THE RISK FACTORS
Any investment carries with it an element of risk. Keeping one’s savings in fixed term deposits may probably be the safest on an investment risk-return continuum, but it, nevertheless, carries with it the risk of negative return when the rate of inflation is higher than the rate of interest return received on fixed deposits, leading thus to the loss in purchasing power per dollar principal to the saver; otherwise known as the inflation or purchasing power risk. Direct investment in the stock market will subject the investor to the specific risk of falling share prices without reprieve offered by the benefit of portfolio diversification or fund management expertise available under collective investment schemes.
A unit trust fund is exposed to a variety of risks by nature of the investment schemes it is engaged in. Where the unit trust participates in stock market-related investments, the following risks become key considerations:
1. Variable factors and not guaranteed: The performance of a unit trust fund is affected by many variables factors and is not guaranteed. These include overall economic and financial market conditions, interest rate fluctuation,stability of local currency, general economic environment and the Manager's capability. And while a track record may provide some insight on future performance, it is by no means guaranteed. The prices of units may go down as well as up. Likewise, distribution may vary from year to year, depending on the performance of the unit trust fund.
2. Market Risk: The purchase of equities represents a risk since the prices of stocks underlying the NAV of the fund fluctuate in response to many factors. Therefore, stock values fluctuate in response to the activities of individual companies, and general market or economic conditions. Such movements in the underlying values of the shares of the investment portfolio will cause the NAV or prices of units to fall as well as rise, and income produced by the fund may also fluctuate.
3. Particular Stock Risk: Any major price fluctuations of a particular stock invested by the fund may affect the NAV and thus impact (adversely or favourably) on the prices of units. This impact can, however, be minimized through the process of portfolio diversification by the fund managers.
4. Liquidity Risk: Liquidity risk is defined as the ease with which a security can be sold at or near its fair value depending on the volume traded on the market. If a fund has a large portfolio of stocks issued by smaller companies, the relatively lower level of liquidity of these stocks can adversely affect the value of the fund. This is because there are generally less ready buyers of such stocks compared with the stocks of larger and more established companies. This risk is managed by taking greater care in stock selection and diversification.
5. Interest Rate Risk: Generally, bond (fund) prices move in the opposite direction of interest rates. If interest rates rise and bond (and bond fund) prices fall, this will lower the value of your investment.
6. Credit Risk: A unit trust fund could lose money if the issuer or guarantor of a fixed income securities, or the counterpart to a derivatives contract, repurchase agreement or a loan of portfolio securities, is unable or unwilling to make timely principal and/or interest payments. Securities are subject to varying degrees of credit risk, which are often reflected in the credit ratings.
7. Manager’s Risk: Poor management of the fund will jeopardize the investment of unit holders through the loss of their capital invested in the scheme.
8. Loan Financing Risk: It is considered inadvisable for unit holders to finance the purchase of fund units through borrowings. The price/value of units will fluctuate with the underlying fund portfolio and unit holders may find themselves faced with the scenario of being forced to provide additional funds to top up on their loan margins when the market goes down, or suffer the higher cost of financing when interest rates trend upwards; both these increase the potential for capital loss. In addition, the returns on unit trusts are not guaranteed and may not be earned evenly over time.
9. Compliance Risk: There is the risk that the Manager and others associated with the fund will not comply with the deed of the fund, the law that governs the fund, or the internal policies, procedures and controls. Non-compliance of the deed, the law, or internal policies, procedures and controls may affect the investment of unit holders.
