Annual reports: Read before you weep

There is no short cut when you're dealing with investments, even if it is one of the less complicated and taxing reports, says Securities Industry Development Corp

AFTER last week's article, some of you may have already started going through unit trust fund's annual reports for your future funds.

If you somehow stopped at the pages filled with a plethora of numbers, waiting for this installment to be released, so as to get a rough idea about what those numbers represent, do not fret! Read on and we will tell you what the following pages of your annual reports are all about.

Financial Statements

Never ignore the financial statements part! For those of you who are interested in drilling down further into the financial details, what you need to scrutinise are the financial statements that have been elaborately presented before you.

Your financial statements comprise:

* Income Statement

* Balance Sheet

* Statement of Changes in Net Asset Value (NAV)

* Cash Flow Statement

What do all these mean?

* Income Statement

The income statement will provide details on the investment activities, relative to the previous financial year's activities.

This statement will provide you with a way to differentiate the net income/loss contributed by realised gain/loss versus unrealised gain/loss, which is the result of portfolio revaluation.

For example, a fund's net income is reported as RM1 million, but the realised investment loss is RM2 million, offset by an unrealised gain of RM3 million. Here, you can tell that the RM1 million net income reported does not truly reflect the actual performance of the company. It's simply a matter of accounting practice that the amount is recorded as such.

As an investor, you need to be mindful of the unrealised items, such as unrealised gain or loss on foreign exchange, which may appear in the Income Statement.

* Balance Sheet

There are a few critical pieces of financial information that you can learn from this statement:

(i) whether the fund's total asset is appreciating or depreciating as compared to the previous period.

(ii) whether the units in circulation are increasing or decreasing - a significant decrease in units in circulation shows that the cancellation of units is much greater than creation of units for sale, which also implies that the fund is losing popularity among its existing customers.

* Statement of Changes in NAV

This statement will provide the details on the changes in the NAV during the period and differentiate between the changes contributed by investment activities and transactions with unit holders.

You should be able to see the net impact of undistributed income due to investment activities versus movement due to unit creation or redemption.

From here, it will tell whether the increase or decrease in the fund's value is due to investment effort or expansion/shrinkage in the funds.

For example, if a net decrease of RM5 million in NAV is attributed to RM1 million net increase in undistributed income and RM6 million in amount paid on cancellation of units under the movement due to unit redemption, you may want to be more cautious and investigate further on the reasons behind the redemption from the unit holders.

* Cash Flow Statement

This statement tells you where cash flow for the year is being generated and spent, whether the sources of cash flows are from operating or investment activities and financing activities.

Notes to Financial Statements

Notes can be rather mind-boggling but they function as a supplement to the financial statements and help make sense of the numbers presented.

* Management Expense Ratio

As managing a fund requires a whole team of professionals, the cost incurred to run a fund is part of the cost of investing in unit trust for an investor.

The cost inherent in operating a fund includes management fees, trustee fee, audit fee, administrative expenses (printing of annual reports, distribution warrants, and postage) and other service charges incurred in the management of the fund.

Management Expense ratio is the ratio of the total of all the fees incurred for the period deducted from the fund and all the expenses recovered from and/or charged to the fund, expressed as a percentage of the average value of the fund. It can be summarised as follows:

The MER ratio should be fairly consistent over the years. If you see a significant difference from the previous year, you will need to find out the reason for the change. This is a useful ratio to compare the fund you have invested in or intend to invest with other similar funds in your fund selection process.

The higher the MER ratio, the more expenses are required to manage the fund. Therefore, when you draw up comparisons between funds within a similar range, the ones having similar performance but with lower MER will be more beneficial to you as an investor, because less money is being spent by the managers and more is available for distribution.

* Portfolio Turnover Ratio

Portfolio Turnover ratio measures the average acquisitions and disposals of securities of a fund. The calculation is as follows:

The PTR usually comes after the section on MER in an annual report's notes to financial statement. PTR indicates the rate of trading activity in a fund's portfolio of investments. If the PTR is high, it means that the fund manager is constantly changing the companies or financial instruments in the portfolio. As each and every transaction involves cost, high turnover indicates that the transaction cost incurred is high and it will in turn eat into the profit earned, which will eventually not work out to the benefit of the investors.

You should also look for any other extraordinary items stated in the notes to financial statements, especially events that can materially affect the portfolio's performance or investors' interests, such as change of fund managers and investment committee members, compliance issues, change of investment objectives or policies and major change of shareholders.

Now that you know what to expect from a unit trust fund's annual report, it is high time you get started with the actual reading! There is no short cut when you're dealing with investments, even if it is one of the less complicated and taxing reports. You need to know what you are parting your money for and to whom you will be giving it in order to manage it, so "Read Before You Weep!"

