In the article, it quoted a stellar performance of HSBC GIF BRIC Freestyle M1C fund which despite its obscene 12.97% ratio returned large returns over a one year period. The obscene expense ratio is due to its performance fee. It implied in the article that in this example, high expense ratio did not mean poor performance.

According to Morgan Stanley International, the MSCI BRIC Net Index for the same period was 47.0% in US dollars. The Net Index were dividends reinvested after tax.

This means that the HSBC GIF BRIC Freestyle M1C actually underperformed a corresponding index by 47-33.5 = 13.5%. This turns out to be very close to its expense ratio!

Thus, from the simple exercise above we can see that a simple passive fund that invests in whatever is being tracked by the MSCI BRIC would have done much better then the HSBC GIF BRIC M1C fund.

So how can we apply for our own investment? There are times which we mistakenly believe that an investment is “good” because of its large returns. The large returns could be simply due to the good underlying market returns. It does not mean that the fund manager is good. In the above arithmetic, it can be seen that the fund manager had no skill because its returns before cost were similar to an index return. After cost, the fund underperformed – not by a little bit but by a lot. Therefore, it is important to understand whether the return is due to skill or market performance.

To preempt a possible misunderstanding that low expense automatically means good returns, I would like to cite APS Alpha Fund which is the worst Asia equity fund over a three years period despite an expense ratio of 0.46% (according to The Edge)