In a listener requested episode, Shani goes through why she uses managed funds and how she chose to use the investment product for the problems that it solves for her.

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Mark LaMonica: Welcome to another episode of Investing Compass. Before we begin, a quick note that the information contained in this podcast is general in nature. It does not take into consideration your personal situation, circumstances, or needs.

Shani Jayamanne: Mark, you were burning the midnight oil last night. Midweek.

LaMonica: I went to a concert.

Jayamanne: Yeah, tell us about it. Who was it?

LaMonica: This guy, Tyler Childers, he's like, at least he used to be more of like a bluegrass guy. And I don't know what's going on with him. Like he quit drugs and alcohol.

Jayamanne: What a shame.

LaMonica: Well, I mean, it's not like I'm part of his family. And he went right before, so he was in New Zealand, then he came over to Australia. Right before he was in India, he wasn't playing in India. I don't want to – there's a lot of people in India. Somebody must like bluegrass music, but he's become very spiritual.

Jayamanne: Okay. He is like the Beatles.

LaMonica: Yeah, he went on this like very long, like you would call it a rant, about Krishna.

Jayamanne: He was ranting about Krishna, or he was preaching about Krishna. Preaching.

LaMonica: So, anyway, it was okay. That brought the average age of the concert goers up.

Jayamanne: Oh, like young people like him?

LaMonica: Apparently. Like I was surprised.

Jayamanne: All right. Well, you got a mic in front of you. Why don't you sing us your favorite song?

LaMonica: I don't think that's going to happen. Speaking of musical performances, you are a big Drake fan.

Jayamanne: Yes. The music. Yes. There's a lot of controversy around him at the moment.

LaMonica: Well, because of the Super Bowl.

Jayamanne: Yes.

LaMonica: And like Venus Williams. Yeah. And so, what do you think about all this?

Jayamanne: I thought it was a really good performance from Kendrick Lamar.

LaMonica: Even though you're pro-Drake, don't you have to pick a side?

Jayamanne: I don't think you do. I think you can like both of them.

LaMonica: I think you do.

Jayamanne: You're just putting me on the spot.

LaMonica: You would have been somebody in the '90s who's like, I'd like the East Coast and West Coast rappers.

Jayamanne: Yeah.

LaMonica: Okay. There we go. Let's get into the episode as much as people like our musical tastes or lack thereof.

Jayamanne: Today, we have – actually, when you go into Spotify, a little aside. When you go to Spotify and you look at our podcast statistics, you can see what people like. So, if you're listening to the podcast, we get an insight into the type of music that you like. A lot of people do listen to Drake, a lot of people listen to Ed Sheeran.

LaMonica: It might be because you're the only person that listens to the podcast and that's what you do listen to.

Jayamanne: I don't listen to Ed Sheeran, but yeah.

LaMonica: He's like a Harry Potter character. I don't know why you don't like him.

Jayamanne: Anyway, we have a listener requested episode today.

LaMonica: We do, which is not for us to talk about music, but we do really appreciate it. So please keep sending those in.

Jayamanne: Yeah, it does take some pressure off us to pick the topics, and I know it's something that's helpful to people, hopefully.

LaMonica: Yeah, exactly. All right. So, what are we talking about today, Shani?

Jayamanne: All right. We're going to speak about Managed Funds today. And normally we gravitate towards ETFs when it comes to managed products. We see a lot of investor interest there through their increasing popularity demonstrated by Fund Flows, but also the way that you engage with our products. So, we can see that you really like our ETF research. We can see that you like our Investing Compass episodes on ETFs, our articles.

LaMonica: Yeah. I mean, they're very popular. They are very popular.

Jayamanne: So, we might be shooting ourselves in the foot by talking about the ugly cousin.

LaMonica: Yeah, which you actually really like, Shani?

Jayamanne: Yeah, I don't discriminate based on looks.

LaMonica: There we go. So, there's a possibility that Shani was the person that sent in this request.

Jayamanne: Yeah, maybe.

LaMonica: I have no absolute proof about it. But now...

Jayamanne: Didn't you get the email, and you forwarded it to me?

LaMonica: I think that's true, but you probably set up an email address. Okay. And thank you for laughing at me and looking at me when you said I don't discriminate on looks.

All right. So, we're going to talk about the difference between Managed Funds and ETFs, but we're also going to talk a little bit about you, Shani, and why you use Managed Funds, because that is the question that the listener asked. And it was hard to tell the tone in the email. So, it could have been like...

Jayamanne: Why are you using these products?

LaMonica: Yeah, what is wrong with you?