Securities Industry Development Corp (SIDC), the leading capital markets education, training and information resource provider in Asean, is the training and development arm of the Securities Commission, Malaysia. It was established in 1994 and incorporated in 2007.

Look before you leap: Analysing companies before investing

In investing; the three most fundamental aspects are research, research and research! says Securities Industry Development Corp

IN REAL estate, the three most important factors are location, location and location whereas in investing; the three most fundamental aspects are research, research and research!

In a bearish market, the stock prices for many fundamentally good companies can drop to a very low level. It is during times like these that investors should search for good quality companies that can be invested in for the long-term.

As an investor, one of the most critical steps in identifying good stocks is the understanding of the business. The ever famous investment guru, Warren Buffett has clearly stated that there is no fundamental difference between buying a business and buying shares in the business. In fact, there is a clear link between the two as "if a business does well, the stock eventually follows". These were Buffett's words.

In keeping in tune with Buffett's sentiments, investors need to make stock purchasing decisions by approaching it from the perspective of a business person. You need to have the same mindset as a business person when it comes to evaluating stocks.

Here are some guides on what to look for in a business:

In analysing a business, there are a number of key factors that you need to scrutinise and these can be categorised into two main areas; the company itself and the people who run the company. (Remember,the secret in business today is not about money, technology or ideas alone but its people - really good people!) .

The company

* Product: Single or diversified?

* Product: Single or diversified? You need to know what a company's business is if you intend to invest in that company. Knowledge of what the company produces is crucial in giving investors an insight into the company's potential and ability to perform. If a company relies purely on a single or very narrow range of products, then you have to evaluate the product carefully in terms of its market dominance, economic characteristics, cost of production and entry barriers. A company focusing on a single product has the ability to tap on its strength. However, despite this edge that such companies have, there is a downside as you will have to analyse whether the product is positioned strongly enough in the market to fend off competition. The risk that companies focused on a single product have to face comes from competitors. The possibility of other products taking over its market position is extremely high, especially in the realm of fast changing technology or fashionable items.

As an investor who intends to avoid such risk, companies with diversified products and long history of successes will be more favourable. Such companies will have the ability to sustain themselves despite the presence of substitutes for one or a few of their products. The availability of substitute goods introduced by competitors may take away a portion of the company's share in the market, but it will have other products that are still strongly positioned in the market to keep itself steady.

A company's future prospect is also highly dependent on the type of products it has. If a company provides a product that is an essential item, one that is needed during good or bad times and it is highly differentiated, then its future prospect is most promising. Such companies will thrive on the fact that substitutes are not readily available, thus not jeapordising their market share. This type of business usually has the power to command the price in the market even when the demand is flat.

* Operating history: New or seasoned?

* Operating history: New or seasoned? "Wisdom comes with age". While this is commonly said about people, the same can apply to a business as well.

Companies that have been around for years will be able to provide you with a track record of their performance. With that, you can zoom in to companies that have managed to produce consistent results and those that have weathered tough economic situations. Companies such as these coupled with the ability to manage cost effectively are companies that come with lower risk as compared to their younger counterparts; companies that are still new or have been experiencing changes in business directions and are trying to turn around.

* Ability to grow: Organic or stagnant?

* Ability to grow: Organic or It is when the economic situation is weak that investors get the chance to judge whether a company is a growth company or not. Normally, if a company is able to maintain or grow its sales during a weak economic situation, it will very likely be able to grow its businesses even further during an economic recovery. In fact, if a business has been able to grow organically, through innovative products and sensible business strategy, then it has shown that the business itself has the room for future growth. However, if the growth has been achieved through mergers and acquisition, then you will have to be careful as historically, the success rate in marrying two companies with different cultures has been poor. Ideally, you best look out for a company that is able to grow organically and at the same time make strategic acquisitions to strengthen its market position and product offerings.

The people behind the company

* Ability to act in shareholders' interest

* Ability to act in shareholders' interest A successful company inevitably depends on its management team. Ideally, the management must be able to make strategic decisions in increasing shareholders' value. Their ability is reflected in their track records, performance in their previous companies or investment decisions being made in the current company. When companies retain earnings for the purpose of re-investment, the type of projects they invest monies in and the return on such investments will tell you whether they are putting priority on shareholders' interests or not.

Decisions to hit unrealistic short-term earnings targets might please the market and make the current management team look good, but, in the long-run, this move may hurt the company's prospects, which will in turn affect shareholders.

* Ability to control cost

* Ability to control costExercising tight cost control at all times is something that management needs to practice. However, members of management sometimes have the tendency to build up costs over time. These sometimes fly out of control, and will result in them taking a one-time action to reorganise and restructure. This action will also mean that the shareholders will have to suffer exceptional asset write-offs and severance costs due to redundancies, which might not have happened if careful planning on hiring and capital expenditure control were exercised at all times.

