What serious investors should look for in a mutual fund

When it comes to saving and investing money, people are drawn towards figures that measure returns in cold, hard figures. Returns become some sort of Holy Grail that indicates whether an investment is any good, regardless of volatility and default risk. In this exclusive interview with Karen Liza M. Roa, president and chief executive officer of Philam Asset Management, Inc. (PAMI), Roa says stability of the company and a well-defined investment process should also be topmost consideration for serious investors. PAMI is one of the top three players in the mutual fund industry in terms of size. Learn about several sticky issues about mutual fund investing in this interview, like costs of investing, clues on upcoming new funds, the difference between mutual funds and UITFs, and what is the best strategy if you decide to invest in this instrument. MoneySmarts asks the hard questions so that you will be an informed investor. Happy reading! MoneySmarts: Mutual fund practitioners are fond of saying that one of the benefits of going into a mutual fund is that you have professionals working for you. It’s like having your own investment manager, even if you’re actually only part of a pool. How professional are the professionals in this industry? Roa: There are about 14 to 15 fund houses that manage mutual funds. The market, however, is dominated by three players. You have BPI through ALFM managed by the BPI Asset Management group. The fund house manages both the mutual fund and the UITF. And then you have Sunlife, and then you’ve got PAMI. The biggest is still ALFM, they are about P30 billion plus for the mutual fund, we have about P22 billion. These three dominate the industry. That’s already two-thirds of the entire market. So if we are talking about reputation, you can immediately see the dominant players. They are reliable. MoneySmarts: Is there a requirement from the SEC on length of investing experience for fund managers? Roa: You have to have the license to be a fund manager. As a corporation, there’s a capitalization that is required. I am not aware that there is a number of years experience required, but that should be the lookout of the issuer. It will show in the fund’s performance. For PAMI, there’s a defined investment process. And that investment process is not only Philippine-based or localized, its an international investment process that’s applicable in New York, in Hong Kong and in other countries where AIG operates. Our models are the same. The ratios that we look at, the criteria, and all that. It gives you a sense of comfort that it’s a global practice. Even if, let’s say, our regulations are not as stringent here as it would be in other countries, the investment processes that we use have been tested already in those markets. We have one investment team for the entire Philam group. And I think Sunlife is like that as well. We have fund managers in each entity because the objectives of the funds are different. For the life insurance company, you are probably looking at more than 10 years, for mutual funds probably 3 to 5 years, for pre-need depending on the education liabilities. But they all come together often to have the same economic outlook. So you have the same view, you have the same strategy, and you apply it to the different funds that you manage. MoneySmarts: So AIG-wide, the top-down approach comes from the big group and the bottom-up approach will come from each company? Roa: Yes, because the bottom-up will come from the issuer that will be good for our investment objective but may not be good for the others. MoneySmarts: Within each fund, do you also make sure that the people you hire to pick stocks have the qualifications? Roa: Oh yeah, like Wilfred D. Son Ken Po is the managing director for AIG Global Investment Corp. specifically for Philippine stocks. He must have 20 years experience in equities. He started in BPI, World Sec…he is highly regarded. Track record counts. When you are an institution as big as AIG, you are not going to risk with people who are not good in what they are doing. You get highly professional investment people. And yet we also do not subscribe to a star performer. It’s always a team. There are committees that take a look at various criteria depending on the sectoral issues, issue-specific concerns. We have people like Wilfred who is so focused on the Bloomberg screen with all of his broker reports because he is also trying to read up on what all the others are saying. So you have fundamentals, you have valuations, technicals, and then what other people are talking about, and then he does company visits, on a weekly basis he gets together with his counterparts around the world. MoneySmarts: He reports directly to you? Roa: No, he reports to the Equity group of AIG. Cris, our fixed income for PAMI, reports to me. In multinationals, its really matrix reporting. So, she also sits in the asset liability