Jayamanne: Yeah. So, it's really a battle between like the old school Managed Funds and the new kid on the block, the ETF.

LaMonica: If Managed Funds or ETFs, if one of them was Drake, who would it be?

Jayamanne: Probably Managed Funds.

LaMonica: Oh, there you go. There you go. And later we'll talk about Shani's childhood love Usher. But...

Jayamanne: We won't.

LaMonica: Okay. Well, I will. But Managed Funds and ETFs obviously have a lot in common, but there are some characteristics that differentiate them. And that might mean, of course, one would work better for somebody, and another would work better for another person.

Jayamanne: And Managed Funds have been around for a long while. Some of Australia's oldest Managed Funds were launched over 65 years ago. That's all (to the new) Mark. It has mainly been an advisors' game. Perpetual Managers, one of Australia's oldest Managed Funds, their client base skews heavily towards advisors with around 80% of their assets coming from advised clients.

LaMonica: Yeah. And ETFs are the – we'll say relatively new kids on the block. They've been in Australia for around 20 years. So, they offer an easy way to trade. There's no paperwork if you already have a brokerage account setup. They're increasingly popular with investors, and many fund managers are embracing them as a new way to bring in client funds, and it's working. So, ETFs have never been more popular. So, global ETF flows captured annual record US$1.5 trillion for the calendar year. And funds grew organically 13.6%. That's the highest rate since 2021. Assets reached a record US$13.8 trillion, that's $2.7 trillion higher than at the end of 2023. And I got an email right before we started this episode from Vanguard saying January was the best month ever in Australia for flows into ETFs.

Jayamanne: Really popular.

LaMonica: They're very, very popular. And that's why I will talk about why Shani does not like…

Jayamanne: It's wrong.

LaMonica: No, everyone else could be wrong. I think all of these investors are wrong and you are right.

Jayamanne: But we've done a whole episode on ETFs and Managed Funds, but very quickly, the main differences are really transaction costs for me. So, it doesn't cost to trade Managed Funds. It does cost to trade ETFs, and that'll depend on the broker that you're using.

LaMonica: And of course, there's management fees that we always talk about. So, they're typically higher with Managed Funds, but not drastically higher.

Jayamanne: There's tax consequences. A lot of investors don't like Managed Funds because of the tax consequences that you inherit from other investors, but we'll talk a little bit more about this later.

LaMonica: Yeah, we need something. There's less sort of things you basically convince everyone not to use Managed Funds. Okay, that was a summary. So, we will cover more of those topics as we go along. So, Shani, as we mentioned, as I've been teasing you about, the listener specifically asked you what you like about Managed Funds. So, we have spoken about this a few times on the podcast, but do you want to reiterate what you've been saying?

Jayamanne: Sure. So, there is a few reasons I like them, but I think the overall point to make here is that investment products are a means to an end, that they're there to serve a purpose for you, and you just need to find the best one to do that.

LaMonica: Okay, and I think that some people approach the problem of finding the right products for their portfolios by thinking there is a best one. And I think the great thing about this question is that the listener really just wanted to know why you use Managed Funds, Shani, and why they're the right decision for your particular situation?

Jayamanne: So, let's get to a few reasons why I like them. The first relates to my savings habits. I invest from every paycheck into Managed Funds. I'm able to do that because there's minimum additional investments of $1 for the Managed Funds that I use. And if I have extra funds available at the end of the month, I'll just put it straight into my Managed Fund. So, in short, I make a lot of contributions, and a core part of my investment strategy is focusing on what's in my control. So, reducing the brokerage that I pay will help me over the long term and investing as much as I can will help me over the long-term as well. So, Managed Funds really suit both of those purposes.

LaMonica: Okay. And that's all very rational, the way that you described that. But I think we should tell people about how crazy you are about doing this. So, we get paid twice a month.

Jayamanne: Bimonthly. Yes.

LaMonica: We get paid twice a month and about sometimes up to a week before we get our paychecks. Shani is so excited to transfer her money into her Managed Funds. She takes it out of her savings and transfers it into her Managed Funds. Her like periodic investments. And then when she gets paid, she just replaces it in her savings.

Jayamanne: I know it's nuts. Let's not go into the depths of my mind. It is nuts.

LaMonica: Yeah. That would be an audio book rather than a podcast. So, the alternative to Shani's approach is that each time you get paid, not her crazy approach like the rational way she explained it, is that you save from each paycheck and then you would amass Shani enough money that justifies the cost of brokerage. And then you go in and you buy an ETF. So, this obviously is very dependent upon your broker. So, they all have different trading prices. It's also very dependent upon your savings levels. So, Stake is one of the lowest cost brokers on the market, they charge $3 per transaction. CommSec is the largest broker in Australia.

