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An
investor’s guide
to mutual funds

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An investor’s guide to mutual funds


MONEYܜÀŽÃÊGuides
Published by: Rasalmal Financial Publishing FZ-LLC #HAPTERS
About this guide
A Dubai Media City Company
P O Box 10656, Dubai, UAE
Tel.: +9714-391 2160, Fax: +9714-391 2173
Email: info@moneyworks.ae 06 NBAD AGM
An interview with Nazem Al Kudsi
Board of Directors
Saud A. Al Amri - Chairman CIO, NBAD Asset Management Group The term mutual fund seems to be surrounded by a level of
Abdulaziz Al Mashal
Greg Hunt Profiles of key figures at the NBAD mystery and confusion that it really does not deserve. As such,
Asset Management group
General Manager: Don Taylor I’ve tried to explain, in simple terms, what a mutual fund is,
Distribution 14 What is a mutual fund? how it works and what it can be used for. I have also tried to
Dar Al Hikma, Dubai, UAE, Tel: +9714-266 7384
Jashanmal, Abu Dhabi, UAE, Tel: +9712-673 2327 It makes sense to start at the beginning. explain risk versus reward, the effect of time and the benefits of
What, exactly, is a mutual fund?
Printing diversification in relation to investing in mutual funds to try and
Nabeel Printing Press, Ajman, UAE
Tel: +9716-743 4445 20 Mutual Funds: offer a clear understanding of how best to use these products.
• A History • Types • How they work I hope that after reading this guide, a potential investor
Group Editor: Utpal Bhattacharya

Deputy Editor: Ehab Heyassat 30 The rewards for risk will have a much better idea of what they are putting their
Sub Editor: Kara Sensoli When it comes to investing, risk and money into, why it is useful to them and how to look after
Operations Manager: Tim Elliott
reward are inextricably entwined the funds going forward.
Design & Layout: Zak Parayil, Sonia Landoulsi 40 How & why to diversify As a regular contributor to MONEYܜÀŽÃ, and a financial
Administration: Sessie Fernandes, Rolla Daniel Diversification is so absolutely critical consultant by training and profession, I hope I’ve managed
in any financial portfolio to shed some light on the mysterious world of mutual funds.
Sales & Marketing Manager: Mark Freeman

Sales & Marketing Executives: 42 Who rates the funds? As always, feedback and comments are gratefully received.
Zarko Ackovik, Ali Jaber, Arshad Malik
Mutual fund performance is Please feel free to get in touch via info@moneyworks.ae.
Advertising Enquiries: UAE: Tel. +9714-391 2163 independently assessed and analysed
Email: sales@moneyworks.ae

Advice to readers - Information carried inÊ 46 Shari’ah Compliance James Thomas


MONEYܜÀŽÃÊGuides is checked for accuracy, but we
recommend that you make enquiries and, if necessary,
How mutual funds can work within Project editor
take appropriate advice before entering into any the framework of Shari’ah
transactions. Never forget, investments can go down as
well as up, and you may get back less than you originally
invested. Companies offering financial services, products
50 Funds across the GCC
James Thomas is a Dubai-based financial consultant and currently works for a UAE Central Bank-licensed and
or advice in the UAE must be licenced accordingly. If in The GCC mutual fund industry will regulated wealth management firm. He has been in the financial planning and advisory industry for 10 years – six
doubt, check with your local Chamber of Commerce or
Department of Economy. be worth US$160 billion by 2010 in the UK and four in the UAE. He is a holder of the Advanced Financial Planning Certificate.

All rights reserved in respect of all articles, drawings, 52


photographs, etc, published inÊMONEYܜÀŽÃÊGuides Fund Terminology
anywhere in the world. Reproduction or imitations What’s the difference between multi- Information carried inÊMONEYܜÀŽÃÊGuides is checked for accuracy, but we recommend that you make enquiries
of these are expressly forbidden without the written
permission of the publishers. manager and fund of funds? and, if necessary, take appropriate professional licensed advice before entering into any transactions. MONEYܜÀŽÃ
Guides are not meant to offer advice, nor are they a promotion of any particular service proposition. MONEYܜÀŽÃÊ
© Rasalmal Financial Publishing FZ-LLC 2008 Guides are intended ONLY to offer impartial financial information to assist with informed financial decisions. Careful

ThisÊMONEYܜÀŽÃÊGuide is a free supplement ofÊ


57 Financial Terms independent research is essential before making a financial commitment. Never forget, investments can go down as well
as up, and you may get back less than you originally invested. Past performance is no guarantee of future performance.
MONEYܜÀŽÃÊMagazine, April 2008. Mutual funds terms explained

2 Investing in Mutual funds Investing in Mutual funds


NBAD Asset Management Group An Interview with the CIO

of the forty five strong team are undertakes extensive market,


now committed to research, the industry and equity knowledge
An interview with
aim being to gather as much acquired through extensive primary
Nazem Al Kudsi, CFA
Chief Investment Officer information as possible for the and secondary research; AMG
NBAD Asset Management Group benefit of clients. Therefore, we undertakes fundamental, macro,
are operating in a pure buy-side technical and quantative research.
research platform only. We have strengthened the research
NBAD has recently cultural, multi-talented group of There has been a drive capability through the hiring of
restructured it asset people from all corners of the towards an ethical, detail-based, a technical analyst, quantitative
management business. Please globe, but we all share similar professional form of asset analyst and a number of specialised
can you elaborate on this? values and we have the same management – setting NBAD apart equity analysts.
What changes have been made mentality. There must be real from other banks in the region. 3. International Compliance
in products, direction, plans? team effort – it’s vital for people The client is the number one Standards – AMG has introduced
Since I have joined NBAD Asset to really feel they are part of the priority, ahead of short-term gain to the business a dedicated
Management Group (AMG) in family and value one another. It and profits. We had to change the Compliance Officer with local
February of 2007, there have been is this sense of closeness that the culture of the organisation. and international experience and
some major developments. In a Asset Management Group aims to Foundation blocks have already qualifications.
matter of 12 months, the number transmit to NBAD’s clients. been put in place to strengthen the 4. Flexible Product Range
of people working in the division Our clients are our main delivery of existing services and – A number of new retail and
has rocketed from just eight to forty responsibility and we need to identify new areas for growth and institutional products will be
five. And with talent being brought understand their needs. When development: launched towards mid to end of
in from around the globe, an ethos I arrived there was a lack of 1. Fund and Portfolio 2008 to ensure coverage across the
of teamwork and co-operation has knowledge in some quarters, so I Management - Recruitment of UAE and MENA regions.
forged what I would call a “family said we have to roll up our sleeves. new fund management staff with 5. Customer Relations &
atmosphere. It’s very important that our clients both regional and international Business Development Team
We have people from the UAE, value and trust us: in this way we experience. Recruitment of – recently developed as part of the
Egypt, Jordan, India, Turkey, can continue to move forward. The dedicated traders to ensure best core AMG team to ensure that the
Lebanon, the US, UK, Ireland focus of the division has shifted execution of deals in the market. customer is at the centre of our
and China. We are a multi- towards research. Eleven members 2. Research Function – AMG business.

