AMMAN, 3 November 2003 — Mutual funds or unit trusts are investment vehicles that provide a means of participation in the various stock and bond markets for those who are not capable of managing their own direct investments in these markets either because they do not have the time or they lack the expertise and the knowledge base to do so or if the amount invested is relatively small.
The basic idea of a mutual fund is simple. A large number of investors pool their money in order to obtain the benefits of professionally managed investments that could not have been attained individually. The advantage is that the expertise provided by the managers of the fund would insure greater success than the inexperienced investor could achieve on his own. Pooling funds in unit trusts will also reduce the administrative burden of managing the investment. Furthermore, the investor in a mutual fund is taking a lower risk than someone who is investing directly in the markets, because the greater number of stocks or bonds held in the fund and the diversification of the investment across markets, sectors and instruments reduce the effect that any one of these variables can have on the overall performance of the portfolio.
Most mutual funds have a charging system that consists of an initial subscription fee and an annual management fee. There is no limit on unit charges, even though these tend to be competitive. The common level of initial charge and annual management fee range between 0.5 percent and 1 percent. Some funds, particularly those which invest in a highly specialized markets charge a bit more. There are funds that do not impose an initial charge, instead the subscription fee is included in the price at which managers sell units to the public.
In choosing a fund the investor needs to ask the following important questions:
• Is the unit price of the fund rising or falling?
• Is the fund growing or contracting is size?
• Is the fund achieving its aim, (e.g. increasing income, attaining capital appreciation etc.)?
• How does the fund’s performance compare with the market’s benchmark, e.g. performance of a stock fund in comparison with the stock market index?
• Liquidity, how easy is it to get in and out of the fund?
• What is the track record of the fund and the qualifications of the fund managers?
• How trust worthy is the institution promoting the fund?
Mutual funds tend to be liquid, i.e. investors can enter the fund or sell their holdings in it at the end of every month similar to a fixed monthly deposit with a bank. The price of units in any fund is governed by the value of the underlying securities, fluctuating with movements in market prices of shares and securities in which the funds have invested. The unit price is calculated by dividing the net asset value of the portfolio that the fund holds (shares, bonds, cash, time deposits, treasury bills etc.), either at market value or at amortized cost including accrued income, less expenses (data processing, audit, legal, management fees, etc.), by the total number of units outstanding in the fund.
Of all the decisions one makes in his investing life, the choice of how to divide up his money among financial categories i.e. asset allocation, is by far the most important. Stocks produce the highest returns but they are the most risky, cash generates the lowest returns and it is the least risky, bonds fall in between. Over longer periods, however, the risk of stocks decline. Over a 20 year holding periods, the risk is about the same for the three assets but the returns are considerably higher for stocks. Mutual funds give investors the diversification they are seeking in the most professional way.
Capital guaranteed funds provide the investor with a protection of his capital. But remember there are no guarantees when it comes to investing, and low risk always means low return. Furthermore, protection from market volatility means high fees and often you are required to tie up your money anywhere from three to ten years. But if you are willing to consider such a time horizon for your investments, you are better off having your money in a fund that invests in stocks and bonds rather than investing in a capital guaranteed fund.
Investors do appreciate the advantages of having a more diversified portfolio investment, managed by high caliber professionals who keep themselves abreast of market developments and are backed up by specialized equity research to help them in their daily investment decisions. Good track record of a mutual fund is necessary for future success but is in no way sufficient. Even the best fund managers cannot make money in prolonged bear markets. Investors should, therefore, take a view on the relevant markets where the fund invests before joining a mutual fund. Alternatively, they may choose a diversified fund that invests in a range of instruments including stocks, bonds and deposits.
Today, we have mutual funds managed by Arab banks and financial institutions that target investments in the region’s stocks, bonds and money market instruments dominated in the regional currencies or in US dollars. Such funds are attracting investors who feel comfortable with their money invested in a familiar environment where there is no risk of appropriation, no foreign exchange risk, and no taxes, and where the mutual funds are managed by institutions that they know. These mutual funds are now being governed by regulatory authorities that are gaining more sophistication and have captured the trust of the general public in this respect.
The total size of mutual funds that invests in the Arab region’s stock and bond markets is estimated at around $2.5 billion, with more than three quarters of that in funds directed toward Saudi stocks and government bonds. Regional equity funds own currently less than 1 percent of the total market capitalization of Arab stock markets and less than 0.7 percent of total regional savings. The potential of growth for the regional mutual fund business is huge given that the percentage of total savings directed toward mutual funds in comparable emerging markets regularly exceed 10 percent.
(Henry T. Azzam is chief executive officer at Jordinvest.)