* Corporate governance and uncompromised integrity

* Corporate governance and uncompromised integrity A management team with uncompromised integrity means that you can be sure that the management team is always acting in shareholders' interest and they will not be breaking any codes just to satisfy their own interests. Management who share these values are highly valuable to a business and they are the ones you want managing the company you're interested in.

At the end of the day, the results of the factors that have been mentioned above will be reflected in the company's financial performance, which matters most to all investors. Knowing the business will help you to understand the financials better when you move on to the next step of valuing the stock itself.

Securities Industry Development Corporation (SIDC), the leading capital markets education, training and information resource provider in Asean, is the training and development arm of the Securities Commission, Malaysia. It was established in 1994 and incorporated in 2007.

Selecting the most suitable ETF

The second article of a four-part series by Bursa Malaysia looks at how to select suitable Exchange Traded Funds in building your investment portfolio

THERE are a number of factors to consider when investing in Exchange Traded Funds (ETFs). Here are a few important factors used by investors to select the best "fit" ETF.

ETFs offer investors a cheap and easy way to invest. Listed on a stock exchange, ETFs trade like shares but offer diversification and exposure akin to an index unit trust fund. The performance of an ETF and an index fund depends on its underlying index but ETFs are cheaper to acquire and can be bought or sold at their current value. In comparison, unit trust funds impose sales charges or redemption fees and priced once a day.

There are a few factors unique to ETFs which investors should consider when deciding on which to invest in. This minimises the chances of acquiring an ETF that does not meet specific needs, preferences or complements a portfolio. To find the best "fit" ETF, consider the following points:

Determine what the ETF offers

There is a wide array of ETFs in the market and this makes it possible to construct a portfolio using ETFs as core holdings (refer to box below).

ETFs can also be used as tactical investments if investors acquire specific industry ETFs. After establishing an investing strategy and the role that the ETF plays in a portfolio, read the ETF's description and objectives to ensure that it fulfills your overall investment plan.

Look at the underlying assets held by the ETF and its top holdings are already in your portfolio perhaps as individual stocks or via unit-trust funds. Basic information about the ETF value and portfolio composition is available on its website.

Examine fees involved

The cost to invest has a significant impact on the returns of a portfolio. Much like shares, ETFs trade on a stock market and investors must pay for brokerage fees, stamp duty and clearing cost. The manager fee, however, depends on the ETF issuer and can differ. Malaysia's first equity ETF, FMB30etf managed by AmInvestment Services Bhd has a manager fee of 0.5 per cent per annum. Asia's first Islamic ETF, MyETF-DJIM25 which is managed i-VCAP Management Sdn Bhd levies a manager fee of 0.4 per cent per annum. The country's first ETF, ABFMY1, is a bond ETF with a manager fee of 0.1 per cent per annum.

Consider liquidity and size

Unlike stocks, all ETFs have a creation and redemption process that keeps its market price in line with its underlying net asset value. This process creates new ETF units when demand increases. The reverse of the creation process occurs when authorised market participants redeem large blocks of ETF units, usually after many investors sell their ETF investments, in exchange for its underlying basket of securities. Due to this structure, the degree of the ETF's liquidity depends primarily on the trading volume of its underlying securities.

Generally, ETFs that invest in large-cap stocks, broad market indexes and investment grade bonds are more liquid that ETFs that invest in narrow niche industries.

Trading volume of the actual ETF indicates investor's interest in that particular ETF. Extremely low liquidity can have a minimal impact on the ETF's bid-ask spread. Higher spreads, the difference between the "bid" and "ask" price of an ETF cost a little bit more to trade. The more illiquid ETFs tend to have wider bid-ask spread.

Investors should consider the size of the ETF as issuers may close and liquidate their smaller, unpopular ETFs. American ETF issuers, Claymore Securities Inc closed 11 of their 37 ETFs last year while Invesco PowerShares Capital Management LLC closed 19 ETFs in early 2009.

Although investors get their capital back once the ETF's underlying assets have been liquidated, this situation is far from ideal for those planning to hold ETFs for long-term.

Investors should decide on which factor is more important than others. For example; some may find the ETF's investment objective and index exposure to be the most important criteria while fees and size are secondary considerations. But all criterions must be known to make an informed decision.


The article is written for general information purposes only. The information contained does not constitute legal, financial, trading and/or investment advice and neither does it make any recommendation or endorsement regarding the services mentioned herein.

Readers are advised to seek independent advice prior to trading, listing and/or investing. Although care has been taken to ensure the accuracy of the information in this article, Bursa Malaysia does not warrant or represent, expressly or impliedly as to the accuracy or completeness of the information herein and in no event shall Bursa Malaysia be liable to the reader or to anyone else for any claim, howsoever arising, out of or in relation to this article. All applicable laws, regulations and current Bursa Malaysia rules should be referred to in conjunction with this article.