6 Investing in Mutual funds Investing in Mutual funds 7


We are determined to build up outstanding YTD performance and different investment options to rates, continuing inflows of foreign
the professionalism of the AMG numbers with our UAE Growth our customers. institutional investors and relatively
team; four members of staff are Fund, the best performing fund low PE ratios.
CFA charterholders, with a number in the UAE with a performance How is the fund environment
of level II and level I candidates. of 62.97 per cent (beating the in the UAE currently? Considering the exponential
Senior Managers within AMG benchmark by 18 per cent). UAE The UAE markets, just like so growth in financial services in
have over 105 year’s experience of Trading fund came in second many emerging stock markets the UAE in recent times, what
the asset management business. with a performance of 60.31 before, have undergone a period do you think we can expect to
per cent (beating the benchmark of exuberance followed by a see in the funds arena over the
What are you now offering by close to 16 per cent). UAE sharp and painful decline. Many medium term?
your customers? Distribution Fund came in third investors were severely hurt and We will continue to see that
The National Bank of Abu with a performance of 59.23 per are still suffering massive losses. investor needs are changing
Dhabi Asset Management Group cent (beating the benchmark by However, again just like many stock as they are becoming more
is currently the largest local mutual close to 15 per cent) and the UAE markets before it, the markets will sophisticated. We will also
fund manager in the country, Islamic Fund “Al Na’eem” had a recover over time. The underlying continue to see new international
supporting assets of approximately performance of 40.43 per cent economic fundamentals are strong players emerging, which will
AED7.5 billion, as of February 08, (beating the benchmark by close and the companies are reporting provide a bigger variety of funds
and providing investment expertise to 7 per cent).Year to date, three of healthy growth. In fact, in a in the market place.
through managing five regional the four funds I just mentioned are regional context, the UAE markets
funds, five offshore funds and ahead of the benchmark. are cheap and present a window of Is there anything else you wish
numerous portfolios for a range of opportunities to long-term investors to communicate?
institutional investors and high net Do you have any new product who are looking to participate in We want to be the first-stop shop
worth individuals. launches planned? the development and growth of one for investors in the MENA region.
AMG has recently launched of the fastest growing countries in This is a great challenge, but things
How are your funds it new offering: NBAD GCC the world. look positive in this region. Geo-
performing? Opportunities Fund “AJAJ” in The UAE has entered an era political and economic factors are
In 2007, our fund swept gold, February 2008. A number of new of unprecedented growth. Our all converging to make this region
silver and bronze in terms of retail and institutional products positive outlook on the UAE market very exciting. People often say this
performance. Our portfolio will be launched towards the mid is based on strong Corporate region is volatile, but where there
management and research team to end of 2008 to complement the Earnings, major projects in is crisis there is also wonderful
was able to put together some product range and offer flexibility pipeline, high oil prices, low interest opportunity.

8 Investing in Mutual funds Investing in Mutual funds 9


NBAD Asset Management Group Key Figures in the Group

Nazem Al Kudsi, CFA David Sanders, CFA


Chief Investment Officer, AMG, NBAD Senior Fund Manager, AMG, NBAD

Nazem Al Kudsi, CFA - Chief Investment David Sanders, CFA – Senior Fund Manager,
Officer, AMG, NBAD. Mr. Kudsi is a CFA AMG, NBAD. Mr. Sanders is a CFA charterholder
charter holder and was awarded an MBA and was awarded an MBA in Finance from
from Brigham Young University. Before Brigham Young University. Mr. Sanders
joining AMG as CIO, Mr. Kudsi has held graduated Summa Cum Laude with a BA from
numerous senior positions with Abu Dhabi BYU in Japanese. Before joining AMG as a Senior
Investment Authority (ADIA) and was also a Fund Manager, Mr. Sanders has worked with Abu
member of the select Asset Allocation decision Dhabi Investment Authority (ADIA) and with
making body within ADIA Procter & Gamble as a Fund Manager.

Derek Hong, CFA Giyas Gokkent, PhD


Senior Fund Manager, AMG, NBAD Director of Research, AMG, NBAD

Derek Hong, CFA – Senior Fund Manager, Giyas Gokkent, PhD- Director of Research.
AMG, NBAD. Mr. Hong is a CFA charterholder Dr. Gokkent was awarded his PhD from the
and was awarded an MBA from the Stanford Florida International University and a BA
University Graduate School of Business. Mr. from the University of Florida. Dr. Giyas is a
Hong graduated with a BS from the United recognised expert in regional economics and
States Air Force Academy. Before joining AMG the banking sector and has been interviewed
as a Senior Fund Manager, Mr. Hong has on global financial news networks. He worked
worked with ADIA, Allstate Investments and with Garanti Bank in Istanbul and Volkswagen-
Aegon Affiliate as a Fund Manager. Dogus Finance Company.

10 Investing in Mutual funds Investing in Mutual funds 11


THE BASICS What is a mutual fund?
It makes sense to start at the beginning. What, exactly, is a mutual fund?