If you're likely going to be paying a fee of $5 for trades up to $1,000 and then $10 on trades up to $3,000. So that can be a large percentage of the funds you're investing if you're investing really frequently like Shani is. So, Shani would have her money out of the market for longer while she's saving up to get to a level where it makes sense to go and pay this transaction fee.

So, we can illustrate the difference that small contributions can make. You wouldn't make these additional contributions unless there were no transaction costs. And in this example, I'm assuming an 8% return per year, which is in line with Morningstar Investment Management's long-term forecast for Aussie equities. And we're assuming a 2.5% inflation rate. So, in this example, if you had $100,000 and invested $1,000 per month for 20 years, you would have $1,035,000. And if we adjust for inflation, that's $631,000 in today's dollars.

So, as I said, we get paid twice a month, Shani. And if you invested just $50 more per paycheck, the balance would be $1,091,000 or $666,000 adjusted for inflation. So that's the difference in a balance without any additional cost.

Jayamanne: Good example, Mark.

LaMonica: It was a long example.

Jayamanne: Yeah. Thanks for doing that. Part of this decision is also behavioral for me. Having the cash sitting there, waiting to invest, opens up the opportunity for a couple of things to happen. And the first is that I deviate from my investment strategy, and I speculate. And I know this because I've done it before. So, once I've reached a sizeable trade amount, it's easier for me to consider investing in investments that may not be part of my investment strategy. And my job makes this much more likely. I read analyst reports all day telling me about undervalued companies. I read a lot of commentary about can't miss opportunities. I'm constantly exposed to eye-watering returns and it's easy for me to block out the noise and focus on what I'm trying to do and achieve when I don't have parcels of money sitting there ready to invest. And I really want to reduce that behavioral risk. And if I invest, it's gone from my mind.

And the other scenario – sorry, I might, can I give another one?

LaMonica: Okay, give one more.

Jayamanne: It'll be really short. Is that I try and time the market. So, if I wait and save up a large parcel of money, I worry more about the unit price that I'm going to get.

William Ton: Hi, I'm Will, producer of the Investing Compass and here are this week's must reads on Morningstar.com.au.

Mark's unconventional wisdom column takes readers on a trip to Monte Carlo this week. He looks at the levers that investors can pull to have a more secure retirement, reducing uncertainty for investors. Shani's Future Focus column explores the trade-offs that parents are making with private school.

Requested from a listener, Shani explores the costs of Government, Catholic and Independent schools and the impact that these costs can have on financial outcomes. The concept of economic moats is central to how our analysts weigh up companies. In this week's Bookworm, Joseph taps a classic investing article on the idea of legacy versus reinvestment moats. As it turns out, the differences could explain why some companies are able to compound in value far faster than others.

Australia's housing crisis is well known with young, prospective homeowners feeling betrayed by our governments. This frustration has put public housing policy in a spotlight in an already overpriced housing market. This week, Sim explores the housing affordability issue by looking at some proposed solutions and the implications.

Find these articles and more in our episode notes, and now it's back to Mark and Shani.

LaMonica: Okay. I have two questions that I think listeners would have. So, number one is what do you speculate in? Or what have you historically speculated in? Individual shares?

Jayamanne: Yes. Individual shares. I think you shared your yes, individual shares.

LaMonica: Okay. We can leave it at that. Did it work out well for you?

Jayamanne: Yes, it did.

LaMonica: There you know, new podcast. Shani trading her way to riches.

Jayamanne: So the thing is like, I had no basis for investing. It was not connected to my investment strategy at all. So, it just meant that as soon as the price got to overvalued territory, I just got nervous and I sold it, which isn't great.

LaMonica: Okay, and when. And this is more of a question for me. You say that you spend your days reading analyst reports in between like the coffees and chit chatting in the kitchen. When do you have time to do this?

Jayamanne: You know that I have my headphones on basically all day and I'm like a little hermit. I sit in the corner with my headphones on and don't interact with anybody.

LaMonica: We're supposed to go to lunch today and Shani canceled the lunch with me and now I have nothing to eat because I didn't make a lunch for today.

Jayamanne: We can go to lunch, Mark.

LaMonica: No, it's okay.

Jayamanne: Okay.

