achieve the same returns. Not more, not less, just the same.
Technically speaking, you can refer to the index’s list of companies and buy all the individual stocks yourself. But market indexes typically would have hundreds or even thousands of individual stocks. Buying them individually would not only take up an insane amount of time, but it will also rack up transactional costs that will eat heavily into your returns.
So unless you have the dedication to sit in front of the stock exchange website and click buy until your fingers fall off, we need to get help from another party, or in other words, an investment vehicle.
Investment vehicles are investable products, or so to speak, the method in which we can invest our money for a chance to make a profit. Some of the more common investment vehicles are:
- Individual Stocks
- Mutual Funds
- Exchange-Traded Funds (ETFs)
- Real Estate Investment Trusts (REITs)
- Fixed Deposits (FDs)
- Employee Provident Fund (EPF)
All of them can differ in terms of risks, potential returns, cash flow, fees structure etc. For example, FDs have low risks but lock your capitals for a set period of time; On the other hand, individual stocks have more inherent risks but boast a huge upside potential. Choosing the best investment vehicle should depend on our intended purpose.
It’s like picking a car.
If we want a smooth ride for city-drive, then we can consider buying a Toyota Camry that boasts a spacious interior and superior shock absorbing ability. If we’re going to be driving on mountain terrains, maybe what we really need is a 4 wheeler.
Similarly, a risk averse investor that wants a steady flow of income might want to invest into Bonds and REITs instead of penny stocks.
In the case of a passive investing style like index funds, we can take advantage of investment vehicles like Mutual Funds or Exchange-Traded Funds (ETFs).
Instead of doing all the hard work ourselves, e.g going through the market index, buying thousands of individual stocks, monitoring and then rebalancing our index fund portfolio ourselves, we can let the Mutual Funds or ETFs companies do it for us.
Getting Index Fund Through Mutual Fund
A mutual fund is a pile of money that is pooled from investors like you and me that are entrusted to professional fund managers to invest collectively into financial securities such as stocks and bonds.
Of course the mutual fund’s designed fund managers can’t just do whatever they want with the money. They will have to try and grow the portfolio following a set of legally binding principles and investment strategy clearly stated in their respective fund’s prospectus. When we buy into a mutual fund, we are buying into their investment methodology and their financial skill sets.
At the end of every day, we—the investors—can cash in on our returns depending on whether the fund’s portfolio has increased (or decreased) in value.
Mutual funds can be actively-managed or passively-managed with the former being more popular. Whenever someone says “mutual fund”, they are usually referring to actively-managed mutual funds.
Actively-managed mutual funds hire a group of fund managers and financial analysts that study, research, and analyse the financial market to make investment decisions on behalf of the investors. Based on their findings, they will invest in securities as long as it (a) can make money, and (b) aligns with the investment approach outlined in their prospectus. They aim for better-than-average returns.
Passively-managed mutual funds that track indices are
as rare as unicorns less common in Malaysia. Again, it features a group of fund managers, but instead of picking securities themselves, they will design the fund’s portfolio to replicate the index that they are trying to track. They want a return that exactly mirrors the index’s returns.
Now, I did some digging and finally managed to find a few examples of passively-managed mutual funds (a.k.a index fund) that I would love to share with you. But before the big reveal, one thing I’d really like to emphasize is that we should always look at the prospectus and its investment approach to find out if a certain mutual fund is actually an index fund, despite its marketed name.
Truth be told, I have come across some fund portfolios that have very misleading names. They literally call it *beep beep BANK* INDEX FUND but when I look closer, they’re just run-of-the-mill actively-managed mutual funds.
Here is a snippet of such a fund.
As you can see, despite the fund’s name, it explicitly states that the fund will buy into non-index stocks and aims to outperform the index. This is not an index fund. The fund name is nothing more than just a marketing gimmick. Gotta read the fine prints.
In contrast, a true index fund mutual fund should have an investment approach that is similar to this…
Now that’s more like it.