T he term mutual fund is an


American term and originates
from the idea that these investments
with the fund’s objectives. The mutual
fund will employ a fund manager, who
is responsible for investing the pooled
were for the mutual benefit of all money into specific investments (e.g.
who invested. The British call stocks or bonds). The combined
these investments unit trusts, while holdings the mutual fund owns are
Europe refers to them as open-ended known as its portfolio of assets.
investment companies (OEICs). They When you invest in a mutual fund,
are all basically the same thing, albeit you are buying shares (or portions)
with local variations. of the mutual fund and thus become
The general concept of a mutual a shareholder or unit holder of the
fund is a financial vehicle that fund. Each share/unit represents an
allows a group of investors to investor’s proportionate ownership of
pool their money together with a the fund’s holdings and the income
predetermined investment objective. those holdings generate.
The main benefit of this concept is For example, if an investor had
greater security and better economies US$1,000, it would barely be worth
of scale than if investors had invested investing directly in the stock market,
directly in company shares. due to the costs involved in actually
The investors’ money is pooled buying, holding and then selling
together within a legal framework, that stock. If, however, he or she put
usually a trust, which gives the fund US$1,000 into a mutual fund with
its legal status and protection. The many other investors, then the pot
investors will employ a board of of money that accumulated could
trustees, whose sole job is to safeguard be invested in company shares by
the investors’ assets and ensure that investment managers much more
the fund is managed in accordance effectively.

Investing in Mutual funds 15


There are many fund managers,
from large managers (such as Black
Rock/Merrill Lynch, Fidelity
Investments and HSBC) through to
much smaller specialist managers,
which aim to increase the value of
the portfolio so that investors see the
value of their investment rise. Fund
managers buy and sell shares from
around the world and concentrate,
for example, on income, growth, or
income and growth. Other areas in
which unit trusts and OEICs might
specialise include emerging markets,
Japan, Europe, the US, international
growth, special situations and
property. Funds are usually valued The various laws also dictate how a (i.e. issues new shares, cancels ended investment companies and
at around US$5 million – US$300 mutual fund is structured: redeemed shares and distributes investment trusts.
million, though some can be worth - There must be a custodian dividends and capital gains to the
billions. whose functions include shareholders). Mutual Fund
Mutual funds are arguably safeguarding the fund’s assets. This - The investment adviser, which is There are some traditional,
one of the best investments ever is the role of the trustee within usually the same as the management distinguishing characteristics of
created because they are very cost a unit trust fund. The custodian, company, is in charge of the fund’s mutual funds.
efficient and very easy to invest in. which is usually a bank, will provide portfolio. The investment adviser For one, investors purchase mutual
By pooling money together in a payment when securities are bought makes the buy and sell decisions of fund shares from the fund itself
mutual fund, investors can purchase and receive payment when securities the fund and is usually paid based on instead of from other investors on a
stocks or bonds with much lower are sold. a percentage of the fund’s assets. secondary market, such as the New
trading costs than if they tried to - The transfer agent, which may To give a better understanding York Stock Exchange or Nasdaq
do it on their own. But the biggest or may not be the same institution of the general names given to these Stock Market.
advantage to mutual funds is as the custodian, administers investments, I will describe them as The price that investors pay for
diversification. shareholders’ account records mutual funds, unit trusts, open- mutual fund shares is the fund’s per

16 Investing in Mutual funds Investing in Mutual funds 17


share net asset value (NAV) plus in contrast to unit trusts, there is no
any shareholder fees that the fund bid/offer spread with OEICs, so the
imposes at the time of purchase. price of the shares should be the same
Mutual fund shares are whether you are buying or selling.
“redeemable”, meaning investors
can sell their shares back to the fund. Investment Trust
Mutual funds generally create and For completeness, I have included
sell new shares to accommodate new a fourth variation of a mutual
investors. In other words, they sell their fund, known as an investment trust.
shares on a continuous basis, although This vehicle is similar to the types
some funds stop selling when, for mentioned above, but is set up
example, they become too large. differently and in a number of ways.
Firstly, it is a company quoted on the
Unit Trust London Stock Exchange that invests
Unit trusts are open-ended, which its shareholders’ funds in the shares of
means that the trust can issue new other companies. They enable private
units in response to demand. This by the trustees. These managers make London Stock Exchange and use the investors with limited funds to get
means that unit trusts trade at their annual charges. Every day, the trustees money raised from shareholders to diversified share ownership without
net asset value – that is, the value of compute the value of the trust, divide invest in other companies. Unlike incurring heavy dealing costs.
their underlying assets divided by the it by the number of units in issue and investment trusts, they are open- Unlike unit trusts, investment
number of units in issue. produce a bid and offer price based ended, which means that when trusts are closed-end funds; that is,
Different trusts have different on that calculation. demand for the shares rises, the there is a fixed number of shares in
investment objectives. Some invest manager just issues more shares. circulation, and the price of those
for income, some for growth. Some Open-Ended Investment With an investment trust, if demand shares is determined like other
invest in small companies, some in Company (OEIC) exceeds supply, the response may be quoted shares – by supply and
large. Some invest in the UK, some OEICs are hybrid investment funds a rise in the share price. demand. As such, investment trust
in other territories. As an investor, that have some of the features of an The price of OEIC shares is shares often trade at a discount to
you can choose the trust that matches investment trust and some of a unit determined rather differently; more their NAV (i.e. the value of their
your interest and objectives. trust. like a unit trust, in fact, with the underlying investments), and it also
Investment decisions are made by Like investment trusts, OEICs are key factor being the value of the makes investment trust shares more
professional fund managers appointed companies that issue shares on the underlying assets of the fund. But, volatile than unit trust prices. MW

18 Investing in Mutual funds Investing in Mutual funds 19


Mutual Funds: A History
Mutual funds have come a long
way since the first one in 1924.