committee and they talk about interest rates, economic outlook and all of that, together with the fixed-income team of Philam life. I have always worked for multinationals, so I’m very much used to talking about our company profile and the strength behind it. There is always a tested process and you are not only pushing process, there is a countercheck of compliance. You know, sometimes business can be very aggressive. It becomes a marketing thing. You need the balance of compliance. MoneySmarts: Another reason for people to go to mutual funds is instant diversification. For a P5,000 investment, you are instantly diversified. But the options in the Philippine market are really very few. We don’t have a lot of options here the way they do in North America. How diversified can the funds here really get? Roa: Admittedly, the market here is not deep enough. We still have to develop the stock market. If you do big cap, that’s only a few companies. I don’t think we would like to dabble into small caps. Our philosophy is, you have to look at value over the long-term. You have to justify it in terms of that and not just a trading speculative thing to get a quick buck. We are managing a portfolio and we are saying our investors are in this for the long-term. Besides, the justification for our stock picks go all the way to New York. MoneySmarts: Is it possible for the stock pickers down below to get away with speculative play without letting the board know about it? Roa: No. There’s a reporting. MoneySmarts: Let’s talk about transaction costs in the mutual fund industry as a whole. Would it be possible for me to save up on costs if I go directly to the stock market or is it cheaper to do it the mutual fund way? Roa: It’s cheaper via the mutual funds because the cost of the trades is allocated to all of the shareholders on a pro-rata basis. What you are really getting into when investing in mutual funds is the professional fund management, the diversification, and the liquidity. You don’t even have to do P50,000. P5,000 in an equity fund will get you into 30 to 40 stock selections already without having to go into who are these companies. You rely on the fund manager. MoneySmarts: I understand you can demand a lower fee from the traders because you are a big player. Roa: Yes, you save up on cost that way. Our equity portfolio is P5 billion to P6 billion, PAMI alone lang yan. MoneySmarts: The brokers are probably fighting over your account pa. Roa: Yes, because we are an institutional client. MoneySmarts: Fund managers charge management fees whether the fund makes money or not. Doesn’t this mean that even when investors lose money, you still get a cut? Roa: Lets say I have a P1 billion portfolio. Hypothetically, I get one percent, that’s P1 billion divided by 12. That should be about P333 million. If next month that P1 billion becomes P800 million, I only get P800,000 divided by 12, which is less than P333 million. So, my management fee goes down. MoneySmarts: It’s smaller, but you still get a cut. Roa: Yes, that fee pays for our custodians, our salaries, etc. But we share in the loss because it’s a reduced income. It’s not a fixed fee. And mind you, all of our funds have PAMI money in it. We have retained earnings in each of those funds. At least P50 million.

That’s the beauty of a mutual fund. It’s a corporation. So it has authorized capital. At least 75% of that must be paid up. That’s the difference between the UITFs and the mutual funds. UITFs are merely contractual obligations. They are not obligated to the people who invest in them. We are obligated. I cannot just say lets put up this kind of fund, this kind of fund. Because I have to think, “Wait a minute, how much is PAMI’s money?” It has to be thought out carefully because I’m locked in.

MoneySmarts: What is the tax treatment? Roa: According to the CTRP, the capital gains from the mutual funds are tax-free for the investor itself. So when you redeem, you are not expected to pay any tax. MoneySmarts: Since three years ago, the types of mutual funds have increased. Would you say that the new types of funds could already meet the needs of Philippine investors? Roa: No, it still can’t. What we have right now are plain vanilla type of funds. You don’t even have derivatives, and they are all Philippine names. It’s only now that regulators are slowly becoming open to funds investing outside the country. MoneySmarts: Are you going to do that soon?

Roa: Soon (smiles). We don’t even have capital-protect type of funds. Investing in capital-protect type of funds means you are assured that your principal stays intact. That’s possible because there are certain structures that you can do. In other countries, there are socially responsible investments, sectoral funds, there real estate investment trusts (REITS). There is still so much out there that can be brought in. But the thing is the awareness. It’s still a niche market. What I really want to do is to open up the mass base.

