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buy managed funds directly vs. exchange traded funds

Discussion in 'Exchange Traded Funds (ETF)' started by pinkeye, 18th Nov, 2007.

  1. pinkeye

    pinkeye Active Member

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    Hi InvestEd,

    I don't have a stock trading account because I can't pick stocks and I have no interest to trade frequently, so I bought some managed funds directly.

    Now I am wondering what happens when the next serious market correction occurs. I understand that if I bought exchange traded funds, I could set a STOP order to automatically cut my losses at chosen point, but I bought the funds directly. Is it likely that the fund managers will have STOP orders set on the fund assets on my behalf anyway? Or will the fund just plunge with the market? :eek:

    If the fund manager will make this call for me, I would prefer to leave this decision to them (rather than setting my own STOP order). If they have no such order and will allow the fund to plunge in a serious correction, then I worry that I should have bought exchange traded funds so that i can set my own STOP order (and why would anybody buy the funds directly)? :confused:

    Is there some peril of the STOP order which I don't understand...?

    Thanks,

    Anthony
     
  2. Rod_WA

    Rod_WA Well-Known Member

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    Interesting point. It's unlikely that the MF manager will have such stop loss protection in place. You'll need to check the PDS of the fund, as this usually describes the fund's methodology and risk management policy. Often, the PDS might say something like, "At times, the fund may implement risk management practices, including the use of derivatives."
    However many funds (maybe the majority?) will not use derivatives, and probably not stop losses, and will closely track any fall that the index suffers.

    Is there some peril in a Stop Loss? Firstly, realised capital gains - let's say you were in the fund for five years and have doubled your money. You don't want to sell the fund, as you'll be up for a whack of CGT. So do you want the fund manager to make this decision for you, and force you to take CGT when perhaps you're not prepared to?

    If you're worried about market corrections, then you can choose to protect your holdings, and this can be done in several ways. But before you go "Yep, I want to protect my funds!" you also need to ask whether you can also say yes to "Yep, if the market goes up further, I don't want to be a part of it."

    Are you a bull or a bear? If you're a believer, then roll with the dips and corrections. If you're a bear, then maybe you shouldn't be in the market right now. If you're on the sidelines, then a bet each way (hedging) may cost you a bit (consider it an insurance premium) and require a strategy.
     
  3. pinkeye

    pinkeye Active Member

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    Hi Rod,

    Thanks for the info. If a fund manager sells some of the fund assets (increasing the cash position of the fund) using a STOP order or otherwise, could this really cause the individual investors to incur a CGT event? I thought that the CGT in this instance would be an expense of the fund, manifest as a decrease in the unit price. The individual investors have not sold any of their units! Have I misunderstood this? :confused:

    Thank you,

    Anthony
     
  4. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    It is a normal part of a fund managers operation to occasionally sell assets (for any number of reasons), which will trigger a CGT event for the fund.

    Capital losses are quarantined within the fund to be offset by future capital gains, while capital gains are assessable in the hands of the beneficiaries (ie the unit holders).

    What will happen is that when you receive your distributions, part of that distribution will include capital gains components. Your distribution report will detail any capital gains that you must declare, including discounted and non-discounted gains.

    This is what can make actively traded funds less efficient than those which just buy-and-hold.
     
  5. pinkeye

    pinkeye Active Member

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    Hi Sim,

    Just to clarify, this means that even if I don't sell any units and have all distributions reinvested in the fund, I will still probably have to declare some capital gains at the end of each year, based on the reports I receive from the funds?

    Thanks,

    Anthony
     
  6. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Yes, quite possibly. Not all funds will incur realised capital gains ... but I'd think the majority would have at least some component of capital gains in the distribution for the year as they rebalance the portfolio or sell assets to meet redemption requirements.

    Even an index fund is likely to have a small component of capital gains as they re-weight the portfolio to match index changes throughout the year.
     
  7. pinkeye

    pinkeye Active Member

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    Thanks, this is starting to make sense! :D
     
  8. Rod_WA

    Rod_WA Well-Known Member

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    Pinkeye, what colour is your other eye? ;)

    And remember that even if you reinvest distributions automatically, you'll need to declare these in your tax return - even though you didn't receive the cash - whether it's capital gains or dividend income; the exception if deferred distributions, which you don't have to pay tax on until you sell (they form part of your capital gains calculation).
    But all of these different amounts will be detailed on the annual tax statement.
     
  9. voigtstr

    voigtstr Well-Known Member

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    Rod, in reference to your sig, I guarantee you 20% PA.
     
  10. Rod_WA

    Rod_WA Well-Known Member

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    Very funny. But I don't reckon that was a stupid question.

    Reminds me of a Young Ones episode (now there's an irony: the only people who remember the Young Ones are us oldies!). Two funny men lookiing out a window with binoculars (with the lens caps still on). One says to the other, "This might sound like a silly question... Nip Nip Nip Nip Pip?"

    Now back to the 20% guaranteed... what's my max investment in the Voigtstr Fund?
     
  11. voigtstr

    voigtstr Well-Known Member

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    Um Nip Nip Nip Nip Pip!

    And isnt a pinkeye a reference to conjunctivitis?

    (and even more off topic, but related to the young ones, I'm reading Ben Eltons "Blind Faith")
     
  12. naz

    naz Member

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    I think that managed funds don’t usually sell most of the shares because they are being paid to invest. For instance a fund that invests in say Australian shares is being paid to pick good Australian shares – not to just hold the money in cash (of course it might be better if they held it in cash but then they may also miss a lot of profit). I’m fairly sure most PDSs I’ve read state asset allocation something like:
    Australian shares 80-100%
    Cash 0-20%
    which would mean they couldn’t sell them all (unless there was some other clause saying they could).

    Also regarding getting a capital gain without selling, I think a lot of investors in America had a bad time with this a few years ago. A quote from foxreno.com - Money
    “…last year, when many portfolios sported negative returns and paid out sizeable capital-gains distributions. The cause? Faced with a market downturn, the funds' managers were selling stocks to lock in profits. Others were forced to sell shares when investors dashed for the exits. For those who experienced it, we probably don't need to remind you that the result was a nightmarish capital-gains season.”

    This is one reason I’m planning on moving to ETFs.