Oran Hall | What collective investment schemes reports tell us

Collective investment schemes – mutual funds and unit trusts – publish reports on their performance weekly. While the information on the composition of the funds tends to remain unchanged, the prices and performance figures tend to change regularly, but can help investors decide how to invest.

Each mutual fund and unit trust has several investment portfolios, also described as investment funds, which are meant to cater to the varying needs of investors. They are not, however, customised to the specific needs of individual investors, but are often suitable enough to make them worthwhile to the investor either by themselves or in combination with other funds.

It is important, therefore, that each fund is what it says it is, particularly because its composition has a strong bearing on its level of risk and expected return. Further, investors should not be exposed to more risk than they want to expose themselves to by choosing a fund on the basis of its name, only to find that the name does not give a full reflection what of it contains.

There are three basic types of funds in our market – capital growth, bond, and money market – which are further divided into US dollar funds and Jamaican dollar funds.

The capital growth funds, inclusive of equity funds, real estate funds and mixed funds, are meant primarily to give returns to investors based on appreciation in the values of the assets. These funds generally give good returns in strong markets but also give bad returns in weak markets. These are the most volatile funds, but serve as good hedges against inflation.

The bond funds invest in medium to long- term government and corporate bonds, some of which are fixed-rate and some variable-rate. These are meant to grow primarily by the interest earned being re-invested in the funds. The interest is meant to make unit values increase, but the prices of the fixed-rate instruments generally rise or fall if interest rates fall or rise and thus affect unit values.

Money market funds invest primarily in interest-earning securities maturing in a year, although instruments maturing in two years are considered to be money market instruments in some quarters. The returns on these funds are generally lower than those on bond funds, but they are supposed to be more stable as the prices of the instruments tend not to change, except in the case of treasury bills which are issued at a discount and mature at face value, so their value increases daily.

The fund composition column of the report generally states whether the funds invest in equities, real estate or bonds and debentures – fixed-rate or variable rate. While the column shows some funds investing in one type of security, it shows others investing in more than one type.

To get a clearer view of the particular types of instruments in which the funds invest, it is advisable to consult the document called the offering document, the prospectus, or the offering memorandum, which is available online. What it says regarding the instruments a fund invests in can be quite revealing, if not surprising.

While the offering memorandum of some funds makes a general statement about the instruments they invest in, others are far more specific. The information gleaned sometimes shows instruments one would not expect to see in a particular type of fund, for example, equities in a money market fund or foreign currency-denominated securities in a Jamaican dollar fund.

The challenge I have with this is that investors, though getting good returns in a good market, are exposed to more risk than they would expect, thus likely causing them losses in adverse market conditions relating to the securities outside of the core securities they would reasonably expect to be in the fund.

The net asset value, or NAV for short, is the price of the units in a unit trust, and of the shares in a mutual fund. It is not determined by demand and supply as in the case of ordinary shares but by subtracting the liabilities from the assets of the fund, then dividing by the number of units or shares. The buying and selling prices are the same when no selling charges are added to the NAV, but there is generally a lock-in period of up to 90 days, meaning that investors cannot sell the investment during that time. Where this is allowed, they are subject to a charge, generally four per cent.

The 12-month growth rate tells the percentage change in the value of the NAV for that period only. It would do investors well to focus on the performance of their investment from the time they made the initial investment.

The year-to-date return measures the percentage change in the unit or share value from the beginning of the year up to the point at which the calculation is being made.

The yield is an estimate of the annual income the fund earns relative to the value of the fund. In most cases, the income – rent, interest and dividends – is reinvested in the fund. Some fixed income funds, called distribution funds, however, pay some of the interest earned to investors.

It is never easy to compare even funds that have similar names considering how different they tend to be. It is also possible that a fund that does well in one year might not do so in another year. Looking at performance over a few years if the data are available might help in establishing the better funds.

Oran A. Hall, author of Understanding Investments and principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel. Email: finviser.jm@gmail.com