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Monday, August 11, 2008

Eight Principles of Successful Unit Trust Investing

Unit trust investing is a convenient and sensible way to build one's wealth in the medium and long term. Investment specialists will manage the investments and spread the risks through careful diversification. There are eight principles which are helpful to you in making a wise decision in unit trust investing.


What Is A Unit Trust And How Does It Work?
A unit trust is a professionally managed investment fund which pools together the money of investors who have similar objectives. The total sum is then invested in a diversified investment portfolio comprising stocks, bonds and other assets in accordance with a fund’s investment objective. The unit price of a fund is its net asset value (NAV), derived from its assets less its liabilities and divided by its total number of units. Unlike stocks, whose prices are changed at each trade, a fund's NAV is based on the closing prices of the stocks in its portfolio on each trading day.
To protect your rights and interests, an independent trustee will ensure that the unit trust fund manager like us complies with the requirements of the deed, Capital Markets And Services Act 2007, the SC Guidelines and the Securities Commission Act 1993. We also appoint an approved company auditor under the Companies Act 1965 to audit a fund's accounts before we publish the fund's annual report.

What Is A Typical Unit Trust Fund Investors' Profile?
A typical unit trust fund investors' profile would be individuals who/corporations that:
have a similar investment objective as a fund.
are willing to take some form of risk through participation in the stock market and/or fixed income market.
want to hold investments that are liquid and easily redeemed.
want to enjoy a lower transaction cost while investing in the stock market.
want to have a well diversified investment portfolio which is professionally managed.

What Are The General Benefits Of Investing In A Unit Trust Fund?
Diversification - For any given amount of investment return, investment risks may be spread over a wide variety of securities in different countries, sectors and securities for a small investment sum. On your own, this will normally require a large amount of effort and capital.
Professional fund
- A fund's pooled resources makes it cost-effective to engage a team of qualified and experienced in-house investment professionals such as our fund manager. We conduct full-time regular investment research and analysis and make on-site visits to gain greater insights into the investments that a fund holds. We also invest in research facilities and information resources essential for making sound investment decisions.
Liquidity - We stand ready to repurchase all or part of your unitholding on any business day.
Hassle free - It is convenient to buy and sell investment units and you are spared the time, trouble and expense of researching and monitoring investments on your own if you are to invest directly in the stock market.
Affordability - Only a relatively small amount of money is needed to participate in a professionally managed portfolio of investments. For personal direct investments, you will have to invest considerably more in order to have the same reach in investment opportunities and to benefit from the same level of expertise in portfolio management.

What Are The Risks Of Investing In A Unit Trust Fund?
Company specific
This risk refers to the individual risk of the respective companies issuing securities. This risk could be a result of changes to the business performance of the company, consumer tastes and demand, lawsuits, competitive operating environment and management practices. Developments in a particular company in which a fund has invested would result in fluctuations in the share price of that company and thus the value of a fund's investments. This risk is minimised through the well-diversified nature of a fund.