MoneySmarts: Let’s go back to fees. On the average, the industry charges around 1.5 percent to 3.0 percent management fees (MER)? Roa: Yes. That’s a fixed amount. Maximum of 3%. For the equity fund, its 2%, for the bond fund its 1%. The trading, the expense, the custody is higher for equities. MoneySmarts: For some people, these fees are very high, especially for those who are used to investing outside the country. They eat into the investor’s returns. Roa: Yes they do, but these are to shoulder the cost of the provider. Our custodian is Citibank. If we downgrade our partner (to save on costs), we will get what we pay for. We don’t want to do that. We also try very much to have segregated duties. So, BPI is our transfer agent who keeps our stock records. Citibank is our custodian. We have to pay them fees, too. MoneySmarts: When a fund is still a start-up, its natural for management fees to be on the high side. Do you foresee the fees going down as the industry matures? Roa: Yes, because it will be driven by competition and economies of scale. MoneySmarts: What about the loads? You have back-end and front-end fees and these are a bit high. Roa: The back-end should really not be material to the investor. We disclose that from the very beginning and it is just a means to discourage short-term investing. And a protection that the other investors in the fund are not unduly disadvantaged because we need to provide a higher liquidity for those that come in only for the short-term. So, that’s just really just a control mechanism. The front end is really just something that we provide our distributors. MoneySmarts: Is that negotiable? Roa: Our agents are commission-based. Some of them are insurance agents also. If you reduce the sales load, that comes from the commission of the agent. MoneySmarts: How much is the back-end fee? Roa: The back-end fee for the equities is 2% if its less than 2 years, and 1% if its more than one year but less than 2 years. The front-end is 2% for equities, 1% for fixed-income but if it’s more than P1 million, it goes down to half a percent. MoneySmarts: Isn’t this double dipping? Roa: The back end will not apply unless you redeem. MoneySmarts: You also have performance fees, right? Why? Roa: Some funds have incentive fees if they reach a certain threshold. Ours is one-tenth of 1%. Why? Because we’re not just riding the market. Like in the bond funds, if there’s a threshold, it gives them more incentive and us as well as a fund house to be able to reach that. It’s just an incentive, to do better than the agreed threshold. MoneySmarts: Isn’t that what you are supposed to be doing anyway, to beat the odds, to be better and better? Why do you have to charge the investor if you do better? Roa: It’s just an incentive. MoneySmarts: But you know that it is going to be a turn-off to some investors? Roa: You can turn it around and say, you can just do index. But a performance fee determines how you are going to do it, what you are picking so that you can go over and above a certain benchmark. If the market is doing good, any monkey can earn and just ride the market. MoneySmarts: Like last year? Roa: (Laughs). Yeah. MoneySmarts: What are the investment strategies of PAMI. Is it top-down, bottoms-up, value oriented? Roa: It’s a combination. You have fundamentals, value, technicals. There’s less reliance on technical and more on fundamental. But there is qualitative and quantitative. MoneySmarts: Why did you choose these strategies? Roa: That’s an AIG thing. Technicals is an analysis tool but if you really want to look at the value of a company, you have to look at the fundamentals. Technicals is all historical. You want to be able to look at expansion plans, borrowing, management and all that. These are things that are not covered by technicals. MoneySmarts: Why would an investor buy Philam funds? It’s your time to market (smiles). Roa: First of all, we have a long track record. The stability provided by an institution as big as Philam, affiliated with AIG. I’m convinced that as a mutual fund affiliated with an insurance company, we have more experience in managing long-term funds. The skill in managing long-term funds is more inculcated with us. Right from the beginning, we said medium to long-term, because that’s the insurance mentality. In Philam, you have a big name, stability, 60 years in the country, P150 billion in life business alone. In AIG global network, you have compliance, 650 billion in assets for our segment alone. So its really strength, stability, track record, that’s something you look for in any type of issuer. MoneySmarts: How correlated is your equity fund with the PSE? Roa: The Phisix has a large exposure to PLDT. Our equity fund is limited to a 10% exposure to each issue. It’s a challenge for us because we cannot just mirror and do as the Phisix has done. But we beat the index