T he concept of mutual funds


originated in the United
Kingdom. English and Scottish
investment companies (or trusts, as
they were known) helped finance
the American economy after the
American civil war. They did so
by investing in farm mortgages,
railroads and other industrial
companies.
The first modern, open-ended
investment company (mutual fund)
was Massachusetts Investors Trust
founded in 1924 (it is still operating
today). Many other funds followed, In addition to the federal statutes, association of investment Also, mutual funds must provide
until the stock market crash of 1929. most states have adopted their own companies in the US, with potential investors with a current
The first unit trust was launched in regulations governing mutual funds. combined assets of US$12.356 prospectus. The prospectus must
the UK in 1931. With renewed confidence in the trillion. By comparison, in the contain information regarding the
Because of the abuses that stock market, mutual funds began UK at the end of 2005, a total of fund’s management, its investment
occurred in the stock market during to blossom. By the end of the GBP350 billion (or US$700 billion) objectives and policies, fees and
the 1920s, several major legislative 1960s, there were approximately was invested in the 2,000 or so unit other information. The laws also
acts were enacted. Among them 270 funds with US$48 billion in trusts and OEICs in existence. limit what a mutual fund can state
were the Securities Act of 1933, the assets in the US. As of October These laws require, among in its advertisements. These laws,
Securities Exchange Act of 1934, the 2007, there were 8,015 mutual other things, that a mutual fund as well as more recently enacted
Investment Advisers Act of 1940 and funds belonging to the Investment be registered with the SEC and legislation, serve to protect the
the Investment Company Act of 1940. Company Institute, the national meet certain operating standards. individual investor. MW

20 Investing in Mutual funds Investing in Mutual funds 21


Mutual Funds: Types
When it comes to mutual funds,
there are plenty to choose from.

T here are many different types


of mutual funds, with widely
varying objectives. The objective is
set in documents governing the fund
and must be adhered to by the fund
manager.
called equity funds). Each type has been lower than for either bond or invests in will depend on its focus, but
Different Types of Funds different features and different risks stock funds. That’s why inflation risk investments may include government,
When it comes to investing in and rewards. Generally, the higher the – the risk that inflation will outpace corporate, municipal and convertible
mutual funds, investors have literally potential return, the higher the risk and erode investment returns over bonds, along with other debt securities
thousands of choices. Before you invest of loss. time – can be a potential concern for like mortgage-backed securities.
in any given fund, decide whether the investors in money market funds.
investment strategy and risks of the Money Market Funds These funds can be denominated Stock Funds
fund are a good fit for you. The first Money market funds have relatively in any currency or in a combination Although a stock fund’s value can
step to successful investing is figuring low risks, compared to other mutual of currencies, depending on what the rise and fall quickly over the short term,
out your financial goals and risk funds (and most other investments). manager is trying to achieve. historically stocks have performed
tolerance, either on your own or with Money market funds try to keep their better over the long term than other
the help of a financial professional. NAV – which represents the value Bond Funds types of investments, including
Once you know what you’re saving for, of one share in a fund – at a stable Bond funds typically pursue strategies corporate bonds, government bonds
when you’ll need the money and how US$1.00 per share. But the NAV aimed at producing higher yields. and treasury securities.
much risk you can tolerate, you can may fall below US$1.00 if the fund’s Because there are many different There are many types of stock funds
more easily narrow your choices. investments perform poorly. types of bonds, bond funds can vary (also referred to as equity funds). As
Most mutual funds fall into one of Money market funds pay dividends dramatically in their risks and rewards. you can imagine, stock funds are more
three main categories – money market that generally reflect short-term These funds invest primarily in popular than bond funds and money
funds, bond funds (also called fixed- interest rates, and historically the bonds and other debt instruments. market funds, especially for younger
income funds) and stock funds (also returns for money market funds have The exact type of debt the fund investors. MW

22 Investing in Mutual funds Investing in Mutual funds 23


FUND STRATEGY How mutual funds work
Mutual funds utilise a number of strategies to offer investors returns.

T here are many different types


of mutual funds available,
but let’s look at the most widely
long term, although it will start out
lower.
The growth on balanced funds
recognised, strategy-wise. can be used to enhance income
through simultaneous capital
Growth Funds withdrawals, which can bring the
Most growth funds fall into the total of income and capital up to
higher-risk category and are likely a desired level. This can work very
to pay small dividends. Where the well over the longer term, provided
fund volatility is in line with market that the rate of capital withdrawal
volatility, this is referred to as is not too high.
“market risk”.
Value Funds
Income Funds These funds invest in large and
Corporate bond and gilt funds mid-sized companies that appear
can generate decent levels of to be overlooked or out of favour.
income, although capital growth is These undervalued stocks tend to
likely to be low and the funds are pay dividends.
vulnerable to changes in interest
rates. Some high-yielding corporate Blend Funds
bond funds contain debt of lower These funds are a “blend” of
quality and higher risk. both growth and value stocks.

Growth and Income Funds By Size


Equity funds provide a source Large-cap funds – These funds
of growing income that often invest in companies whose market
outperforms fixed deposits over the value (# of shares outstanding

Investing in Mutual funds 25


X current market price) is large. US$1 billion. These companies Index funds are a hands-off Emerging markets funds – These
By large, I mean greater than tend to use profits to grow rather approach to investing. The manager funds focus on small developing
US$9 billion. These “blue-chip” than pay dividends. is not trying to find the hot stocks or countries.
funds tend to be well-established great deals. Instead, the manager is
corporations and tend to pay Index Funds simply trying to match a chosen index. Sector Funds
dividends. These funds try to mimic a These funds are very cost efficient, as Sector funds choose to invest in
Mid-cap funds – These funds chosen index. Examples of indices their operating costs are very low. a particular industry or segment
invest in mid-sized companies include the S&P 500, NASDAQ of the market. Examples of sectors
whose market value is more in and the Russell 2000. An index is International Funds include automotive, technology,
the range of US$1 billion – US$9 simply a group of stocks chosen Global funds – These funds invest banking, air transportation,
billion. to represent a particular segment in international stocks. biotechnology, health care
Small-cap funds – These funds of the market. Usually this is Country specific funds – These and utilities. Sector funds are
invest in emerging companies accomplished by purchasing small funds focus on one country or considered less diversified than
whose market value is less than amounts of each stock in a market. region of the world. most mutual funds, but they do

