The Risks of Investing in Unit Trust Funds
THE RISKS OF INVESTING IN UNIT TRUST FUNDS
Investing is known to be an adventure that is filled with risks. However, the type of investment you choose will determine the degree of risk that is involved. Thus, before we invest in any funds, we should be very clear of the potential risks involved.
Unit trust funds are widely known for having lower risks due to its widely diversified portfolio holdings. Nevertheless, this does not mean that it is a riskless investment. it is crucial that we study the risks involved and make sure that it is well aligned to our risk profile before we make our decision to invest in the funds.
At the end of this article, you will learn the general risks that are inherent in unit trust investment, regardless of the type of assets or sector being invested in.
Fund Manager Performance risk
Unit trust funds are professionally managed by fund managers and therefore, the performances of the funds are highly dependent on the managers’ styles and abilities. Good managers are those who are able to produce consistent good results through good or bad times. However, it is difficult to determine whether the fund manager is going to be able to deliver good results even though we may refer to their track record as guidance. For example, if a key member of the fund management team decides to leave during our investment period, it may have an adverse impact to the investment process.
Unit trust is considered as medium to long term investment. Financing unit trust investment using loan increases both the possibility of gains and losses. The returns of unit trust funds are not set in stone, thus we cannot rely on it to repay the loan. There could be times when the value of our unit trust holdings falls below certain level, and we may be required to top up our collateral or reduce our loan amount. When the interest rate is on the uptrend, the cost of loan repayment will increase as well. Therefore, you should weigh all pros and cons before deciding to finance your fund investment with borrowed money.
Country and Currency risks
If the unit trust investments are in foreign market and denominated in foreign currency, we may also bear the risks of any changes in the country’s political, regulatory or economical situation that will adversely impact the value of our investments. Any fluctuation in the foreign currency, especially the weakening of the currency will also reduce the asset value of the foreign investments.
Equity investment risks
When unit trust funds are invested in equities, the overall market situation causes many internal or external factors that will have an impact to the value of the unit trust holdings. For example, in the recent euro zone debt crisis, even though it happened in the European countries, however, the impact rippled through the entire global economy, which includes our local market. No matter how diversified the equity holdings are, the investments will not be free from market risk.
There are also company or sector specific risks. Company specific risk could be arising from changes in the management team, the company losing its competitive edge, or any other factors that are causing the company not meeting its financial target, while sector specific risk could be coming from changes in certain economic condition that affects the entire sector. These types of risks are particularly obvious in smaller size funds or sector specific funds.
Fixed-income securities risks
Bond funds or sukuk funds are exceptionally sensitive to changes in interest rates. The up and down trends on the interest rates would affect the net asset value of the funds. The longer the maturity of the debt securities and the lower the coupon rates of the debt issues, can also cause interest rate changes. This in turn could trigger early redemption of the issuer which will result in early return of principal to the investors.
Apart from that, all bonds are subject to credit risk, which refers to the ability of the issuer to make timely coupon payment or principal repayment. In the event that any of the bonds being invested by the unit trust funds facing default on its payments, it will negatively impact the net asset value of the funds.
As investors, we must evaluate all the risks that may occur in the potential investments that we make. Get to know your investment products so that you are able to make wise and informed investment decisions.
Brought to you by Securities Commission Malaysia, as part of its ongoing efforts to create well-informed and savvy investors in the capital market. The information provided in this article is only for educational purposes and should not be used as a substitute for legal or other professional advice. For more information, log on to www.investsmartsc.my, call 03-62048888 or visit our Facebook page at www.facebook.com/InvestSmartSC