How to choose the best MPF fund in Hong Kong: four checks for index funds

This article is a rewrite of a report from July 2012.

As fee pressure mounted, more MPF trustees in 2012 were launching passively managed index-tracking funds. Beyond the familiar Hang Seng Index funds, trustees were rolling out index funds tracking other markets. But picking an index fund takes more than reading its name — there were four things members needed to check.

What makes an index fund worth choosing?

Index funds win on lower fees and simplicity, but members should clear four hurdles first: risk level, diversification, tracking method and tracking error. Research cited at the time showed 60 to 70 per cent of actively managed funds underperformed the market; for members who couldn’t pick funds or managers, a passive index fund could deliver better results — and all they had to do was watch the underlying index.

Four checks before buying an index fund

First, the risk level. A fund that puts everything into a single stock-market index may carry more risk than a member can stomach.

Second, diversification. A Hang Seng Index fund concentrates on the index’s constituents, and its volatility can exceed that of active funds. Members could check the fund fact sheet — issued at least twice a year — for the top 10 holdings: the smaller their combined weight, the better diversified the fund.

Third, full or partial tracking. A fund called an index fund might only partially track an index. The offering document and fact sheet spell out whether it fully replicates an index or just invests part of its assets in one, so members can judge whether the objective fits their expectations.

Fourth, whether returns actually track the index. Trading timing gaps and management fees mean fund returns never match the index exactly. The MPFA required all MPF index funds to disclose fund-versus-index returns in the fact sheet — though funds less than six months old carried no performance data.

One more point: index funds could lag active funds in bull markets but usually held up better in bear markets. And the reason they cost less was simple — no fund manager picking stocks meant no manager’s pay to cover.