26 Investing in Mutual funds Investing in Mutual funds 27


offer diversification within a management argue that most actively Costs funds with no upfront costs, but will
particular industry. managed funds under-perform the As with all investment products, structure their funds so that you
market and that outperforming funds there are costs involved with mutual have to leave your money invested
Active vs. Passive Management cannot be identified in advance. funds. These costs can vary between for at least five years, otherwise
Active fund management attempts Active fund managers argue that companies and their funds, but the there will be a surrender charge
to outperform a market index index tracker funds overpay for new charges are usually split between applied.
through stock picking. entrants to the index and sell shares initial and ongoing charges. Funds also charge an annual
Passive fund managers create tracker too cheaply. This is because new The initial or upfront charge can management for the ongoing costs
portfolios that reflect the content of a entrants to the index are bought be up to five per cent and is often associated with running the fund.
chosen market index (e.g. FTSE100, only after their shares have risen known as the bid/offer spread – the These can vary between 0.5 percent
FTSE250, FTSE All Share) and their in price, while shares in departing difference between the purchase and two percent, depending on what
weightings in the index. companies are sold after their prices price and sale price of the fund’s the fund is investing in and how the
Supporters of passive fund have fallen. units. Some companies will set their fund is structured. MW

28 Investing in Mutual funds Investing in Mutual funds 29


DIVERSIFICATION The rewards for risk
AND RISK When it comes to investing, risk and reward are inextricably entwined.

Y ou’ve probably heard the phrase


“no pain, no gain” – those
words come close to summing up the
a number of ways it can be looked
at, but basically what we are asking
is how much risk you are willing to
relationship between risk and reward. take with your initial investment
Don’t let anyone tell you otherwise: to try to obtain a particular rate of
all investments involve some degree return.
of risk. If you intend to purchase For example, with a bank account,
securities – such as stocks, bonds or your capital is completely secure, but
mutual funds – it’s important that the return over the longer term can
you understand before you invest that be poor. You could argue that this
you could lose some or all of your makes a bank account a higher-risk
money. investment because the buying power
The reward for taking on risk of your money could be reduced in
is the potential for a greater the future.
investment return. If you have At the other end of the scale, a
a financial goal with a long time fund investing in emerging markets
horizon, you are likely to make stocks and shares could be viewed as
more money by carefully investing high risk because over the short term,
in asset categories with greater risk, the value could fall below the initial
like stocks or bonds, rather than investment level, but over a longer
restricting your investments to assets period of time, it has the potential
with less risk, like cash equivalents. to grow at a much faster rate than a
On the other hand, investing bank account.
solely in cash investments may be For an indication of your own risk
appropriate for short-term financial appetite, try our simple questionnaire
goals. on the next page. It should give you a
When we discuss risk, there are clear idea of where you stand.

Investing in Mutual funds 31


Assessing your risk Another way to spread your risk is
by investing on a monthly basis, as
1. A good way to assess your own attitude to risk is to answer the questions you will benefit from GBP or USD
below and then see where you sit on the risk scale.
cost averaging. This is the result of
‘drip feeding’ your money into the
Strongly Somewhat Somewhat Strongly
agree agree disagree disagree investments on a regular basis, so if
markets are down, you will purchase
I would feel comfortable if my
investments could easily rise and fall by 7 5 2 1 more units, so that when markets
a quarter (25%) or more in a year recover you will have more units to performing fund and a badly
If my investments fell significantly
in value, I might see this as an
benefit from the growth. Overall, performing fund can produce rather
7 5 2 1
opportunity to buy more at cheaper this should smooth out some of the surprising results. In each case,
prices.
volatility in the equity markets. US$1,000 per annum is invested over
I would not feel comfortable if my
investments could fall in value at all.
1 1 4 7 a 10-year period.
3.5
Fund A’s unit price triples in value
I prefer the security of bank accounts 3.0
1 1 4 7 over the period, the number of units
to stock market-related investments. 2.5

Unit price
I can sleep at night knowing that my 2.0 bought reduces or remains constant
investments might rise and fall quite 7 4 2 1 1.5
rapidly in the short term. 1.0
all the time and the total number of
0.5 units bought is 4,840. On the other
0.0
2. Now add up all the numbers 1 2 3 4 5 6 7 8 9 10 hand, although Fund B only manages
Risk
and circle your risk level From To Time to recover its original price after
Level is Fund A Fund B
0 5 1 10 years, the investor benefits from
If you answered, for example, between 6 9 2 being able to purchase more units for
0 to 5, it means your appetite to risk is 10 11 3 By saving regularly into a mutual his premium – the total number of
very low. 12 14 4 fund, the investor can actually benefit units bought is 26,580. This is a very
If you answered between 31 to 99, it’s 15 16 5 from stock market fluctuations. The simple set of figures, but even so, it
likely that you make your living bungee 17 19 6 graph above compares how regular shows that it is possible to benefit
jumping or sky diving. 20 21 7 contributions into a steadily from falling markets.
Most people, in risk terms, are 22 24 8
Investment Number of Unit Price Value of unit
somewhere in between. 25 30 9 outlay units bought after 10 years holding
31 99 10 Fund A US$10,000 4,840 US$3 US$14,520
Fund B US$10,000 26,580 US$1 US$26,580

32 Investing in Mutual funds Investing in Mutual funds 33


Another way to show the different the triangle, and the majority in the invested into a portfolio of funds in a that the real value of the cash
types of investments is in the following middle area, thus offering a balanced wide variety of areas and investment investment could well be less than
graph: risk approach and a good level of types. Indeed, it could be argued that when you made the investment, and
diversification. cash may be a more suitable place this time period will remove a lot of
However, there is another big to invest your money and would the risk that comes with investing in
High

ies
uit factor when considering risk, and reduce the risk that your funds were equities.
Eq
that is time. To quote Sir Richard exposed to. In the graph below, the relationship
Growth prospects

ty
er
op

Branson, “Investment is about time Conversely, if you had a 20-year of returns from various assets versus
Pr
s
nd

and not timing.” So, the longer you time line before the funds were inflation is shown. As you can see,
Bo
h

are saving and invested, the better required, the opposite of the above stocks have outperformed over all
Low

