Mutual Funds help investors balance risk

Investment in any instrument, basically, comes down to a game of risk-return trade-off. This simply means higher risk investments, such as equities, will fetch you higher returns, while investment in lower risk instruments, such as bank fixed deposits and bonds, generate lower returns.

Investing in mutual funds – also known as unit trusts in the UK, Australia and a few other countries – pitches in somewhere in the middle of these investment products. Here, generally, the returns are higher compared to the risks investors are exposed to, say experts. And the performance of mutual funds in the global markets speaks of itself.

"Mutual funds don't expose you to leverage so you don't have the same level of risk as when you buy a property and borrow money from a bank to buy it. So investing in stock markets via mutual funds is less risky than buying a property," says Steve Gregory, Managing Partner, Holborn Assets, Dubai.

"The majority of mutual funds in the last 12 months averaged in excess of 50 per cent increase in the Far East and Bric [Brazil, Russia, India and China] economies."

Only high-risk investors would go for buying stocks in companies directly. It makes much more sense to make a smaller profit but carry less risk by investing in mutual funds. The risks are much lower in mutual funds, he says.

Generally, commodity funds have done extremely well. Additionally, regional equity funds focused on non-western regions such as Eastern Europe, Far East, and Latin America have done well. Even many single country funds have done reasonably well, for instance, India, China, Russia, among others, Gregory says.

Experts say the more volatile funds, the better the returns over a long period of time. "Generally, equity funds tend to perform better than bond funds over a period of time. However, over the past five years, equity funds have underperformed bond funds," says Paul Cooper, Managing Director, Sarasin-Alpen and Partners, Dubai.

However, keeping all eyes open on the return prospects while glossing over the objective of the fund – the crucial fine print of investment – is a big mistake investors make, say experts.

"Investors need to understand which fund they are specifically investing in and what the objectives of the fund are. For instance, they need to make sure whether it is an income fund, growth fund or a balanced fund, what is the investment strategy of the fund, what is the geographical focus of the fund, and which asset class the fund is focused on," sasy Kashif Arbab, Managing Director, Killik & Co, Middle East & Asia, Dubai.

No investment is risk-free and mutual funds are no exception. There are no guaranteed returns, say experts.

"If the equity market goes down, the return of the equity funds also goes down," says Cooper.

"Mutual fund risks are derived from the objectives of the fund. The risks also depend on the performance of the fund, the asset class or the region or sector where the fund is invested in.

Another risk could be the management of the fund. The investor also needs look at the volatility or standard deviation of the fund performance. The more volatile the fund is, the higher the risk is," says Arbab.

The investor should also look at the performance and the net yield provided by the fund in the past, although past performance is no guarantee of future performance of the fund. The investor also needs to look at the fees involved, he says.

Should an investor need to look at one-year return, two-year return or say, five-year return? "It depends on how long the investor wants to stay in the fund. If he wants to stay invested in the fund for a year, he needs to look at the one-year return objective and so on," says Firas Mallah, Head of Middle East, Dexia Asset Management, Manama, Bahrain.

However, apart from looking at the fund's past performance, the investor also needs to see what is the investment horizon of each fund. If a fund has an investment horizon of say three years, then an investor, who intends to exit in one year from the fund, needs to be aware that his horizon of investment is not aligned with that of the fund. Therefore, this may not be his best investment vehicle and perhaps he would need to seek other funds for his investment needs, says Mallah.

Further, not checking the consumer protection made available around any fund is another big mistake made by investors, say experts.

People need to be certain that there is indeed consumer protection available. An investor needs to do due diligence on the fund such us who regulates the fund and what is the track record of that regulator, says Gregory.

Over a five-year time-frame, mutual funds have generally made profits in almost all markets globally. The stock markets can go up or down, so you need to be looking at longer term when you are looking for a mutual fund investment. You should keep cash deposit for short term and mutual funds for longer terms, he says.

Fund manager is very important and an investor should try to understand the circumstances under which a fund did well, says Cooper.

Investors today are looking for integrity, transparency and 'cleanliness' of the investment product. So the name behind the fund is a crucial differentiating factor today, says Mallah.

Secondly, an investor needs to look at the cost of investment in the fund. Investment in mutual fund involves a number of fees, such as subscription fee, transaction fee, manager fee, custodian fee and administrative fee. Overall, those fees are not very high, but investors need to inquire thoroughly to understand the cost structure and avoid any surprises. If the chargeable fees are not transparent and clear then this is not the fund they want to be in, he says.

Thirdly, the investor should also make sure how much return he seeks to make from the investment and how much risk he is willing to take for that, Mallah adds.

The GCC and the Middle East have a healthy macro-economic growth prospect as a promising mutual fund sector. However, in the regional market, there are few mutual funds managed within the region, say experts.

"While some mutual funds are offered for sale in this market, they're not managed in the region. Most of them are domiciled elsewhere and managed by fund management companies which are regulated in their own countries. However, in the region, many of the banks do run and manage Shariah-compliant funds as fund managers," says Gregory.

Another major emerging trend in the regional mutual fund industry is that the importance of diversified investment approach has assumed importance.

"The issue that needs attention is how transparent a fund is and how well regulated it is, no matter where it is domiciled. I believe investors in the region have understood the true value of diversification, and of actively investing internationally as well as locally," says Mallah. "So while we saw overweight in local investment of a regional investor two years back, today we're seeing the trend back into international diversification. The regional fund market is seeing increasing competition between local and international mutual funds," he says.

Further, investors who used to trade equities and bonds on the market directly on their own have also learned that if they invested in mutual funds, they would be less exposed to risks and they would also benefit from the expertise of the whole investment team managing a fund, says Mallah.

MUST DO

Before you invest in mutual funds, you must:

- Look at the management team behind the fund

- Study the investment objectives and geographical focus of the fund

- Be clear on the fee structure

- Understand the risks involved

SENTIMENT FAVOURS US AND JAPAN

Globally, investors have recovered their bullishness towards equity markets but are shifting their focus away from Europe and into the US and Japan, according to Bank of America Merrill Lynch's survey of fund managers for March. A total of 207 fund managers, managing $589 billion (Dh2.16bn), participated in the global survey, while 165 managers, managing $403bn, participated in the regional surveys.

After weakened sentiment in February, investors have restored their faith in equities with a net 46 per cent of asset allocators saying they are overweight the asset class, up from 33 per cent the previous month. However, the asset allocators have retrenched from Europe, the survey says. The net number of European fund managers predicting growth in their own economy over the coming 12 months has fallen to 45 per cent, down from 72 per cent in January. While European sentiment might have been expected to weaken, a similar fall in optimism is also evident among US investors. A net 43 per cent forecast growth in the American economy over the next 12 months, down from 76 per cent in January.

The US and European investors have significantly scaled back their cash allocations. A net nine per cent of the European panel is overweight cash this month, down from 26 per cent in February.

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