How to read a PDS

Smart Investor, February 2008

When you consider buying a fund, the main document you need to look at is called the product disclosure statement. The Australian Securities & Investments Commission (ASIC) requires all fund managers to produce these: superannuation, insurance, retirement savings and deposit products have to have them too. This is your starting point to find out the fund’s features, fees, risks and other details.

But there is a tension about the disclosure of information in products like this: the tension between being thorough and being clear. Regulators require that all relevant information be disclosed to investors; product manufacturers, in turn, are told by their lawyers to put in absolutely everything that could have a bearing on a product and its performance, in fear of litigation if they don’t. This can produce documents that are legally watertight but close to useless in terms of communicating succinctly to an investor exactly what they’re buying. Some manufacturers therefore add a short-form version, containing the basics, alongside the longer one (an unspoken recognition of the fact that nobody is ever going to read the big version).

So where should you look for the information that matters in a PDS? Well, let’s take a couple of examples.

We’ll start with one of the very largest funds in Australia: the Platinum International Fund. You can get the PDS for this product (which embraces all Platinum funds) by going to www.platinum.com.au, following the menu “PDS and forms” and then clicking on product disclosure statement.

It is often said that the first thing you should do with an investment document, whether an IPO prospectus or a fund offer document, is rip out all the pretty pictures: they have absolutely no bearing on your investment and will serve only to distract you. Platinum, fortunately, doesn’t bother with any so you can go straight to the information summary (page one if you’ve printed it out; page three on your browser if you’re reading it on the internet. From now on we’re going to assume you’re looking at it on your computer and give you the computer page numbers, which are two ahead of the numbers on the pages if you’ve printed them out.)

This is where to start: it tells you things like your minimum initial investment, and the minimum if you want to top it up from time to time; basic fees, although you’ll want to look deeper into the PDS to find out more about this; and where to find out the unit price after you’ve bought in. This might be able to tell you straight away if it’s not for you: if, for example, the minimum investment is too high.

So what else do you want to know? Well, first and foremost, what does this fund do and how does it do it? All PDSs will have something called investment methodology, or something similar, and this should be your next port of call. In this PDS, it’s on page 4 (on your computer). Here you find out who the manager is, what its experience is, and how it invests.

Read that? Well, you’ll already be seeing the shortcomings of most PDSs. This DOES tell you what you need to know – that Platinum looks for undervalued companies with good stories to tell, builds portfolios based on stock selection rather than a pre-determined allocation, can move to cash if it wants to, uses software alongside broader thematic ideas, considers every potential purchase in a global context, and that managers travel frequently to see companies and their suppliers – but it does so in the style of a dull text book. You may be better off at this point jumping to some other data that will typically be available from the same manager: fund updates (which will usually tell you the fund’s top holdings), or on Platinum’s case the excellent quarterly investment reports which tell you, candidly, how the manager is thinking. This will give you a much better flavour of what the fund is about than some anodyne description of market inefficiencies. Page 6 of the Platinum PDS gives you more info on the International fund itself, but this is pretty basic stuff and again you’ll get a better gist by looking at its holdings and updates. (Page 14 covers the fund’s holdings and performance, but there are more up to date numbers elsewhere on the site.)

Many in the market say that when looking at a prospectus or PDS, start at the back: that’s where the risk are. Actually Platinum puts them further forward, on page 13, but in any event a look at this section tells you that you never really learn a lot from the risks section: that’s because absolutely everything, from manager error to global health pandemics, gets lumped into these sections. What a risk section doesn’t do, and what you really want to think about, is: what’s my worst case scenario? How much could I lose at the end of the year and how likely is that to happen? To get a better sense of that, investors are better advised to look at a fund’s long term returns, and see how much they have soared and plunged over the years. (Of course you can only do this with a reasonably long-established fund.)

Another vital place to look is the fees section. More attention has been paid to proper disclosure of fees than any other area of investment products. Over the years we’ve gone through all sorts of different terms to describe the total fees people end up paying; the current expressions of choice are “management expense ratio” or “indirect cost ratio”. An MER is the aggregate of the fees you would expect to pay year after year – for management, and any other regular payments like expense recoveries – while the ICR is the ratio of the fund’s costs (apart from those deducted directly from your account, like an up-front fee) to the total assets. Usually these two figures are the same.

The fees section, starting on page 22, tells you more. Some of the distinctive things you learn from this section include the fact that Platinum offers a choice between a regular fee of 1.54% a year, or a lower fee of 0.89% plus a performance fee. Also, purchased directly from Platinum, there are no up-front fees to pay (this wouldn’t be the case if you bought through a financial advisor). And there’s a vital and often overlooked piece of information, the buy-sell spread. This is what’s charged when you enter or exit a fund on top of the various annual fees; at 0.25%, Platinum’s is pretty much in line with the norm. Performance fees are explained on page 25: it’s always vital to understand exactly when a performance fee kicks in (for beating the benchmark? For beating it by 10%?) and whether there is a high water mark (meaning if the fund comes down in value, those losses must be recouped before any new performance fee can be levied).

A few other useful things to look for: policy on gearing and derivatives; policy on whether or not to hedge against movements in the currency; and policy on environmental and social issues. In this PDS they’re all on page 12. There is always a section on tax, but you are generally better off discussing with an accountant than trying to draw conclusions from these, as the people writing the PDS don’t know your own personal tax circumstances.

OK, armed with this approach, let’s look at a recent PDS. Go to www.liontamer.com.au and click on the ‘product disclosure statement’ button for the manager’s Global Water Fund.

As you can see, this one makes a much bigger effort in the visual presentation and marketing side; but as we’ve discussed, that makes not a jot of difference to the investment case. Much of the front part of the book is made up of the overall investment premise, which is: there’s not enough fresh water in the world, it’s getting worse, and listed water companies worldwide ought to benefit from the situation.

Not until page 12 (on your computer) do you get to the meat of the fund itself, with the key points on page 13. Some good things about this PDS are the clear statement of an objective (beating the MSCI World) and a very detailed description of the investment process. This one is also distinguished from the Platinum one because it contains discussion of fees to advisors (the Platinum PDS was for direct investments without an advisor), although generally the precise fees advisors can charge are between you and them, and don’t involve the fund manager at all. Since you might well never have heard of Liontamer, you might be drawn to the description of the manager and its ownership (through the Belgian KBC group) on page 31. The risks section here, starting on page 18, is a classic example of what we talked about earlier:  it covers absolutely everything (and, legally, it has to) so that a more pertinent message – that a water fund is really just a sector fund, and therefore involves concentration risks – is perhaps lost.

Some other things to look at. Page 22 tells you what happens when you want to pull out of an investment, and says that it generally takes 10 days to process a redemption request. Given how far markets can move in 10 days, you might want to think if you’re happy with that. And page 24 stresses that the company does not enter into soft dollar arrangements with financial advisors.

PDSs are a handy place to start in any assessment with a fund, but typically you’ll want to consider other things too: the opinions of independent research groups about the merits of funds and their managers (often these are picked up in the financial press); how a fund fits in to your broader portfolio, and what its tax impact will be on you (both things you are best to discuss with a financial advisor or an accountant).

But when you get a glossy document for a new fund, remember to keep your considerations simple: what does it do, who is running it, how much am I going to be charged, and what could I lose. And pretty pictures don’t mean a thing.