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Monday, December 31, 2012

RISK OF INVESTING IN UNIT TRUSTS

All investments carry some form of risk. It is important to note that when you invest you should be prepared to accept a degree of risk, as most investments are affected by ever changing market conditions, some of which impact positively and some negatively. Therefore, no matter how experienced an investment manager may be, certain factors, which will affect the value of investments, may be beyond their control. So, the value of your investments may go down as well as up. One should consider the following when investing in a unit trust fund: -
Stock or Bond Market Risk
For a unit trust that has stocks or bonds in its portfolio, fluctuations in the market performance due to factors such as fluctuation in interest rates, changes in economic climate, political and social environment that will affect the stock or bond market as a whole, will also affect the value of investment either in a positive or negative way.
Individual Stock Risk
The performance of a fund that invests in stocks is affected by every individual stock that the said fund has invested in. The volatility of prices in each stock will affect the fund's value daily.
Compliance Risk
This is the risk that the manager and others associated with the scheme will not follow the rules set out in the scheme’s constitution and internal policies, or the law that governs the scheme, or will act fraudulently or dishonestly. However, this risk is greatly reduced via stringent internal controls and constant cross-departmental checking employed by the manager. In addition, a yearly or any unscheduled internal audit exercise will be conducted to check any compliance matters that might have been inadvertently overlooked by compliance department. The presence of the trustee whose duty is to ensure that the fund's investment mandate is complied with will further add to the reduction of such risks.
Inflation Risk
Ideally the purpose of any investment is to secure returns that are greater than the inflation rate. While a fund will constantly seek to maximise returns and exceed inflation rate, it may occasionally experience losses, which result in returns that will not keep pace with inflation in the short run.
Liquidity Risk
The various securities that are purchased by a fund may encounter liquidity risk. Liquidity risk relates to the fund's ability to quickly and easily trade, at a reasonable price, in and out of positions. Should a fund comprise a security that has become temporarily or permanently illiquid or difficult to sell, the investment manager may need to sell the security at a discount to its fair value, which eventually affects the fund's value.
Management Risk
Performance of the fund depends on the experience, expertise, knowledge and investment techniques of the investment manager. Poor management of a fund can cause considerable losses to the fund, which in turn may affect the capital invested.
Institutional Risk
The risk that the institution, which operates the fund, will collapse.
Returns Not Guaranteed
As a result of market risks, the manager is unable to guarantee the distribution payout to unit holders or the investment returns of the fund. However, the manager will take reasonable steps to ensure that this risk is minimized through a prudent investment approach, which is centred on fundamental stocks and market analysis.
Loan Financing Risk
Investors who take end-financing loans to purchase units in a unit trust fund must be prepared to accept gearing risks as the prices of the units can go down as well as up. The investor may be required to top up the difference in the event the unit price goes below the margin of advance.
Interest Rate Risk
Fixed income securities and bonds are particularly sensitive to movements in interest rates. When interest rates rise, the value of fixed income securities and bond prices fall and vice versa, thus affecting the NAV of the fund. The general interest rate of the country may affect the value of the investment even if the fund (e.g. Syariah fund) does not invest in interest bearing instruments.
Credit/Default Risk
Credit risk refers to the possibility that the issuer of a fixed income security or bond may not be able to make interest payments or repay the principal in a timely manner. This will translate to losses that will reduce the value of a fund.

Currency Risk
Currency risk is also known as foreign exchange risk. It is risk associated with investments that are denominated in foreign currencies. When the foreign currencies fluctuate in an unfavorable movement against Ringgit Malaysia, the investments will face currency losses in addition to the capital gains/losses. This will lead to a lower NAV of the fund.
Country Risk
The foreign investments of the fund may be affected by risks specific to the country, which it invests in. Such risks include changes in a country economic fundamentals, social and political stability, currency movements and foreign policies etc. These may have an adverse impact on the prices of securities of listed companies.

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