Anyhoo, here’s some of the passively-managed mutual funds that I’ve found. Feast your eyes!
|Buy/Sell Fee||Management Fee||Trustee Fee|
|RHB KLCI Tracker Fund||1.0% / 1.0%||1.50%||0.07%|
|AMB Index-Linked Trust Fund||5.0% / 0.0%||1.00%||0.08%|
|Principal KLCI-Linked Fund||5.5% / 0.0%||0.95%||0.07%|
|Manulife Investment Equity Index Fund||0.0% / 0.0%||0.75%||0.06%|
*Please don’t quote me on this, but this is what I’ve found as of 9th October 2020.
So to answer the question, yes. Turns out that we can invest into an index fund in Malaysia with mutual funds.
Personally, I’m not a huge fan of passively-managed mutual funds because they charge an absurd amount of fee. Index funds that Warren Buffet has spoken so highly about are low-cost index funds that typically have around 0.2~0.5% annual fees. Well, last time I checked, ~5% one time fee and ~1% annually is A LOT higher than 0.5%.
The weirdest thing is… If you look closely, most of these passively-managed mutual funds have just about the same annual fees as other actively-managed mutual funds out there.
It doesn’t make sense!
Basically, the mutual fund company is asking us to pay the same price for a passive fund manager whose job is to mindlessly buy and sell based on what’s listed on the stock index, versus an active fund manager who needs to proactively research and analyse the stock market to make above average investing decisions.
Why? Unfortunately, I don’t have an answer for that. But my gut tells me to put my money elsewhere.
Perhaps, an ETF?
Getting Index Fund Through Exchange-Traded Fund
An exchange-traded fund (ETF) is a type of security that is a basket of multiple securities. Remember our metaphor about fruit salads? Buying a bowl gives you a little bit of everything.
Similarly, the ETF companies take securities such as stocks, bonds or futures and bundle them together, usually in a combination that tracks an market index, as a single product to sell on the open market.
Both Exchange-Traded Funds (ETFs) and mutual funds are almost identical (more about their differences later) in a sense that both these investment vehicles give us an easy way to add a pinch of diversification to our portfolio. Likewise, ETFs can also be actively managed or passively managed, featuring ETF fund managers that do similar, if not exactly the same tasks as mutual fund managers.
But, passively-managed ETFs are significantly more popular than its actively managed counterpart. In fact, I don’t think there are any actively-managed ETFs in Malaysia yet due to the nuanced complexity and conflicting interests in creating them, even though it is something that can and has been done in the foreign markets.
So, when most people talk about ETFs, they are most likely referring to passively-managed ETFs or “index funds” in general. For anyone who is interested, I present to you the entire list of ETFs in Malaysia by BURSA.
I also wanted to point out that if you read the fine prints on this list, you will notice that most of the ETF’s description will mention something along the lines of “closely tracking the performance of its underlying index”. Yeap, now that sounds like index funds to me.
A Quick Comparison Between Mutual Funds and ETFs
So far, ETFs and mutual funds sound like they’re one and the same, don’t they? Well, almost but not really.
The biggest differentiator between the two is their tradability and management cost, both of which are direct consequences of how they are structured.
A mutual fund is being treated like a company. Whenever we invest into a mutual fund, we become part owner(s) of the mutual fund “company” whose business is buying financial securities.
We don’t directly own the stock and bonds, but we own the company that owns the securities, which in turn, means that we get to split the profit and loss of the fund’s portfolio.
Let’s say that a mutual fund issued 1,000,000 shares at RM 1 each, and pooled RM 1,000,000 cash from investors like you and I. The fund manager would use that money to buy 100 Stock A, 80 Stock B, and 50 Stock C. The stock price will proceed to fluctuate to its heart’s content during the trading day. Although the underlying stocks’ values have changed, the mutual fund share price will remain the same. Why? Well, I’m guessing it’s hard to deal with the complexity of tracking large numbers of changing variables, which might spawn arbitrage pricing.