In addition, this risk may occur when an investee company's business or fundamentals deteriorate or when or if there is a change in management policy resulting in a reduction or even removal of the company's dividend policy. Such events may result in an overall decrease in dividend income received by a fund and possible capital loss due to a drop in the share price of a company that cuts or omits its dividend payments. This risk may be minimised by investing mainly in companies with a consistent historical record of paying dividends, strong cashflow, or operating in fairly stable industries.
Concentration risk - This is the risk of a fund focusing a greater portion of its assets in a smaller selection of investments. The fall in price of a particular equity investment will have a greater impact on the fund and thus greater losses. This risk may be minimised by the unit trust manager conducting even more rigorous fundamental analysis before investing in each security.
Country and/or foreign securities risk - This risk refers to the risks of investing in foreign markets. Emerging markets may have relatively underdeveloped capital markets, less stringent regulatory and disclosure standards, concentration in only a few industries, greater adverse political, social and economic risks and general lack of liquidity of securities. The risk of expropriation, nationalisation, exchange control restrictions, confiscatory taxation and limitations on the use or removal of funds also exist in emerging markets. Emerging markets may also have less developed procedures for custody, settlement, clearing and registration of securities transactions. This risk may be minimised by conducting thorough research on the respective markets, their regulatory framework, economies, companies, politics and social conditions as well as minimising or omitting investments in markets that are economically or politically unstable or lack a regulatory financial framework and adequate investor protection legislation.
Credit risk - This risk refers to the changes in financial conditions of companies issuing debt securities, which may affect their credit worthiness. This in turn may lead to default in the repayment/payment of principal and interest/profit. These events can lead to loss of capital, delayed or reduced income for a fund resulting in a reduction in a fund's asset value and thus unit price. This risk is minimised by active credit analyses and diversification by the bond portfolio of a fund.
Currency risk - Investing globally means some assets are denominated in currencies other than in Malaysian Ringgit. Hence, fluctuations in the exchange rates of these foreign currencies may have an impact on a fund's income and asset valuations. Adverse fluctuations in exchange rate can result in a decrease in returns and loss of capital. This risk may be minimised by hedging against foreign exchange rate movements.
Dividend policy risk - This is a risk particular to a fund which has heavy emphasis on high-yield dividend stocks. This risk may occur when an investee company's business or fundamentals deteriorate or if there is a change in management policy resulting in a reduction or even removal of the company's dividend policy. This risk may be minimised by investing mainly in companies with a consistent historical record of paying dividends, strong cash flow, or operating in fairly stable industries.
Expectation risk - This risk refers to the fact that the following circumstances may lessen the prospects for recovery:

- An unexpected serious global economic downturn.
- A company's proposed restructuring plan fails for various reasons.
- Management's inability to turn around the company within a reasonable period of time due to factors beyond their control.
- The initial cyclical nature of the problem has become structural.

Should a recovery situation not turn out as expected due to the above reasons, there may be a loss or reduction of profits/income resulting in a reduction in a fund's assets. This risk may be minimised by a thorough study of potential recovery situations (economic, industry and company specific) taking into account the favourable probability of a positive outcome, risks and returns before making any investment in such situations. Continuous monitoring of developments in potential recovery situations may be conducted to ensure that these pan out as expected.
Futures risk - As futures are conducted on an initial margin basis, a relatively small price movement in a futures contract may result in an immediate and substantial loss (or gain) for a fund. Adverse price movements can create additional losses over and above the initial futures contract costs. This risk may be minimised by entering into futures contracts only for hedging purposes. Specifically, a fund will only enter into futures sales contracts to hedge against declines in the value of stocks in the portfolio.

Futures contracts can play a part in reducing the risk of a fund's investment portfolio by providing a hedge against shorter-term volatility of financial markets. However, futures carry certain additional risks that if not properly managed can result in significant losses or underperformance. These include:

Futures liquidity risk
This category of risk includes:

- Risk that fair price or firm bid cannot be obtained from a market counterpart.
- Risk that funds are unable to unwind illiquid positions.
- Market price stability affecting funds' ability to meet margin payments.
Gearing risk - Futures contracts may involve a high degree of "gearing" or "leverage". This means that a small movement in the price of the underlying asset may have a very large magnifying effect in the price of the futures contracts, both in an upward or downward direction.
Mismatch risk - Risk that arises when the terms of underlying investments and the instrument used to hedge its risks do not match. Such mismatches could be due to:

- Mismatch of derivative parcel size (or multiple of this) versus actual physical portion.
- Mismatch of maturity, e.g. 3-month KLIBOR interest rates futures contract versus 1-year bond holding.
- Mismatch of component constituting an index, e.g. Kuala Lumpur Composite Index (KLCI) vs actual equity portfolio of fund.
Inflation or purchasing
power risk
- This is the risk that inflation or the loss of purchasing power will erode the value of investment returns and the worth of the investment itself. Investor's returns from a fund may not keep pace with inflation and hence reduce their purchasing power.
Interest rate risk - This risk refers to the effect of interest rate changes on the market value of a bond portfolio. In the event of rising interest rates, prices of fixed income securities will decrease and vice versa. Meanwhile, debt securities with longer maturity and lower coupon/profit rate are more sensitive to interest rate changes. Interest rate movements can lead to fluctuations in bond prices resulting in fluctuations in a fund's investments in such securities. In terms of Islamic debt securities, any fluctuations in conventional interest rates will also affect the indicative/profit rates of these Islamic debt securities, hence, will also lead to a rise or fall in prices of Islamic debt securities. This risk will be minimised via the management of the duration structure of the portfolio of debt securities.