last year and that was through active trading and portfolio management. MoneySmarts: Investors can expect that some years it can be higher and some years lower? Roa: Yes, that’s why we also advertise cumulative returns because I wanted to stress that this is for the long-term. If you put your money in three years ago, and didn’t touch it, this would be how much you earned. It might be better than averaging, because this includes the dip of that particular year. MoneySmarts: How concentrated is your portfolio? Roa: We can’t exceed 10% per position. We have 80% is in government securities, 10% in money market and near cash. Around 15% is in corporates. MoneySmarts: Maturities? Roa: Average is 3 to 10 years? MoneySmarts: (Laughs) that’s almost everything. You have FXTNs? Roa: In our strategic fund. We have 78% in equities, 10% in near cash, a very small portion in FXTNs. MoneySmarts: What about your balanced funds? Roa: 60-40, more on equities. MoneySmarts: In your equities investments, how many positions do you have? Roa: 20-30 stocks all in all. MoneySmarts: What’s the buy and sell criteria. What does it take for a stock to be included in your portfolio? What does it take for you to exit a position? Roa: The investment process will determine if a stock is a good stock. Basically, we look for long-term value. MoneySmarts: How would you describe the risk profile of your funds? Roa: Our bond fund is conservative, balanced is moderate and equities are aggressive. That’s normal in the industry. We say it’s the most conservative because it’s invested in fixed-income. What people don’t realize is that it’s marked-to-market. But the way to counter that is to say, yes there is marked-to-market done on a daily basis but if you hold on to the bond for a 5-year period, at the end of the five year period you get the principal, plus all the earnings previous to that. So what we are saying is, even if it is the most conservative, it is highly recommended that we stick to the objective, the tenor, the time horizon so that you can actually benefit from the cash flow. Lets say Apex Mining is a bond, for example. It’s price dips but it has coupons naman. So in the long run, you’ll reap from the coupon plus you get the maturity value. It’s conservative because of that. I like the balanced. Everybody else likes equities. But I am conservative. I like the balanced because it’s a one-time decision, the fund manager determines whether they should be more into equities, or depending on the time that they revert to the fixed income. I don’t even look at the NAV on a daily basis. But it’s moderate in the type of risk because you’re exposed to both equities and bonds. But because its moderate, your returns are not as high as it would have been if you invested in equity. The equity fund is a high-risk, high-return investment. MoneySmarts: What about investing in purely equities. How risky is that? Roa: If you think about it, it will be more risky if your time frame is shorter. But if you really have a long-term horizon, it still is risky because of the asset class that it gets into. But that risk is diluted over time, and you have time for it to bounce back. There’s always a run every ten years. If your time horizon is 10 years, for sure you’ll reap from the run in the market in that time period. MoneySmarts: What is the principal driver of PAMI’s good performance over the last 10 years? Are your funds immune to what is happening outside the country? Roa: We are not immune to what is happening outside. We are looking at the impact of the US economy, whether there is going to be a slowdown, we are looking at the fall of mortgage interest rates. Definitely there is an impact. Feb. 28 the China sell-off, we all got affected. We are not immune to it. MoneySmarts: What drives the performance of the funds then? Roa: I think it’s the investment process that we have. Looking for value in the equities that we select. Our primary consideration is really to provide consistency rather than ride the volatility. MoneySmarts: What are the ways that investors can earn from mutual funds? Roa: You realize your gains when you sell. Dividends are plowed back into the fund. The same with the coupons of bonds. Whether through interest or dividends, earnings are all plowed back into the fund, reinvested by the fund manager into the fund. That’s why we don’t get anything. MoneySmarts: In the US, mutual fund investors receive earnings. Roa: That’s a feature of the fund. We are looking into it if that is something that would be attractive. This PMIF is a fixed-income fund that has that feature. If the fund has income, we give 90%. MoneySmarts: That’s very interesting. People are looking for alternatives, and there is very little in the market, especially for small investors. The development of the mutual fund industry would be beneficial for the small investors.