Playing pick and mix with share funds

By MARY HOLM

Q: Until two years ago, my involvement in the sharemarket was exclusively in direct shares, and I can't complain about the results.

I believed that luck and a reasonably visionary adviser were all the ingredients required - I suppose time and luck were on my side.

The ever-increasing exposure to the discussion about diversification eventually made me aware of the unnecessarily high risks I took.

By now I have traded in all direct shares for well-diversified share funds.

In last week's Weekend Money, Mark Fryer discussed international share funds.

He pointed out the performances of various international funds, from BNZ International Equity Trust, bucking the downward trend with a gain of almost 9 per cent in the March year, to ASB World Shares fund, down 23.7 per cent.

This suggests that international share funds, even index chasers, are not all in the same league.

What particularly struck me in Mark Fryer's article were the references to the various types of managers - the "value" manager, the "technology" manager, the "growth" manager, and probably the manager who has no clear line at all.

Is it sufficient to cover branches, markets and geographical regions by selecting an international fund?

Or should the characteristics of the individual managers be considered as well?

As it is not realistic to invite all these fellows for an interview, how about spreading the investment, e.g. among the five funds mentioned in Mark's article: BNZ International Equity Trust, BT International share fund, AMP's WiNZ fund, Armstrong Jones' International Shares fund and ASB World Share fund?


A: You could do worse. But I would rather see you just put all your international share money into one or two global index funds.

I'm wondering if you're a bit confused about index funds and non-index, or active, funds.

The managers of an index fund simply buy the shares in a market index.

They change their holding only when the index changes. They don't choose which shares to buy and sell, which keeps their fees down.

BNZ's International Equity Trust is not "in the same league" as other international index funds because it's not one.

You may be confusing it with BNZ's similarly named International Equity Index Trust, which is an index fund.

All the New Zealand-based international index funds follow modified versions of the MSCI World index.

The modifications vary. Some funds hold a greater number of shares than others, and in some years that will work in their favour, while in others, it will work against them.

Still, the performances of all the international index funds are, in fact, in the same league.

The BNZ International Equity Trust, however, is in an active fund.

Active fund managers use different plans for picking shares, including the ones you mentioned - value, growth and technology.

You don't need to interview fund managers to know the style they favour.

They should spell it out in their investment statements and other literature.

As Mark Fryer said last week, the overseas managers of the BNZ International Equity Trust use a value plan, which means they select shares that seem to be underpriced, or good value.

They are the opposite of growth managers, who look for shares that are in favour because their earnings have grown quickly.

In the last few years, most growth funds have included high-tech shares.

That partly explains why they did so much better than value funds in the late 1990s, and since then have done so much worse.

It would be a mistake, though, to assume that value will continue to outdo growth.

I recently saw a graph of American growth and value funds. It was remarkable.

Since 1980, their performances have zigged and zagged across each other.

One crowd does better than average for a couple of years. Then it is the other crowd's turn.

One way to allow for this would be to invest part of your money in a growth fund and part in a value fund.

And while you're at it, why not a high-tech fund, an ethical fund, a "growth at a reasonable price" fund and any other style you hear about?

You could go on diversifying until the cows come home.

Or you could do just as well over the long run - and pay lower fees and keep life simpler - by sticking with New Zealand-based international index funds.

These funds hold the largest shares in the US, Japan, Britain, Germany, Canada and Australia. Those countries, chosen for tax reasons, are home to almost all the world's big shares.

And the big shares will always include some value, some growth, some high-tech, some whatever shares.

You will automatically get a mix.

I don't see any point in trying to do better than that. You might, but only if you're lucky.

Q: We assume that a person could buy shares in an international share index fund and not have to pay tax when the shares are later sold.

We know some people, such as share traders, would have to pay tax, but we would presume that most personal investors would not.

In your article on April 28 you say that, "It's likely you'll get no dividend income if you invest through an international share fund. The fees tend to swallow the dividends."

You do not say explicitly, but there appears to be an implication that this will always be so.

A 1996 Herald Taxwise article, which I enclose, says: "Tax applies if shares are acquired with the purpose of resale.

"If the only attribute of the stock is growth in capital value, it is reasonable to assume that the investor intends to resell the stock.

"The return can be captured only by resale."

It appears that a person would buy shares in an international index fund only for the purpose of capital growth. The return can be captured only by resale. Accordingly, at the time of purchase eventual sale is preordained.

Tax applies if shares are bought with the purpose of resale.

Therefore, tax will apply when the personal investor sells his or her shares in an international share index fund.


A: That all seems to make sense.

But - thanks to the most confusing legislation I've come across in covering tax in three countries - it's not correct.

First, let's be clear what investments we are talking about.

Everything you say would apply not only to international index funds, but to many other international share funds except those invested only in Australian shares.

Companies in countries other than New Zealand and Australia pay lower dividends, keeping more of their profit for growth.

The latest annual report of WiNZ, an international index fund, gives these dividend yields: Japan 0.68 per cent. United States 1.27 per cent, Canada 1.31 per cent, Germany 2.22 per cent, Britain 2.51 per cent and Australia 3.07 per cent.

By contrast, the dividend yield on the NZSE40 index is 5.87 per cent.

With the lower international dividends, it is more likely that fund management fees will cancel out dividend income.

That does not mean, though, that you don't get the dividends. The fund manager could pay them to you, and then subtract the fees from your balance. But it is more efficient just to net out the amounts.

From Inland Revenue's point of view, though, you do receive dividends.

Sure, the IRD could argue that getting those dividends could hardly have been your reason for buying into the fund - as fees were likely to cancel them out.

But it doesn't argue that way, or at least not with taxpayers who invest in New Zealand-based international share funds for the long term.

A spokeswoman for the department confirms that.

As long as you are not trading in and out of the fund - which is not a wise thing to do anyway - I would not worry about having to pay tax on the gains you make when you finally sell.

Footnote: The above may not apply if you invest in an overseas-based share fund, or directly in overseas shares.

You would need to get expert advice on your situation.

Q: I thought that I would make a couple of comments on your column about the student saving to do an MBA in the United States in about four years.

I accept that in a column you can't give all the answers, but a few other comments that could have been made are:

* If Harvard is the objective (i.e. his liabilities are in American dollars) he should think only about investing in overseas shares, unless he wants to speculate in the New Zealand market.

While a general diversified portfolio is "safest," he could think about one with a focus on the US market.

* With only four years, he needs to go into a product with no upfront costs.

The probability that the return is positive is one thing, but to be above zero after allowing for the standard upfront costs is another.


A: Thanks for making two good points.

For the benefit of other readers, I'll go into a bit more detail.

On the first point, the student's tuition and other costs will be in US dollars.

So he can avoid foreign exchange risk by investing in US shares.

If, instead, he invested in New Zealand shares, and in the meantime the kiwi rose relative to the greenback, he would be a winner. But if the kiwi fell, he would lose. And no one can accurately predict currency movements.

On the second point, upfront costs have a big impact on short-term investments. And four years is relatively short term.

With longer-term investments, high continuing costs have more impact than high upfront costs - although it is obviously still good to avoid both.

* Mary Holm is a freelance journalist and author of Investing Made Simple. Send questions for her to Money Matters, Business Herald, PO Box 32, Auckland; or e-mail: maryh@journalist.com Letters should not exceed 200 words. We won't publish your name, but please provide it and a (preferably daytime) phone number. Sorry, but Mary cannot answer all questions, correspond directly with readers, or give financial advice outside the column.