The interest rate is a general economic indicator that will have an impact on the management of funds regardless of whether it is Shariah-based unit trust funds or otherwise.
Liquidity risk - This risk occurs in thinly traded or illiquid securities. If a fund needs to sell a relatively large amount of such securities, the act itself may significantly depress the selling price resulting in a decrease in the value of a fund's assets. The fund is managed in such a way that a portion of the investments is in equity securities and money market instruments that are highly liquid and this allows the fund to meet sizeable redemptions without jeoperdising potential returns.
Loan financing risk - This risk must be considered carefully when unit trust investment is financed by a loan. Borrowings increase the opportunity for profit as well as the incidence of loss. Interest cost may rise and investment value may fall, resulting at times in the lender demanding settlement or more collateral from the investor.
Market risk - This risk refers to developments in the market environment, and typically includes changes in regulations, politics, technology and the economy of the country. Market developments can result in stock market fluctuations which in turn affect a fund's underlying investments and hence its unit price. A fund's diversification into different sectors, however, helps to minimise a fund's exposure risk to any single asset class.
Non-compliance risk - This risk refers to the risk that the unit trust fund manager who does not adhere to legislation or guidelines that govern the investment management and operations of a fund or to a fund's investment mandate stated in the deed. This risk also concerns non-compliance with internal operating policies and the unit trust fund manager acting fraudulently or in a manner that is unfair to unitholders. This risk could result in disruptions to the operations of a fund and potentially lead to reduced income/gains or even losses to unitholders.
Participatory note (P-Note) risk - A P-Note is a market access financial instrument that replicates the financial return of an underlying asset - for example, equity securities. P-Notes are issued by financial institutions, can be listed on a stock exchange or unlisted and generally denominated in USD. Investors in P-Notes enjoy the rights to corporate actions including dividends, rights issues, bonus shares and mergers but usually do not come with voting rights. P-Notes are in general issued for securities traded in restricted markets (such as India, Taiwan and China) where there are one or more complicated and time-consuming administrative hurdles such as foreign exchange controls, controlled regulatory environment, local licensing required for securities trading among others. P-Notes bear the risk of the single issuer of the instrument, specifically the potential insolvency of the issuer of the P-Note. This risk will be mitigated by investing in P-Notes issued by a globally renowned financial institution with a good investment grade credit rating by Standard & Poor’s or Moody’s or Fitch or any other global credit rating agency. The P-Note also carries with it risks inherent in the underlying asset which it replicates, such as country and/or foreign security risk, foreign exchange risk and market risk. These risks will be managed by conducting extensive overall market and macro-economic analysis as well as fundamental security research and to spread investments in different sectors to reap benefits of diversification.
Real estate investment trust (REIT)-related risk - The value of REIT can fluctuate up or down depending on market forces, the general financial and real estate markets, interest rate environment among other factors. A fund which invests in REIT will also be subject to the risks associated with direct ownership of real estate, whose values can be adversely affected by increases in real estate taxes, government policy restricting rental rates and other changes in real estate laws and rising interest rates and a cyclical downturn in the real estate market.
Reclassification of Shariah status risk - This risk is applicable to Shariah-based Funds. This risk refers to the risk that the currently held Shariah-compliant securities in the portfolio of Shariah-based funds may be reclassified to be Shariah non-compliant in the periodic review of the securities by the Shariah Advisory Council of the Securities Commission (“SACSC”), the Shariah Adviser or the Shariah Boards of the relevant Islamic indices. If this occurs, the value of the fund may be adversely affected where the Manager will take the necessary steps to dispose of such securities in accordance with the SACSC, the Shariah Adviser and/or the Shariah Board’s advice.
Reinvestment risk - This is a risk that future proceeds (interest/profit and/or capital) are reinvested at a lower potential interest/profit rate. Reinvestment risk is especially evident during periods of falling interest rates where the coupon/profit payments are reinvested at less than the yield to maturity (actual profit rate) at the time of purchase. Such risk may be minimised by purchasing zero coupon (deep discount) debt securities and through duration management.
Timing of asset allocation risk - This is the risk that, given the prevailing economic and financial market conditions, the unit trust fund manager makes the inappropriate asset allocation decisions between equities and fixed income securities, potentially resulting in lower returns to the fund.
Warrants and options risk - Warrants and options are a leveraged form of investment. A movement in the prices of the equity securities of the warrants and options will generally result in a larger movement in the prices of the warrants and options themselves, that is, higher volatility. The geared effect implies substantial outperformance when the prices of equity securities rise. Conversely, in a falling market, warrants and options can lose a substantial amount of their values, far more than the equity securities.

