In the first part of this series, I started by reiterating the fact that there is strength in unity: the primary reason for which a solitary tree can be broken by the wind. A forest, however, is able to withstand strong winds by sharing the load of the wind strength among all the trees. I do repeat that here for a very good reason: Collective investment schemes operate on this basis. Here, Unit Trust Funds are the focus.
Unit Trust Funds
Whereas mutual funds are incorporated entities, unit trusts are unincorporated. Under the Securities Industry (Amendment) law, Act 590, unit trusts are open-ended funds. This means their managers stand ready to issue new units or redeem outstanding units continuously. The investors are referred to as unitholders. The beneficiary interests in the fund are divided into and represented by units. A unit trust does not have a board of directors; instead, it has a trustee or a board of trustees and a trust deed to govern the funds.
The trustee is the legal owner of the assets of the fund. They hold them in trust for the investors of the fund. The trustee oversees management of the fund manager in respect of the unit trust to ensure compliance with the trust deed. A trustee can also be a unitholder but not the sole unitholder. The trust deed is a contract document between the trustee and fund manager that outlines the purpose of the trust, the rights and obligations of the trustee(s) and unit holders, powers of the trustee, and identifies various parties such as initial unit holders & Trustee(s).
All CISs can also be categorised according to what they are set up to do and what they invest in. For instance, there are balanced funds, money market funds, equity funds, fixed income funds, income funds and index funds. These funds may be mutual funds or unit trusts.
Money Market Funds
A money market fund, as the name implies, invests in short-term (up to one year) fixed income securities. These are usually government issues like Treasury bills and quasi-government issues like cocoa bills, certificates of deposits of financial institutions like banks and savings and loans companies, commercial papers of corporate bodies and bankers’ acceptances. They are generally safe, but with low potential return compared to other types of funds. Yet still, they may offer liquidity and capital preservation, at a minimum. Investment returns are likely to be always slightly above the rate of inflation, so the real return is positive. Investors who have short investment horizons and have capital preservation as a priority over high return may find these funds suitable for their needs.
Fixed Income Funds
These funds invest in securities which offer a fixed rate of return. Securities such as government bonds, corporate bonds and, at times, preference shares that pay out steady dividends and income all qualify for investment by fixed income funds. The objective is to provide income to subscribers on a regular basis from the interest payments of securities the funds are invested in. Though these funds may not necessarily be dividend-paying, subscribers can take advantage of the high liquidity to make withdrawals as and when the need arises.
Income funds are very much like fixed income funds. The difference is that they are not limited to only fixed income securities. They may invest in equities that have high dividend yields or have a history of strong dividend payout ratios. These would include preference shares and common shares. Again, the objective is to provide income to subscribers. Not all funds can pay out dividends, and are not required to do so. In other jurisdictions, however, all funds are required by law to distribute their accumulated dividends at least once a year. This may be done through the issue of more shares to subscribers or through cash payments.
These funds invest in shares. The funds are susceptible to the volatilities stocks usually experience, so are riskier than funds that invest in fixed income securities. The flipside to that is these funds have a higher returns potential to reward investors who purposely take on the additional risk the funds pose. Equity funds may specialise by restricting investments in particular categories of equities. For instance, a fund may be a growth fund which invests in equities with high growth potential; an income fund invests in equities that regularly pay high dividends; large-cap/mid-cap/small-cap funds invest in shares of large capitalisation/mid-sized/small companies; value funds invest in shares of companies which appear to trade at a lower price relative to its fundamentals, etc.
These funds invest in a defined mix of shares and fixed income securities. The mix is spelt out in their asset allocation strategy. Some balanced funds may be aggressive (with a larger share of equities) or conservative (with a smaller share of equities), or have equal weighting of equities and fixed income securities. Some balanced funds may initially invest in a conservative mix, then plough interest earnings from their fixed income securities into equities. That way, a significant portion of initial principal investments are insulated from large erosion of value from a bearish stock market.
These are funds that aim to replicate the performance of a specific index. They therefore exhibit market risk only. In Ghana, for example, we could have a fund that tracks the GSE indices: Composite and Financial Stocks Indices. Index funds are passively managed, and usually have lower fund manager fees compared to other funds. Just as there are thousands of indices globally, there are also many index funds that track them. Despite diversification across the specific market they operate in, these funds may have wide swings of returns – just like the market indices they track. Investors usually invest in different indices to further diversify across different markets.
These funds invest specifically in real estate, commodities or selective areas like socially responsible ventures. There are three broad types:
- Thematic – Invests in groups of stocks with certain themes; e.g. renewable energy stocks, ethical stocks,
- Sectoral – Invests in particular sectors of the economy; e.g. energy sector stocks, real estate/construction sector stocks,
- Regional – Invests in specific geographical accounts offshore; e.g. sub-Saharan stocks, EMEA stocks, Latin-American stocks.
These are funds which invest, in turn, into other funds. For this reason, their asset allocations are wide and well diversified, and their risk profiles are lower than other types of CIS funds. They are also referred to as multi-manager investment funds. The risk inherent in such funds is minimal, but they tend to have higher expense ratios. Some fund of funds may invest in funds managed by the same company that manages them and are categorised as ‘fettered’. Others invest in funds managed by companies other than the company that manages them. Those are referred to as ‘unfettered’.
It is important for investors in any CIS to be actively involved in how the funds they are invested in perform or are managed. In our next piece, we shall look at what subscribers of such funds should do to keep an eye on how their investments fare in these funds.
About the Writer
He was recently the resource person of Metro TV’s business show Bottomline, where he shared thoughts on Goal-Setting for 2022 from the perspective of financial planning. Through his writings, Kwadwo has discovered his love and knack of simplifying complex theories spicing – them with everyday life experiences for the benefit of all.
Kwadwo Acheampong, as Head of OctaneDC Research, has over the years garnered much experience in fund management and administration, portfolio management, management consulting, operations management and process improvement. Feel free to send him your feedback on his article. Kwadwo at [email protected] or call him on +233 244 563 530