LaMonica: So, let's get back to not the 50 questions for Shani, who just rolled her eyes at me. So, let's talk about the rationale for why Managed Funds suit Shani's situation. But it's also important for all of us to know that you do need to be efficient with your investments. And not so efficient that you actually impact the total return outcomes you receive. So, the industry is going to continue to innovate. There will always be new investment products and options for investors to choose from. So, choosing a marginally better option each and every time that when appears will be to the detriment likely of your long-term outcomes. You'll incur tax if you sell something if you've made a profit. There are transaction costs as we've been talking about.

So, investors know in principle not to chase returns and switch in and out of products. There should be a logical and sensible reason why you decide to switch out of an investment product with a long-term plan. So, you'll inevitably continue to see innovation as more of these products come out and they, of course, are competing for your money.

Jayamanne: And there are, of course, downsides to Managed Funds compared to ETFs. These investment products are trying to find solutions that will suit the majority while still running a profitable business. And there's no perfect investment vehicle.

LaMonica: And Managed Funds are not as easy to set up as ETFs. There's paperwork involved. And often, the processing lead times mean that you aren't issued your units in the fund immediately. So, this shouldn't really bother long-term investors. The paperwork is usually only at the beginning of the process and it's quite seamless afterwards. Even if there is paperwork involved and longer processing times over these long-time horizons, this really shouldn't make a difference.

Jayamanne: And Managed Funds also tend to be marginally more expensive than ETFs, compared to the savings from the brokerage and paying the difference in management fee is negligible. And it's important if you're considering between the two investment products that you consider all of the fees when you're making a decision.

LaMonica: And a large concern that many investors have are the taxes that are associated with Managed Funds. So, the way that Managed Funds pool assets with other investors means that the actions of other investors may impact you. So, when investors sell out of a fund, they leave you with the capital gains consequences. So, many investors were burned by this during the GFC when investors panic sold, and the remaining members were left holding the bag. Many investors who were investing when this occurred will never touch Managed Funds again because of these poor experiences.

Jayamanne: And again, no investment is perfect. It would be nice if I didn't face tax consequences from the actions of other investors, but it would also be nice if I didn't get charged every time, I wanted to make a trade on an ETF.

Ultimately, Managed Funds solve more problems for me than ETFs for the parts of my portfolio where I use them. I think it's worth remembering here that I'm splitting my investments each time into three or four Managed Funds. So, I'm also able to diversify properly and keep my portfolio mix aligned to my portfolio strategy. And I'm not incurring brokerage four times over each time I get paid.

LaMonica: And you certainly do not have to. We've done this all episodes where it's like ETFs versus Managed Funds, but you don't have to pick one. So, just remember that this is not some sort of philosophy that just governs your life. Investing is a means to an end and investments are just the vehicles that get you where you want to go. So, one approach may be right for some investors, not a great fit for others. And even more commonly, both approaches might work in different situations.

Jayamanne: Yeah, well, speaking about why I prefer Managed Funds, but it's not a preference. I also invest in ETFs as well. They serve different purposes in my investment portfolio and are aligned to different goals. The Managed Fund industry is still innovating, and that means that some investment options can't be accessed unless you have a high minimum investment with unlisted funds, the circumstances and benefits they do change from provider to provider. So, there are some asset classes and investment options that are easier to access with ETFs.

LaMonica: Yeah, you don't have to label yourself, Managed Fund invests, although you do like doing that. No labels. Also, a good philosophy for life. So, as we said, you don't need to choose if you're a Managed Fund or ETF investor. I think a lot of people have sort of said they're never investing in Managed Funds, but you should consider them. They might be the right thing. Yeah, you just don't need to choose. Like you don't need to be in property or into shares. Like they're all sorts of different things where you can actually do what works best for you, which is generally some combination.

All right. So, last question before we sign off today, Shani.

Jayamanne: These are a lot of questions for me.

LaMonica: So, we have Drake as the Managed Funds. Kendrick Lamar as an ETF, I assume.

Jayamanne: Yes.

LaMonica: Usher, your early teenage crush.

Jayamanne: Like, railroad stocks. I don't know he is really old now.

LaMonica: Okay. So, like Ben Graham was writing in detail about Usher.

Jayamanne: Yeah.

LaMonica: All right. Well, that finishes up our music edition of the podcast. Thank you, guys for listening. Once again, thank you very much for the listener who submitted this question, this episode topic. If you have one, send it to my email, which is in the podcast notes.

(Disclaimer: Any advice in this podcast is general advice or regulated financial advice under New Zealand law prepared by Morningstar Australasia Proprietary Limited and/or Morningstar Research Limited without reference to your financial objectives, situations or needs. You should consider the advice in light of these matters and any relevant product disclosure statement before making any decision to invest. To obtain advice for your own situation, contact a financial advisor.)

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