Returns on warrants and options may be nil and a fund may lose a substantial portion of its investments in them. The returns may not reflect those that were realised if a fund had invested in the equity securities rather than the warrants and options.

Warrants and options have a limited life and will depreciate in value as they approach their maturity date. If a warrant’s exercise price remains above the share price for its remaining subscription period, the warrant is effectively “out of the money” and theoretically without value. Warrants that are not exercised at maturity become worthless.

Warrants and options do not participate in dividends or cash flows that accrue from the underlying equity securities.

This risk may be mitigated by conducting extensive fundamental analysis of the warrants’ equity securities to ensure their viability as an investment for a fund. The percentage allocation of warrants held by a fund will generally mirror the allocation of the equity securities, that is, higher when there is an anticipated market rise and vice versa.

How Do Unit Trusts Compare With Direct Investments In The Stock Market And Bank Deposits?
If a person has a very large amount of money to invest directly in individual stocks, he may be able to achieve a sufficient level of diversification. Losses in one or more of his stocks may substantially reduce the value of his portfolio. A unit trust fund, however, has a diversified portfolio and losses in some of the stocks will probably be offset by gains in other stocks. Nevertheless, a person with an undiversified portfolio may reap great returns if one or more of the stocks increase in value. Unit trust prices rise more gradually when some of its stocks rise in price because unit prices are based on the total value of the portfolio. Bank deposits are generally safe with low risk of capital erosion. The returns are however usually lower than investments carrying more risk and may be eroded by inflation more significantly. Unit trusts have historically yielded better returns than bank deposits but such investments carry more risks of loss.
The equivalent Islamic instrument for fixed deposits is General Investment Accounts.

Management Expense Ratio (MER)
MER will inform the investor of the total annual expenses incurred by a fund as compared to its average NAV. Management expenses include management fee, trustee fee and expenses incurred for fund administrative services. A low MER indicates the effectiveness of the unit trust manager in managing the expenses of the fund.
MER = Total annual expenses incurred by the Fund x 100
Average net asset value of the Fund

Performance Indicators/Benchmark
Investors measure the performance of their investments in unit trusts by various means, and very often take into account pure price changes (rise or fall in unit prices) or the amount of distributions received from a fund. The appropriate method of calculating performance is by including both. This performance measure is called total returns as it includes all sources of income and gains (or losses). Investors need not compute these calculations themselves as total returns figures are published weekly in leading financial magazines, local daily newspapers and foreign financial publications, or the websites of the financial institutions concerned. For a better picture of a fund's performance, you may look at both short (three to six months) and longer-term (three and five years) performance figures. Performance benchmarks such as Kuala Lumpur Composite Index (KLCI), FTSE Bursa Malaysia EMAS Index and FTSE Bursa Malaysia EMAS Shariah Index are used to measure the relative performance of equity funds. For global investments, benchmarks such as the MSCI All Countries World Index, MSCI Asia Pacific Ex-Japan Index and the Dow Jones Islamic Market World Index are used. The performance benchmarks for bond funds are the fixed deposit rates or General Investment Account (GIA) rates (one year) as quoted by a major Malaysian financial institution. The performance benchmark for balance funds is a combination of the performance benchmark for equity funds (e.g. KLCI) and the benchmark for bond funds (e.g. fixed deposits rates), in a ratio that reflects the funds’ general asset allocation. For example, a balance fund with a 60% equity allocation mandate would be compared against a composite benchmark comprising a hypothetical investment of 60% in KLCI and 40% in 3-month Kuala Lumpur Interbank Offer Rate (KLIBOR) rates. Other fund categories such as equity and income funds may also adopt composite benchmarks to properly reflect their maximum equity asset allocation ratio.

