In one of my recent pieces, I elucidated on the importance of and need for standardized reporting on mutual funds. Just recently, the Security and Exchange Commission (SEC), as the apex organization that regulates operations of mutual funds in Nigeria, issued “new rules on collective investment schemes”. This new rule bothers more on the calculation and reporting of expense ratios for mutual funds. This is indeed a step in the right direction, as mutual fund investors should be made to know, in no equivocal terms, how much fees they are paying for the mutual funds they invest in. The importance of that is that it helps the mutual fund investors with the opportunity to compare fund fees, while investing and even before investing so as to make informed choices
Though the new rule has been lauded as a step in the right direction, it does not seem to go far enough. Mutual fund, as an investment vehicle, is still new and young in Nigeria and it is begging for understanding among investors, especially, retail investors. As a result, the industry needs to be properly regulated and with proper enforcement so as to instill confidence among investors.
Historical Performance: Though knowing how much a fund costs is important, such information becomes almost useless when used in isolation of some other parameters. In most cases, fund fees are used together with fund performance to find out if what is being paid for is worth it. For example, if you have two funds, in the same category, one having 0.5% expense ratio and the other 0.75% expense ratio, intuitively, the fund with the lower expense ratio becomes the choice. What if I tell you that the 0.5% fund has historically made 10% return over the past 10 years while the 0.75% fund has made 25% return over same period, your fund of choice will probably change, even though past performance does not guarantee future performance. Therefore, in addition to asking fund managers to report expense ratios, the SEC should ask them to also report historical performance, among others.
Risk Return Profile: Again, what if I tell you that the 0.5% that has the history of 10% return has a low risk or is a fund with a risk-return ratio of 5% while the 0.75% fund with a history of returning 25% gain is a high-risk fund with risk-return ratio of 50%. Meaning that in a bad market, there is 50% chance of losing all your money while the other fund offers 5% chance of losing your entire investment. Depending on your risk tolerance, your choice of fund may change with that additional information. Therefore, the SEC should advocate for fund managers to report the risk-return profile of their funds. Currently, Stanbic IBTC Asset Management Ltd seems to be the only fund manager that reports the risk profile of their funds, on a scale of 1 through 5.
Sill or Luck: Again, what if I had told you that the fund with 0.5% expense ratio made 5% return 3 years ago, 8% return,2 years ago and 7% return, last year but the fund with 0.75% expense ratio made 45% gain, 3 years ago, lost 20% 2 years ago and lost 25% last year. Over the three-year period, you will see that the fund with 0.5% expense ratio made 20% gain but the fund with 0.75% expense ratio made 0% gain, even though it made 45% three years back. Again, with that information, you may wish to rethink your thought on which fund to invest in. Investors should, and many do pay attention to consistency of fund performance because it helps them to know if the fund manager outperformed the benchmark as a result of luck or as a result of skill. The fund manager that made 45% 3 years ago and lost all that the next 2 years, most probably hit the 45% jackpot by luck while the fund manager that gained 5%, 8% and 7% respectively over a 3-year period must have done so out of his investment skill. Therefore, the rule should ask fund managers to report their monthly performance over the last 5 or 10 years so that investors can have a feel about the consistency of performance as well as be in a better position to access whether a fund manager depends on luck or skill.
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In Closing: Given the “youthful” nature of the mutual fund industry in Nigeria, one agrees that the role out of the rules may have to be a gradual process, but the earlier the better. More importantly, such rules should be enforced, as research has shown that most of what the fund managers promise in their prospectuses are not delivered as at when due. A good example is daily mutual fund prices, which only a handful of fund managers make available on their websites. Yet there does not seem to be anything being done to enforce the publication of the daily prices.