By Mary Holm
Monday 29th April 2002 |
Text too small? |
This applies as much to investment as anything. It's easy to tell which investments were best in the past.
Unfortunately, it's also easy to leap to conclusions about future investment. Those conclusions might be wrong.
I'm not just saying that past performance is a poor guide to future performance. I'm also saying that it's easy to look back at a group of investments, pick out a top performer, and present it -misleadingly - as typical.
The writer of a recent investor newsletter committed that sin.
The article raises an excellent question: Should we invest in fixed interest funds - which hold corporate bonds, government bonds and the like - rather than just buying the bonds ourselves?
It comes up with four advantages of the funds. The first three are:
- Diversification. Individuals tend to hold just a few fixed interest securities.
"While the risk of these corporate issuers failing is relatively small (with the possible exception of junk bond issuers), the effect of a failure on a portfolio's performance could be significant," it says.
Bond funds, though, own many securities. If one company goes belly up, it won't matter much.
- Flexibility. Usually, if you invest in a bond fund, you can easily move your money into, say, a share fund within the same stable.
That makes it simpler to re-weight your portfolio. If, for example, your bond fund performs better than your stock fund for a period, you'll end up with more in bonds and less in shares than you had planned. Re-weighting gets you back to your original allocation.
- Regular savings. Usually you can drip-feed money - say $100 a month - into a managed fund. You don't have to accumulate a large sum before you invest.
All of this is good stuff - although it's worth noting that people sometimes re-weight too often, so easy re-weighting could be a mixed blessing.
But the article then lists as its fourth advantage "Performance".
"Good fixed interest fund managers can create value for investors .. Based on their intimate knowledge of the market's dynamics," says the article.
For example, the Royal & SunAlliance Corporate Bond Trust "compares very favourably with the NZSE40 and CSFB gross indices" since its inception in 1994.
I've got a couple of quibbles here. Firstly, the CSFB index measures government bond performance. You would expect a fund that holds corporate bonds to do better, given that corporate bonds are riskier than government bonds.
Secondly, the comparison happens to cover a particularly weak period for New Zealand shares. For instance, it just misses including 1993, when the NZSE40 rose an impressive 48 per cent.
More importantly, though, the writer has taken advantage of Billy Wilder's twenty-twenty vision. She or he has picked which fund to highlight after the fact.
If you were a bond fund investor in 1994, you might have been lucky enough to choose the Royal & SunAlliance fund. But you could easily have chosen a poorer performer.
And there's certainly no guarantee that a particularly good fund will continue to be good, or even above average.
It's fine to look back on the good performers. But it's wrong to imply that all investments of that type have performed - or will perform - that well.
You might as well judge how sunny the New Zealand climate is using Nelson data.
So, after all that, are bond funds better than direct investment in bonds?
You do get diversification, flexibility and regular savings. You might not, though, get better performance. That will vary. And you have to pay fees to cover fund management costs.
It depends which of those factors are more important to you.
Mary Holm is a freelance journalist and author of "Investing Made Simple", commissioned by the New Zealand Stock Exchange to write an independent personal investment column. She can be reached at maryh@pl.net
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