s
Ca

Low High
Investment risk your funds will perform. And to back could well be true. Cash could time periods, while other assets have
The graph shows the investment risk and growth prospects
that can be expected from each asset class over the long term.
this point, research from Fidelity actually pose a higher risk to your only just maintained their real value.
Investments shows that over 15 years money than a portfolio of mutual Stock markets are virtually always
from 1987 to 2002, if you missed the funds, or indeed a single fund, experiencing uncertainty or volatility;
As you can see, the higher the best 40 days of performance (about because of the effect of inflation. indeed, it is very rare for markets to
potential return that you wish to three days a year), it would have Over this length of time, it is likely be stable. I would suggest that this is
achieve, the higher the risk that reduced the annualised growth from
you have to take to achieve it. Most 9.4 per cent to only 0.6 per cent. Stocks vs. Inflation
investors will want to take more risk Another way to look at this is that the Average (Average rates since 1926)
than leaving money on deposit, but longer you are invested, the better total (%)
12
will not feel comfortable taking a your returns should be. Stocks: 10.4%
10
high level of risk. Therefore, most Tied in with this, time actually Inflation: 3.0%
8
investors will want to take a balanced plays a big role in increasing or
6
approach to investing their money. decreasing the risk that your funds
4
Diversification is important to can be exposed to. For example,
2
consider here as well and can be used if you only wished to invest for five
0
to lower risk. years, which I believe to be the 1-yr period 3-yr periods 5-yr periods 10-yr periods All periods
To do that, you can consider minimum that one should consider Stocks Bonds Treasury bills Inflation
placing an egg in the middle of the investing into equities, and you As of 12/31/2006. Source: 2007 Morningstar. All rights reserved. This example is for illustrative purposes only, and is not meant to
depict the performance of any specific investment. Past performance is no guarantee of future results. Stocks are represented by the
triangle. That way, you will have invested into one high risk fund, your S&P 500, an unmanaged index of stocks that provides an indication of stock price movements. Average returns of the S&P 500,
U.S. Long-Term Government Bond Index, and U.S. Treasury Bill Index were calculated over rolling 1-, 3-, 5-, 10-, and 79-year
periods from January 1, 1926, through December 31, 2006.
some money at the top and bottom of risk would be a lot higher than if you

34 Investing in Mutual funds Investing in Mutual funds 35


a normal and healthy position, and
if you are not comfortable with the
uncertainty, then maybe this is not
the place for you to invest into.
There are a number of factors
that affect market movements,
from supply and demand, merger
and acquisition rumours, market
sentiment and expert opinion to
one-off events. For example, a lack
of supply and an increase in demand
has driven the price of oil to record
levels, and on the back of this, oil
company stocks have also risen to
record levels. Conversely, a lack of
demand and an increase in supply quite quickly. As with all of these ride the peaks and troughs of the back at previous events from the
can cause prices to fall. factors, they are simply points of equity markets, your fund would market collapse in the 1930s or the
Market sentiment can affect prices view or opinions and so can be have been worth US$230,500. It is bursting of the technology bubble
for no other reason than a particular equally right or wrong. Only time also interesting to note that if you in the early 2000s, markets have
stock or company is in or out of will tell which is correct. look over the last 60 years, the results and should continue to recover and
favour at that point in time. Expert There’s no doubting the power of are broadly the same, with equities prosper.
opinion, such as that of the current the argument to invest in equities massively outperforming any other Relating to the area of risk, a
US Federal Reserve’s chairman Ben over the longer term. Over a 25-year asset class. question that is often asked is:
Bernanke or the Bank of England’s period from 1982 to 2007, if you had Obviously, this is the wonder how much should I be saving into
governor Mervin King, can affect invested US$10,000 in 1982 in a cash of hindsight, and it is very easy to my mutual fund? Obviously, this
stock markets in a positive or fund, it would be worth US$37,400 look back on past performance and depends on an individual’s personal
negative manner. at the end of the term. If you had assume that this will continue into circumstances, and no one person is
One-off events can also have a invested into a bond fund, your the future. Of course, there can be the same as another. However, there
large impact on stock markets, but fund would be worth US$96,200. no guarantee of this, but even with is a very rough rule of thumb that
these are usually only short-term However, if you had invested into the current volatility the world’s stock should ensure that you are able to
effects and markets generally recover an equity fund and been happy to markets are experiencing, if you look build a reasonable fund, and that is

36 Investing in Mutual funds Investing in Mutual funds 37


to take your age, half it and then use
that number as a percentage of your
salary to start saving. For example,
if you are 40 years of age and are
earning AED20,000 per month, then
you should be looking to save 20 per
cent of your salary, which equates to
AED4,000 per month.
I must emphasise that this is a very
rough guide, but it does at least give
you some idea as to a realistic level of
saving that will generate a reasonable
lump sum.
portfolio’s overall investment experts agree that you will likely not. For example, investing entirely
Asset Allocation: So Important returns will have a smoother ride. need to include at least some stock or in stock, in the case of a 25-year-old
By including asset categories with If one asset category’s investment stock mutual funds in your portfolio. investing for retirement, or investing
investment returns that move up return falls, you’ll be in a position On the other hand, if you include entirely in cash equivalents, in the
and down under different market to counteract your losses in too much risk in your portfolio, the case of a family saving for the down
conditions within a portfolio, that asset category with better money for your goal may not be payment on a house, might be
an investor can protect against investment returns in another asset there when you need it. A portfolio reasonable asset allocation strategies
significant losses. Historically, category. heavily weighted in stock or stock under certain circumstances. But
the returns of the three major In addition, asset allocation is mutual funds, for instance, would be neither strategy attempts to reduce
asset categories have not moved important because it has a major inappropriate for a short-term goal, risk by holding different types of
up and down at the same time. impact on whether you will meet such as saving for a family’s summer asset categories.
Market conditions that cause one your financial goal. If you don’t vacation. So, choosing an asset allocation
asset category to do well often include enough risk in your portfolio, model won’t necessarily diversify
cause another asset category to your investments may not earn Asset Allocation & Diversification your portfolio. Whether your
have average or poor returns. By a large enough return to meet Many investors use asset portfolio is diversified will depend
investing in more than one asset your goal. For example, if you are allocation as a way to diversify their on how you spread the money in
category, you’ll reduce the risk saving for a long-term goal, such as investments among asset categories. your portfolio among different types
that you’ll lose money and your retirement or college, most financial But other investors deliberately do of investments. MW

38 Investing in Mutual funds Investing in Mutual funds 39


How & why to diversify diversification (like investing in
several NASDAQ companies)
or more narrowed (investing in
Asset allocation
Conservative portfolio

