Is your fund manager a Hobbit?

SINGAPORE (March 16): Fund managers, just like you and me, have different risk appetites. There are the swashbucklers, who sally forth boldly with a few high-conviction bets in pursuit of riches untold. There are those who may play a little safer and maintain a more diversified portfolio. There are also fund managers who, like Hobbits in JRR Tolkien’s The Lord of the Rings, are content to stick closely to their funds’ benchmark index rather than endure the discomforts and risks of adventure.

Almost all fund managers are measured against some kind of benchmark index. To use Japan as an example, many Japan equity funds are measured against an index such as the MSCI Japan, which covers more than 300 large- and mid-cap stocks in the country. Since it accounts for about 85% of the market capitalisation in Japan (based on the MSCI Japan Index factsheet dated January 2017), the MSCI Japan gives a good indication of how Japanese stocks are performing on average.

If we wanted to invest in a diversified portfolio of Japanese equities, we would have two choices. The first is to buy a passive index fund or ETF that holds the same stocks in the same proportions as the MSCI Japan Index. We should then expect our returns to be roughly similar to the market average, minus the usually low costs that index funds would charge for administering the fund.

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