Index investing is very popular, especially in Europe and North America but perhaps less so in Asia. The idea behind index investing is simple: because an average investor cannot beat the market consistently over long periods of time, you are best off putting your money in a well-diversified investment fund and spend your time instead on other things, like playing with your kids, improving your golf handicap, updating your social media accounts, running your business, etc.<\/p>\n\n\n\n
Research suggests that professional fund managers also don’t beat the index consistently, so you will probably also fail to beat the index if you try to pick the “best” actively managed mutual fund (for background get a hold of Malkiel’s A Random Walk Down Wallstreet<\/em> and Bogle’s Common Sense on Mutual Funds<\/em>). Since managed mutual funds tend to have higher charges, that’s another reason to choose an index fund.<\/p>\n\n\n\n But all of this research is typically based on the realities in North America and Europe: large, liquid, (supposedly) well-regulated and sophisticated markets. What about a market like Malaysia’s that’s relatively small and often dominated by large family-owned or government-owned firms. Do index funds beat mutual funds in Malaysia too?<\/p>\n\n\n\n Factors that might make Malaysia’s stock market unlike that of North America and Europe is the fact that:<\/p>\n\n\n\n All of this taken together means that (similar to Singapore<\/a>) the top tiers of the Malaysian stock market are typically filled with rather conservative family or state-owned firms engaged in financial services, utilities or plantations. There are no Googles, Samsungs or Tencents to drive growth like in the US, Korea or China. In such an environment stock-picking might actually be a way to consistently beat the stock market index because it would mainly involve avoiding the “dead wood” state- and family-owned businesses.<\/p>\n\n\n\n So how do we test this theory? Lacking access to any fancy data sets from Bloomberg or Reuters, I used the Fund Selector<\/a> function from FundSuperMarket (FSM One), a discount local mutual fund brokerage. If selecting funds with asset class Equity and their geographic focus on Malaysia around 62 funds provide a total return figure (capital appreciation + dividend) for the past 10 years. Of those 62 funds, 25 are Shariah-compliant funds (including 1 index fund) and 37 are conventional funds (including 2 index funds).<\/p>\n\n\n\n There is a large difference between the conventional and shariah funds in terms of their holdings, and that difference is financial institutions. Most of Malaysia’s large banking groups (Public Bank, Maybank, CIMB) have a conventional banking unit engaged in usury (conventional interest-baring loans, which aren’t allowed under Shariah) and so are removed from the Shariah funds. For this reason its meaningful to make separate comparisons between conventional managed funds vs. index funds and Shariah managed funds vs. index funds.<\/p>\n\n\n\n Finally it must be noted that the index funds must invest in large-capitalization stocks (all follow the relevant FTSE Bursa Malaysia index) whereas managed funds can and do invest in smaller and medium-capitalization stocks. And there could be some survival bias: poorly performing managed funds may have been closed down. Nevertheless, we attempt a comparison…<\/p>\n\n\n\n From the results it appears that in both categories<\/em> (conventional and Shariah) the managed funds on average outperform the index funds. For conventional funds this gap is 3.61% but for Shariah funds its just 0.12%. So in that sense our hypothesis of Malaysia being different from North America and Europe, seems to hold, although for the Shariah funds, only by 0.12%, which may be within the margin of error.<\/p>\n\n\n\n Also noteworthy is that the Shariah index fund (average +5.12%) has significantly outperformed the Conventional index funds (average +1.98%). Taken over 10 years, that’s a stunning gap of 31.4%. If you had put your money in a Fixed Deposit you would probably have beat conventional index funds over the last 10 years. Ouch!<\/p>\n\n\n\nLet’s Hypothesize<\/h2>\n\n\n\n
Running the Numbers<\/h2>\n\n\n\n