Diversification is so absolutely critical in any financial portfolio.


several stocks of the same branch Bonds 35%

D iversification is a risk
management technique
that mixes a wide variety of
Most non-institutional investors
have a limited investment budget
and may find it difficult to create
or sector).
The second type is called
vertical diversification, where the
Stocks
40%

Cash 25%
investments within a portfolio. an adequately diversified portfolio. investment goes into different
The rationale behind this This fact alone can explain why types of investments. Again, it can
technique says that a portfolio mutual funds have been increasing be a very broad diversification, Asset allocation
of different kinds of investments in popularity. Buying shares in a like diversifying between bonds Aggresive portfolio
will, on average, yield higher mutual fund can provide investors and stocks, or a more narrowed
Bonds 15%
returns and pose a lower risk than with an inexpensive source diversification, like diversifying into
any individual investment found of diversification. stocks of different equity sectors. Cash 5%
within the portfolio. There are no magic areas to While horizontal diversification
I would always advocate a invest in, but it is best to stay in lessens the risk of just investing Stocks
strategy of diversification; that mainstream areas, such as equities, all-in-one, a vertical diversification 80%

is, ‘not putting all your eggs in bonds and property. The key is to goes far beyond that and insures
one basket’. As part of a broad have a well-diversified portfolio you against market and/or
portfolio, the local market with investments in a wide range economical changes. To give an example of a typical
could form part of that, along of geographical areas and sectors portfolio allocation, the two
with exposure to the rest of the that you are comfortable with Return Expectations while charts above show a conservative
world’s major stock markets and and is in keeping with your own Diversifying investment strategy and an
asset classes. That way, if one investment philosophy. Then The average of all investment aggressive investment strategy.
sector or type of investment isn’t contribute enough to make the parts will always be below the The aggressive strategy has a
performing, then chances are effort worthwhile. return of the top performer part. much greater exposure to stocks
another will be, so the overall There are two main ways to In some way, it’s the price you have and shares, while the conservative
effect will be to smooth out the diversify your investment. The first to pay for the insurance. However, strategy has less equities and more
peaks and troughs of the markets is horizontal diversification – when strategies do exist that allow you to bonds and cash. A typical balanced
and leave you with a consistent you diversify within same-type maximise the return by keeping the strategy would sit somewhere
rate of return. investments. It can be a broad risk as low as possible. between these two examples. MW

40 Investing in Mutual funds Investing in Mutual funds 41


FUND RATINGS Who rates the funds?
Mutual fund performance is independently assessed and analysed.

T here are a number of


companies whose sole job is to
assess and analyse the performance
Since that time, Standard & Poor’s
has traded on its mission statement to
support “the investor’s right to know”
and the risk profile of mutual funds by providing credit ratings, indices,
and their managers, to enable investment research, risk evaluation
investors to independently assess and data.
and compare funds with each other. Many investors will know of
These companies usually give star Standard & Poor’s for its role as
ratings or ‘A’ ratings. Generally, the an independent provider of credit
more of these the fund has, the ratings and as the home of the S&P
better the rating. Factors that are 500 benchmark index. Standard
considered include how long the fund & Poor’s global organisation is the
has been established, how long the largest source of independent equity
manager has been in charge, how research and a leader in mutual
the fund has performed compared fund information and analysis,
to its peers and in isolation, where and is among the world’s leading
the fund is invested and if it has any providers of independent investment
borrowing. information.

Standard & Poor’s Moody’s Role in the Global


Standard & Poor’s is one of the Capital Markets
most well known and largest fund Moody’s Investors Service is among
rating agencies. It can trace its origins the world’s most respected and widely
to the publication, in 1860, of Henry utilised sources for credit ratings,
Varnum Poor’s History of Railroads and research and risk analysis. Moody’s
Canals in the United States, a precursor of provides research data and analytic
modern stock reporting and analysis. tools for assessing credit risk.

Investing in Mutual funds 43


The company was founded by John Morningstar to provide individual individual classifications for the three,
Moody (1868 – 1958). Relying on investors with much-needed mutual five and ten-year periods. In addition,
his assessment of the market’s needs, fund analysis and commentary. the Lipper Fund Awards programme
John Moody & Company published In 1984, they published their spotlights fund families with high
Moody’s Manual of Industrial and first product, The Mutual Fund average scores for all funds within a
Miscellaneous Securities in 1900, the Sourcebook, a quarterly publication particular asset class or overall.
company’s founding year. The manual containing performance data, Lipper was founded on the principle
provided information and statistics portfolio holdings and other that investment managers and investors
on stocks and bonds of financial information on approximately 400 deserve the most comprehensive and
institutions, government agencies, mutual funds. In the 20-plus years accurate fund analysis and relevant
manufacturing, mining, utilities and since the Sourcebook’s first printing, comparisons. Lipper provides
food companies. Within two months, Morningstar has served a key role in institutional-quality information,
the publication had sold out. the investment community. analytics and commentary to enable
John Moody returned to the ratings were further extended to the asset managers and investors to make
financial market in 1909 with a new commercial paper market and to bank Lipper sound investment decisions.
idea: instead of simply collecting deposits. Michael Lipper founded Lipper In summary, all of the above ratings
information on the property, Analytical Services in 1973 to provide agencies try to assess the funds and
capitalisation and management Morningstar, Inc precise data and analytical perspective their managers to try and put a
of companies, he would now offer In the early 1980s, the mutual fund to mutual fund companies in the simple-to-understand star or points
investors an analysis of security values. industry was experiencing dramatic US. The company soon became rating on the fund and its manager.
His company would publish a book growth. However, comprehensive the pre-eminent source for unbiased This should be able to assist the
that analysed the railroads and their information about fund performance comparisons of fund performance and individual investor so that they can
outstanding securities. It offered was not readily available to individual management in the US. The Lipper look at these ratings and know that the
concise conclusions about their relative investors. Most individuals – for Fund Awards programme highlights fund has met a certain set of criteria,
investment quality. whom mutual funds were created funds that have excelled in delivering be it time in existence, performance or
In 1913, he expanded his base of – lacked the tools they needed to track, consistently strong risk-adjusted level of risk. It still doesn’t guarantee
analysed companies, launching his analyse and make intelligent decisions performance, relative to peers. performance going forward, but
evaluation of industrial companies and about mutual funds. Morningstar The Lipper Fund Awards are awarded it does help see how the fund has
utilities. By that time, the “Moody’s founder Joe Mansueto believed that to funds in 21 countries in Asia, Europe performed and whether it is a fund
ratings” had become a factor in the fundamental information should be and the Americas. Lipper designates that the investor would be comfortable
bond market. In the 1970s, Moody’s widely available, and in 1984 created award-winning funds in most placing their funds in. MW

44 Investing in Mutual funds Investing in Mutual funds 45


SHARI’AH Shari’ah Compliance
COMPLIANCE How mutual funds can work within the framework of Shari’ah.

