The menu of investment channels competing for clients’ investible funds has been growing progressively. In recent years, aside from traditional time deposits, retail treasury bonds, and the stock market, individual investors have also been putting their money in unit investment trust funds and mutual funds. [In the article “UITFs 101” in the May–June 2007 issue of Philippine Business, the author explained how UITFs and mutual funds work.—Ed.]

take your pick

Basically, there are three types of UITFs and mutual funds: equity funds, fixed-income funds, and balanced funds.

Equity funds are quite straightforward. They refer to funds that are largely invested in equity or shareholdings in publicly listed companies. In other countries, some equity funds do some niche marketing by further subdividing their products into small-cap, medium-cap, and large-cap funds. However, this drilled-down subdivision can be somewhat arbitrary and may vary from one jurisdiction to another.

In the Philippines, there appear to be no clear guidelines with respect to classifying listed companies by market cap. Nevertheless, local equity funds, by definition and in practice, are invested primarily in what are generally regarded as the large-cap Philippine companies.

For the investor with no time or acumen to undertake a comprehensive study of publicly listed stocks, an equity fund is ideal because he can rely on the fund’s professional manager to do the research. The aim of an equity fund investor is to maximize the appreciation of his capital through gains in the prices of individual stocks and any cash or stock dividends declared. One must bear in mind, though, that the risk of capital loss is higher with equity funds than with the other types of funds, especially the more stable bond funds.

Fixed-income funds are invested mainly in short-term (money market) and long-term (bond) funds. Short-term funds are invested in short-term instruments, both government and commercial, that have relatively low risk due to the very short investment horizon (less than a year). Investors in money market funds wish to merely preserve the value of their capital and count on a steady income stream from maturing short-term paper.

Long-term funds, on the other hand, are invested in longer-term instruments, also either government or commercial, that have a higher risk level than short-term funds because of the longer investment horizon. Despite the increased risk, however, investors in long-term funds are assured of higher yields when the bonds held in the portfolio are retired. Treasurers and fund managers in the Philippines almost unanimously agree that government securities are the safest instruments in which to park investible funds because these are direct obligations of the Philippine government.

Why fixed-income funds? Basically, there is a sense of security in fixed-income instruments that is not present in equities. As debt paper, fixed-income securities are IOUs of the issuer, and as such represent a commitment to pay the holder of the securities ahead of other commitments that the issuer may have (to stockholders, for instance, in the case of corporations). This explains why government debt securities have the most favorable rating of any type of debt instrument available on the market—they have the full backing of the government, which has the capability to raise taxes, print money, or make new borrowings in order to meet any debt commitments it makes.

For commercial debt paper, a favorable debt rating assures holders that the corporate issuer will deliver on the promised yield at the date of maturity, making the issuance “investment grade” paper, as opposed to entities that have an unfavorable debt rating and whose papers are classified as “junk.” Junk bonds have to promise higher-than-average yields (and therefore have lower prices on the secondary market) as investors tend to be doubtful of the issuer’s ability to deliver on the debt commitment as evidenced by the bond.

The Trust Officers Association of the Philippines recently adopted the Macaulay duration to help investors determine the sensitivity of the different fixed-income funds to movements in the interest rate. Basically, the longer the fixed-income instrument’s maturity, the longer the Macaulay duration, and therefore the more sensitive it will be to interest rate changes. Generally, investors equate this sensitivity with more volatility in the price of the instrument and would tend to avoid such instruments, driving bond prices down and encouraging a less liquid bond market.

Balanced funds combine the distinct advantages of equities and fixed-incomes, mixing the growth and capital gains of equities with the assured yields and cash streams of fixed-incomes. Ideally, such funds keep half their investment portfolio in equities and the other half in fixed-incomes. In practice, however, many fund managers handling balanced funds have, at any one time, either more equities and less fixed-income papers, or less equities and more fixed-incomes in their portfolios.

