Having too much choice can be a double-edged sword. On one hand, it presents more options for consumers, but the downside is that it can also be overwhelming for some, with a whole plethora of options to choose from – and this often leads to the consumer then making no choice at all.
The same can be said to picking a unit trust to invest in, what with a whole range of different growth funds, balanced funds, income funds, etc. that you can choose from. However, by following these few simple steps the selection process is actually simpler than you think.
STEP 1: Investment Goals & Risk Tolerance
Before you make any decision to invest, be it in unit trusts, stocks, bonds or other money market instruments – you need to fully understand your investment goals and determine why you're investing in the first place
Is it to generate a steady stream of income or long-term capital gains? Capital preservation or growth? Are you trying to save enough to put your three adolescent kids through college? Or is it a major trip around the world with your newly-betrothed, because you promised her one when you proposed?
Well, the list goes on and sometimes it can include one or more of the objectives listed above.
This is then closely correlated to your risk tolerance, which is the level of risk that you are willing to take for your investments. Can you stomach large substantial swings in your portfolio? Or do you prefer to play it safe and employ a more conservative approach?
Mapping out your investment goals and risk-level, will help you determine which fund suits your needs best.
STEP 2: Income, Growth, or Balanced?
An investor with a higher appetite for risk will pick more aggressive growth funds which aims to generate long-term capital appreciation through a diversified portfolio. It typically consists of fast-growing stocks that are expanding quickly, and has the potential to deliver higher returns.
Alternatively, income funds are focused on providing regular income streams through investments in fixed-income securities.
However, investors today don’t have to settle for either just growth or income. They can also choose both by investing in a balanced fund, which typically consists of a mixture of both equities and fixed-income instruments.
STEP 3: Evaluating a Fund’s Performance
It is also important for investors to evaluate how well the fund has performed in terms of the quality of the returns and if it was consistent with average market returns.
In this instance, investors would then have to review the fund’s past results and how well it has performed under varying market cycles. Did the fund consistently outperform the stated benchmark? And for income funds, were portfolio yields stable and income distribution history competitive with peer funds?
With that in mind, past performance is still no guarantee of future results. Thus, investors should also read up carefully on the fund’s prospectus to better understand its strategy, as well as its sector allocation and fund holdings. Most importantly, the fund must demonstrate a sound investment process which can be defined and easily understood.
In some cases, it may be worth uncovering the portfolio manager(s) behind the fund. Portfolio managers with a solid track record, who follows a stringent securities-selection process to deliver alpha are widely regarded in the industry.
STEP 4: Charges and Fees
Investors should also pay attention to the different types of fees that may be charged for various transactions. Common fees typically incurred include:-
Initial sales charge/front-end load
Covers the cost of marketing, distributing, and monitoring of unit trust funds by the unit trust consultant for the duration the unit trusts is held
Management & Trustee Fees
Covers fees for portfolio management, trustee & custody expenditures, audit and administrative fees
Incurred when an investor switches unit trust from one category to another
Incurred when disposing or exiting a unit trust fund
However, most asset managers have already waived their switching or exit fees, and is applicable only to certain funds.
The key takeaway is that investors should pick a unit trust that is cost-efcient, by paying attention to the management expense ratio (MER) which is contained in the prospectus. A higher MER indicates that the fund costs more to run, which could put a drag on an investor's returns.
STEP 5: Measuring Volatility
Whilst, it is important to assess a fund’s relative or absolute performance – the selection of funds should also consider the volatility of those returns.
In the Malaysian-context, financial analytics firm Lipper provides both the fund’s volatility factor (FVF) and Fund Volatility Classification (FVC) to guide investors in their selection process.
The FVF provides a standard deviation measure of a fund’s returns, which is calculated against the annualised returns of the fund over a three-year period. A fund with a higher FVF indicates that its returns have fluctuated widely against its annualized returns. In contrast, a fund with a lower FVF signifies that its returns are less volatile.
In the example above, the FVF value is 1.8, which means that there is a possibility for the fund to rise and fall around 1.8% relative to the annualised return.
The fund also has a classification of ‘Low’, which suggests that the fund resides in a lower risk-band and may be using less aggressive growth strategies to achieve those returns. There are 5 different FVC classifications including ‘Very Low, ‘Low’, ‘Moderate’, ‘High’ and ‘Very High’.
Knowing is Half the Battle
Understanding fund volatility is important as it guides investors in selecting funds which fits their risk-profile and provides a useful gauge to determine the potential volatility of those returns and how much it has fluctuated in the past.
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