I’m feeling lazy today, so here’s a cut and paste response that I posted to a question in LYN:
Can someone recommend some unit trust fund managers for KLCI INDEX fund? Is the OSK KLCI Tracker the only KLCI index fund around? I cannot believe this. Why other fund managers don’t setup an index fund? Why let OSK monopoly? I can’t even find two to compare and see which is cheaper.
Late reply, but this is something that I’ve wondered about in the past on this very forum as well. If you read a lot of general investment advice that comes out of experience in the US markets, the general consensus you should get is that most ordinary people should just buy index funds and forget about everything else. The rationale is that research has definitively demonstrated that over the long run, index funds in the aggregate outperform actively managed funds once you account for the higher costs associated with the managed funds. While it is possible for managed funds to beat the index, research has shown that it is not generally possible to predict in advance which particular managed fund will beat its benchmark index in any particular year. Research has also shown that the simple strategy of choosing the best performer of last year to invest in every year is a losing one.
However, I’ve come to realize that for many different reasons many of these things don’t really apply to Malaysia. Some of these reasons include:
1) The U.S. is a mature and deep market with extremely high liquidity and lots of players. The Malaysian market is puny in comparison and dominated by some extremely big players, including the government. This means that unlike the mature U.S. market which lacks arbitrage opportunities because the market is deep enough that the prices should reflect all relevant information available to all market participants, it is still possible for investors in the Malaysia to identify and exploit arbitrage opportunities due to factors such as information disparity (some market participants know some things that others don’t) and the fact that in some cases government-linked companies and investors are “forced” to act in a certain way and everyone knows this.
2) U.S. index funds are really, really cheap, in some cases as cheap as 0.15% a year. No Malaysian index fund can match that. This makes Malaysian index funds a lot less worthwhile. As I’ve previously mentioned, if “alpha” comes so cheap, why not just buy it? This raises the question of why index funds are so expensive in Malaysia and why no new competitors have entered the field offering low costs? One part of the reason is obvious. An index fund, since it is not actively managed, should have relatively fixed costs and very, very low marginal costs. In other words, it takes a certain amount of money to establish and keep a fund running, but each new customer adds almost nothing in terms of extra costs. Because the U.S. market is so huge, this means that it is possible for the U.S. index funds to spread their costs around to a very large number of customers. The Malaysian index funds can’t do that, so their costs will always be higher.
3) Another reason I can think of is that the various investment funds in Malaysia are heavily reliant on a network of sales agents to sell and service them. On the other hand, if all you want is to invest in an index fund in the US, there’s no way the fund is going to send an agent to you and offer you a personalized, one-on-one service. Since agents are paid commissions that are ultimately paid from the fund’s management fees, obviously any fund that wants to make a serious dent in its fees must find a way to do without them. For various reasons, such as the lower level of financial education amongst Malaysians, this might not be feasible. Or else Malaysians might feel more of a psychological need to speak with a human sales agent to ask questions and solve problems for them.
4) Malaysians are not comfortable with the idea that matching a benchmark is good enough. They do not want average returns. They want exceptional returns, every year. Once again, this is a logical impossibility: it is not possible for everyone in the market to be doing above average at the same time. For every one that is, someone must be doing below average. However, it is possible that most Malaysians have not yet overcome the psychological hurdle that the returns on their personal investments are more likely than not going to be average over the long run and thus eschew index funds on principle because these funds by definition offer only average returns.