Thus, it may be misleading, especially for novice investors, to identify such funds as balanced when in fact they are not. This may be a case of hairsplitting, but in the interest of full disclosure and transparency, some policy reform may need to be pursued in this area.

tracking funds

As mentioned previously, the key advantage to investing in such funds is being able to count on a corps of managers to do the research and decision making on what assets should be kept or discarded from a fund’s portfolio. Most people do not have the time or the inclination to pore over the different types of securities in order to make regular informed and rational investment decisions. With investment funds, you can leave it to the trained experts to make these decisions.

This does not mean, however, that investors should adopt a passive or neutral stance with respect to their investments. Middle-income individuals who would like to boost their incomes, beef up their children’s college fund, or prepare for their retirement should not lose sight of how hard they worked for their money. They should monitor the returns their investments are making, carefully evaluate whether these returns are at par with the returns they were expecting, and consider whether better returns can be had if the money were placed in other investments.

Investors can check various funds’ net asset value per unit (NAVpU) in the business papers like Business World and Business Mirror. They should take time out to carefully read all newsletters, reports, letters, and other communications that they receive from their investment adviser or asset manager. Funds’ annual reports and stockholders’ meetings are also excellent sources of information.

In other jurisdictions, such as the U.S., even the name of the fund manager—the specific person assigned by an investment company to manage a fund—is disclosed in online and printed publications like those of Lipper and Morningstar. The track record of the manager for the fund he is presently managing, and even for any fund he previously managed, can be found there, along with the returns made by those funds for their investors on the standard year-on-year and year-to-date basis. This kind of information is certainly helpful to an investor trying to decide whether an investment is worth making or not.

The Philippines has yet to advance to this level of tracking the performance of funds and fund managers. Given the present size of the local fund market, this activity may not yet be viable here, but in the U.S. and other jurisdictions, the size of the mutual fund industry is able to justify the business case of reporting such information. Nevertheless, this need for transparency should be answered soon. The reason why pooled investments is not taking off faster than it should in the Philippines may be partly because potential investors are unsure of the returns on their investment. Making information more available leads to a more informed decision-making process, which should ultimately expand the industry beyond its present limits.

timing and risk

When to invest is always a tricky question. Ultimately, it’s a question of philosophy — what’s good for the goose may be poison for the gander. Some believe that the earlier one gets in, the better, regardless of the type of investment. Timing is essential if an investor seeks to take advantage of day-to-day price movements and gain on such movements because he is subject to the volatility that is usually found in short-term, especially daily, market movements. One must consider, however, that the gains to be made in such short-term price movements may actually be quite negligible, especially after deducting for taxes, commissions, and other transaction fees. Moreover, frequent transactions (that is, buying and selling) expose the investor to various deductions, and the overall gain could even be negated or, worse, force the investor to make a net payout to the broker or fund adviser.

On the other hand, if an investor is in it for the long term (and that presupposes he will not need the money for the next three to five years at the minimum), then timing should be a non-factor in making the decision to invest. Keeping the investment for a longer time horizon should smooth out fluctuations and allow the investor to enjoy larger and more substantial gains in the long run.

The risks of investing in UITFs and other pooled funds—like the underlying assets that these funds purchase, such as stocks, bonds, and other securities—hinge on the fluctuations of their prices or NAVpUs. Again, it bears repeating that the volatility of daily price movements is less of a factor over a longer investment period. Although there is some debate as to what actually constitutes risk and that volatility does not necessarily translate into risk, the relationship between these two factors is such that a volatile investment (one that would have greater deviations from a pre-set original price level) is generally considered a riskier proposition than a smoother, less volatile one. This is, of course, given that all things—price and yield, among others—are equal.

Other risks also arise from the underlying securities that an investment adviser purchases and adds into a fund’s portfolio. Risks associated with the securities would necessarily affect the overall value-at-risk of the entire portfolio.

It should also be emphasized that while in the Philippines it is the investment banking or securities units of banks that manage UITFs, investments in these funds are not insured by the Philippine Deposit Insurance Corporation. Investors who place money in a UITF may therefore not see any of their invested money coming back, and they cannot turn to the PDIC to get their money back. The loss of the principal is a real possibility.

Reuel Hermoso is an executive assistant at the Bangko Sentral ng Pilipinas assigned to the Monetary Board. The views expressed in this article are solely his and do not necessarily reflect those of the BSP and the Monetary Board