As soon as the stock exchange closes and the stock prices stop fluctuating, the mutual fund company can then calculate the total value of all the stocks that they have bought, which hopefully, has appreciated to a value of RM 1,500,000. Then if we just deduct the management fee of let’s say… RM 300,000, the portfolio will be worth RM 1,200,000. With 1,000,000 shares outstanding, each share is now worth RM 1.2 instead of RM 1.
This “price per share” is what we call the net asset value (NAV). It tells us how much one share of the fund is worth.
Net Asset Value, NAV =(Total Net Assets – Liabilities)Total Number of Units Outstanding
Based on this NAV price, investors like us can then decide if we want to buy/sell the ownership of the “company”. In this case, by selling our shares in the “mutual fund”, we would effectively lock in the RM 0.2 profit per share. Because NAV prices are only calculated at the end of every trading day, we cannot trade them intraday.
In contrast, ETFs can be traded intraday just like any other stock.
A large part of that is due to how ETFs are inherently created. The ETF companies borrow actual ownership of stocks, usually from pension funds, to repackage as units of ETF and then split the ownership of this ETF into smaller shares to be sold/bought in the open market.
Here’s a quick example.
Let’s say that an ETF company bundles 100 Stock A, 50 Stock B, 30 Stock C into a single ETF unit. They might decide to split this ETF unit into 100 shares. In that case, buying 1 share of the ETF unit on the financial market would mean that we own 1 Stock A, 0.5 Stock B, 0.3 Stock C.
Just like any other stock, the price of the ETF will fluctuate. To buy, our bidding price must match with the selling price of another existing ETF owner on the stock exchange so that the transfer of ownership can take place.
Notice the difference?
Mutual funds own the stocks, but ETFs are the stocks.
For those of you who bought mutual funds before, notice how you have to purchase them either through a mutual fund agent, or from the mutual fund company themselves?
This is a very minor but very important distinction.
All of these mutual funds advertising, marketing and distribution are expenses and the money needs to come from someone. I’m sure you know where this is going. These costs usually make their way down to the investors through the mutual fund’s fees. In essence, each existing shareholder pays for the mutual fund to acquire new shareholders by footing a portion of its advertising bill each year.
ETFs have little to no marketing or agents.
In addition to that, the difference between the operating structure of a mutual fund and ETFs that we were talking about plays a huge role too.
Because ETFs are structured like a stock, whenever we buy into the ETF share on the open market (e.g: BURSA), we go through our stock brokers (e.g: Rakuten, M+, etc), and not the ETF companies. The ETF company doesn’t need to micromanage and know who bought what. They just know that they have all the stocks here, and someone out there has a claim on it. End of story.
This hand-off administrative approach means less overheads on their part, which translate to lower annual fees and happier investors.
Conversely, whenever a mutual fund shareholder redeems his/her shares, the mutual fund needs to liquidate enough assets to cover the redemption. The selling of assets accumulates capital gains tax that gets passed down to all shareholders. Besides, the mutual fund company needs to document all of these transactions, ultimately racking up the operating expenses as well.
Here’s a quick summary.
|ETF (Active)||ETF (Passive)||Mutual Fund (Active)||Mutual Fund (Passive)|
|Liquidity||Non-existent in Malaysia||Traded on public market||Sold through private channels||Sold through private channels|
|Fees||Non-existent in Malaysia||Low||High||High|
Was that too much info? Probably.
But thanks for sticking around. I hope the article cleared up any confusion about index funds in Malaysia.
Again, I’m not a financial advisor but my final verdict is that ETFs seem like a much better alternative than passively-managed mutual funds. Personally, I would only consider using a mutual fund for actively-managed ones where the additional fees could be justified by the expertise of a skilled fund manager.
If you’re looking for something “similar” to actively-managed portfolios but without the high fee, try looking into Robo-advisor. The one I personally use is StashAway and I wrote a post revealing my StashAway portfolio wins and losses. Thought it might be an interesting case study for y’all.
See you in the next post!