Who Regulates Unit Trust Funds In Malaysia?
The Securities Commission regulates the establishment and operations of unit trusts in Malaysia under the Capital Markets And Services Act 2007, Securities Commission Act 1993, the SC Guidelines and other relevant securities law. This requires, among other things, that the unit trust fund manager and the trustee create a deed and register it with the Securities Commission. A copy of the deed may be inspected at the unit trust fund manager's office.
In addition, the Securities Commission has placed stringent requirements in the appointment of the unit trust manager, the trustee, the unit trust manager's directors, chief executive officer, investment committee and Committee Members/Shariah Advisers. The appointment of all these parties must be approved by the Securities Commission.

It is conventional wisdom that you should be willing to accept more risk if you are looking for higher return, or be happy with less return at lower risk. There is however some flexibility in planning to meet your needs and preferences. Answers to the following questions can serve as a guide to choosing the most appropriate funds for investment:
What stage of the life cycle am I at now?
What are my investment goals?
What kind of returns am I looking for?
How much risk am I comfortable with?

Most unit trusts work best when taken as an investment vehicle for the medium to long term. Funds selected for investments should be appropriate for your investment horizon, financial goals and risk profile. Attention should also be given to hedging against inflation and achieving a good degree of diversification. Circumstances may change and you should review your strategy regularly.

The power of compounded returns (returns generating more returns) makes it wise to start saving and investing as early as possible. There may still be the risk of decline in the capital value of investment, but a longer investment horizon will certainly give more room for riding out the bad times or the occasional setbacks.

Regular investments have benefited in many cases from the principle of Ringgit cost averaging. Instead of trying to time the market, which even the experts have difficulty achieving, invest a fixed amount regularly especially when such surplus has been budgeted from a regular stream of income. This practice of investing regularly has a tendency to average out wild fluctuations in prices to your benefit.

Historically, unit trusts have provided better returns in the longer term, but have entailed greater short-term risks than other savings vehicles. Your planning and expectations must accordingly be attuned to a longer investment horizon. Unit trusts offer potentially higher returns over the longer term although they do present wider fluctuations in the short run.

Diversification, or spreading your investments among the various fund options can help ride out interim fluctuations. It works because the different asset classes have different fundamental characteristics and can move in different directions. For example, when the economy faces a downturn and interest rates are falling, bonds will usually outperform equities, whereas when the economy is booming, equities will generally outperform bonds. In the long run, diversification increases returns while lowering risks, which is why it is the single most important part of any investment strategy.

Review your investments regularly to ensure that they still reflect your financial goals and personal circumstances. For example, at one stage of your life you might be seeking longer-term investment that focuses on building savings and accumulating capital. Later on, you might prefer a lower-risk investment that places more emphasis on income. Whatever the reason, making adjustments over time is essential and needs to be incorporated into your investment strategy. Through regular monitoring you can ensure that your investment portfolio continues to match your financial objectives.

For investment in Islamic unit trust funds (mutual funds) and other Islamic products in Malaysia, pls contact:
Ahmad Sanusi Husain, Independent Consultant, CIMB Wealth Advisors (CWA) - Islamic Funds
UOA Tower Kuala Lumpur:
e-mail: / Mobile no: +6019-234 8786, +6012-610 0526 / Skype: sanusimy
consultant profile:

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