Tuesday 18 August 2009

China ETFs and Mutual Funds - Any Difference?

The Contenders: the two largest by assets of each type

Mutual Funds
1st answer: No, there is no difference
Though the ETFs are explicitly passive index followers and the mutual funds are presumably active managers trying to pick winners, their holdings all look remarkably the same. Take a look at the top ten holdings table below, where I highlighted with different colours the common companies in each fund. It is a very colourful chart!! There is only ONE company at most in each fund that is not found in at least one other. Six companies are in all four funds. Even the place of individual companies in each top ten looks quite similar. The funds are all heavily concentrated in their top ten, with the total assets devoted to the top ten ranging from 50 to 60%. Finally, even the mutual funds are more or less fully invested, with the maximum cash holding being HSBC's 4.5% - if active fund managers were to be able to time a market peak and pull back, would it not have been a good time a few weeks ago (the time of this data) when valuations seemed to be ambitiously high? Today's Globe article Shanghai exchange: Tea leaves might be helpful talks about a possible growing chinese bubble, which is after recent days' big declines.

The net result is that FXI and GXC track each other's market performance very closely (easily verified by a Yahoo stock chart). I bet HSBC's and AGF's would too, except for ...

2nd answer, Yes, there is a difference
Perhaps this is no surprise for observers of ETFs against mutual funds, but the ETF MERs are vastly lower:
  • FXI - 0.74%
  • GXC - 0.59%
  • HSBC - 2.56%
  • AGF - 2.94%
With the holdings being pretty well the same, the extra MERs will surely drag down the net performance for the mutual fund investor by about that 2% difference. Maybe a series of small trades could eat away that ETF advantage through trading costs but someone planning to buy infrequently and then hold with medium size amounts (e.g. $10 trade commission on an ETF on $1000 purchase is a 1% cost) would be much worse off in the mutual funds.

On the other hand, I have read that professional fund managers with resources to do proper research in less developed and therefore less efficient markets, such as China surely still is, can outperform and produce returns superior to an index (see this 2007 YouTube video of Random Walk Down Wall Street author Burton Malkiel - the market efficiency discussion starts at around 33 minutes).

Maybe the China mutual fund managers need to re-think their value proposition and either adopt outright passive indexing and drop their fees considerably, or start doing their job of company analysis and start earning their fees?

1 comment:

Anonymous said...

Excellent reminder about why to use low-cost ETFs vs. high-MER mutual funds. Thanks!

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