By MARY HOLM
Q. We are a just-50s couple on a reasonable income, who began doing some serious saving towards retirement two or three years ago.
We read lots of advice and began putting $1000 a month each into two passive funds, based on low fees, reasonable growth and planning not to need that money for 10 to 15 years.
We put a third amount into a more diversified, lower-risk fund.
We have handled seeing our money shrink almost every month, knowing this was a long-term investment.
But now a new table appears in the Herald, and we find that our two funds, AMP Passive International Shares Trust and Tower Tortis International, are rated the lowest by Fundsource, with one star.
What happened to all that good advice? Do we continue depositing our monthly savings with these funds?
And what do we do in a year's time when our youngest becomes financially independent and we plan to free up more to save. But save where?
A. Yes, continue using those funds or similar ones, and I would put your extra money in them, too.
I was surprised to see how badly your two funds rate in the FundSource table.
As international index funds, they are still among my favourite long-term investments, despite shocking performances in the last three years.
Index - or "passive" - funds invest in the shares in a market index. They are cheaper to run than active share funds, whose managers decide which shares to buy and sell, so index funds charge lower fees.
In New Zealand, too, index funds don't pay tax on capital gains, while active funds do. This has a big effect on returns.
Over the long haul, index funds' returns are higher than on most active funds, especially after taxes and fees.
So why the terrible FundSource ratings?
Firstly, because the star ratings are based on three-year performance, after tax and fees, and on volatility. They simply reflect what you have already seen.
"It would be hard to pick a worse three years to judge passive funds," says Richard Baker, of Tower.
The tables, though, also give five-year figures. Your two funds don't do so badly there. And if we had data going back into the 1990s boom, I expect they would have done even better, if they had existed then.
Three years, or even five, is too short a period to judge a share fund.
Also, FundSource compares your two funds with 56 other funds involved in international equities. Some of those funds, though, invest only in certain regions, some invest only in property shares, and so on.
Over the last three years, many of those sectors have done better than world shares as a whole. But that certainly won't always be the case. As I've said many times - and it's echoed by Tim Anderson of FundSource - past performance is no guide to future performance.
FundSource also does qualitative ratings, which Anderson suggests investors use when looking to the future. You can get the ratings through financial advisers.
Under those ratings, Tortis International is recommended.
And while the AMP Passive fund is not recommended, the related WiNZ is recommended. (More on the WiNZ/AMP Passive difference below.) "If they are recommended, that means they are robust funds. We have confidence in the fund portfolio, process and people involved," says Anderson.
Okay. But none of this has probably convinced you that these funds are great investments. So what's going on?
Simply this: When sharemarkets are falling, index funds tend to do even worse than active funds. When markets are rising, they tend to do better.
Given that markets rise much more than they fall, over the long haul that's fine.
Unfortunately, you got in at the start of an extraordinary downturn. But if you keep your eye on your original 10- to 15-year horizon, I reckon you'll be happy with your choices.
So why do index funds perform in an exaggerated way?
* The tax break on capital gains cuts both ways.
"No tax on capital gains in rising markets, coupled with non-deductibility of losses in falling markets, sees a more volatile return history," says Baker.
For active funds, the situation is complicated and in a state of flux. Suffice to say that some still deduct all capital losses and some deduct some losses. When we look back over the last three years, all the active funds would have deducted losses earlier on.
Because of this situation, "sometimes the stars are a bit misleading", says Richard Flinn, of AMP Financial Services.
* Under the Inland Revenue rulings about capital gains, index funds must stay almost fully invested in shares. They can't hold as much cash as most active funds do.
This means that when shares rise, index funds with their heavier share investment rise more than active funds. When shares fall, index funds fall more.
There's another factor, too.
Your two funds - although not all international index funds - are not currency hedged, whereas many active funds "would have done a fair bit of hedging in the last 18 months", says Flinn.
In a hedged fund, the managers buy financial instruments that cancel out the effect of foreign currency changes. Those instruments cost money - eating into returns - but provide a sort of insurance.
Unhedged funds are left to benefit when the NZ dollar falls and suffer when it rises.
By a quirk of fate, the late 1990s saw soaring international share prices and, at the same time, a falling dollar. With that winning combination, your two funds did brilliantly (sadly, before you invested).
Then, early this decade international shares plunged and the dollar rose. Your two funds were hit by a double whammy.
Over the long run, though, the dollar will sometimes rise and sometimes fall. With any luck it will all come out in the wash. And unhedged funds have, in the meantime, saved by not buying hedging instruments.
For all that, you might feel that the tax, cash and currency factors together make index funds rather more volatile than you would like.
There's a simple solution. Water down the volatility by putting your $2000 a month into fixed-interest investments such as term deposits or bonds, until they make up 10 or 20 per cent of the total.
Then track the progress of the index funds and fixed interest added together. When shares are booming, having the fixed interest will lower your returns, but when shares are falling, it will boost returns.
Or you could get the same effect by looking at the total of your index funds and a lower-risk diversified fund.
Now, as promised, the difference between AMP's Passive International Shares Trust and AMP's WiNZ.
The money in the Passive Trust is invested in WiNZ, so basically it's the same investment.
But the Passive Trust is not listed on the stock exchange and you get into it directly or via financial advisers. WiNZ, however, is listed. You buy shares in it through a sharebroker.
Entry fees into the Passive Trust may be lower than brokerage into WiNZ. And the trust has no exit fees, whereas you will pay brokerage to sell WiNZ.
But because of the extra layer of administration, ongoing fees in the trust are about twice as high as in WiNZ. For a long-term investment, WiNZ's lower ongoing fees make it the cheaper choice.
You don't, however, get regular reports and adviser support, although you can keep track of your investment through the newspaper share tables.
My advice to you, then? You might want to switch from the Passive Trust to WiNZ. And you might want to water down your investments with a bit of fixed interest.
Beyond that, though, hang in there.
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Q. I am concerned as to the effect of Tower's present problems with Bonus Bonds.
My understanding is that Bonus Bonds are managed by ANZ and Tower is the trustee. Is there a risk associated with the Tower connection?
A. No, for two reasons.
Firstly, the finances of Tower Corp have always been entirely separate from any funds invested for Bonus Bonds.
The trustee holds the Bonus Bond assets on behalf of investors, says a spokesman. "There are very strict procedures around the custody of assets." And the operations are watched over by an independent board of directors.
The spokesman adds that Tower Trust, now called Trustee Executors Ltd, is one of the largest trustee companies in New Zealand and has been in business since 1881.
Secondly, the trustee company no longer belongs to Tower anyway.
On July 31, US investment firm Sterling Grace bought it for $25 million, a price that suggests it thought the trustee company was pretty sound.
You might now ask how solid is Sterling Grace? I don't know, but it says it operates in Australia, Japan, Europe and the US as well as New Zealand, and that it has been around almost as long as Tower Trust, dating back to 1885.
I really don't think you have any cause for worry.
* Mary Holm is a freelance journalist and author of Investing Made Simple.
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