Islamic Funds Despite these successes, this


These funds invest according to market has seen a record of poor
Islamic Shari’ah principles. The funds marketing, as emphasis is on
seek protection against inflation by products and not on addressing the
making long-term equity investments. needs of investors. Over the last few
Of course, no mutual fund can years, quite a number of funds have
guarantee that it will achieve its closed down.
objectives, but Shari’ah-compliant Most of the funds tend to target
funds will try to achieve this while high net worth individuals and
abiding by Shari’ah principles, in corporate institutions, minimum
so far as managing to achieve good investments ranging from US$50,000
results for their investors. to as high as US$1 million.
The Islamic investment equity Target markets for Shari’ah-
funds market is one of the fastest compliant funds vary. Some cater
growing sectors within the Islamic to their local markets; for example,
financial system. At present, there Malaysia and Gulf-based investment
are approximately 100 Islamic equity funds. Others clearly target the
funds worldwide. The total assets Middle East and Gulf regions,
managed through these funds currently neglecting local markets, and have
exceed US$5 billion and are growing been accused of failing to serve
at 12-15 per cent per annum. With Muslim communities.
the continuous interest in the Islamic Since the launch of Shari’ah-
financial system, there are positive signs compliant equity funds in the early
that many more funds will be launched. 1990s, we have seen the establishment
Some western majors have just joined of credible equity benchmarks by the
the fray or are thinking of launching Dow Jones Islamic Market Index and
similar Islamic equity products. the FTSE Global Islamic Index Series.

Investing in Mutual funds 47


Conditions for Investment in
Shares
In light of the forgoing discussion,
dealing in equity shares can be
acceptable in Shari’ah, subject to the
following conditions:
1. The main business of the
company is not in violation of
Shari’ah. Therefore, it is not
permissible to acquire the shares of
the companies providing financial
services on interest (riba), like
conventional banks, insurance
companies or the companies
involved in some other business not
approved by the Shari’ah, such as the
companies manufacturing, selling or
offering liquors or pork, or involved
in gambling, nightclub activities,
pornography, etc.
2. If the main business of the
companies is halal (Shari’ah 3. If some income from interest- cent of the dividend must be given cannot be traded in except at par.
compliant), like automobiles, textiles bearing accounts is included in in charity. Most mutual funds that invest based
and the like, but they deposit their the income of the company, the 4. The shares of a company are on Islamic principles have largely
surplus amounts in an interest-bearing proportion of such income in the negotiable only if the company owns weathered the recent credit turmoil.
account or borrow money on interest, dividend paid to the shareholder some non-liquid assets. If all the assets Two Islamic funds are currently
the shareholder must express his must be given charity and must not of a company are in liquid form beating the Standard & Poor’s 500-
disapproval against such dealings, be retained by him. For example, if – in the form of money that cannot stock index since the start of this year,
preferably by raising his voice against five per cent of the whole income be purchased or sold, except on par largely due to the lack of exposure to
such activities in the annual general of a company has come out of value, because in this case the share any stocks that have been affected by
meeting of the company. interest-bearing deposits, five per represents money only and the money the recent credit crisis. MW

48 Investing in Mutual funds Investing in Mutual funds 49


Funds across the GCC
The GCC mutual fund industry will be worth US$160 billion by 2010.

T here is a growing market here


in the GCC region for mutual
funds, both Shari’ah compliant
fund industry alone reaching a size
of US$50 billion. Saudi Arabia,
which currently has more than 200
• The establishment of the fund must
be approved by the UAE Central
Bank.
its prospects. Like the UAE Central
Bank, the Saudi Arabian Monetary
Agency (SAMA) and the Bahrain
and non-compliant. The market operating mutual funds, will continue • The fund manager must obtain Central Bank also require detailed
for mutual funds has grown along to have the biggest concentration of approval for trading of the fund’s information covering full background
with local stock markets, as more funds. units in the UAE from the Emirates details of the institution floating the
individual companies have listed on Bahrain’s fund industry has also Securities and Commodities fund, the manager and the trustee,
these local markets, thus creating seen significant growth in recent Authority (for closed-ended funds). the size of the fund, the fund’s
more options for mutual funds to years. In June 2006, for example, • The fund must be established investment objective and the fund’s
invest into. The funds now range locally-incorporated mutual funds or floated by either a bank or a dividend policy, as well as all of the
from equity funds to commodity, real totalled 96, compared to 70 at the financial investment company fees, charges and expenses associated
estate and hedge funds. same time in 2005 and 30 in 2002. licensed by the UAE Central Bank. with the fund.
These funds have proved popular The assets under management • The fund must be managed Additionally, SAMA states that
in the UAE, Saudi Arabia, Bahrain, of these funds totalled US$2.72 by either a bank or a financial the exposure of a fund to a single
Qatar, Kuwait and Oman for the billion as of June 2006, compared to investment company licensed by counterparty may not exceed 15
same reason that they have in other US$1.75 billion at the same time in the UAE Central Bank. per cent of its net asset value, while
parts of the world – they offer the 2005 and US$175 million in 2002. • The minimum size of the fund investment by a fund in a single
investor a greater diversity than they As the market has grown, a should be AED10 million. equity or debt issue may not exceed
might otherwise be able to benefit regulatory framework has also • The fund must issue and offer to 10 per cent of its net assets.
from, as well as the opportunity to become necessary to ensure that interested investors in the UAE, free While GCC regulatory systems
pool their funds with other like- investors are protected from the of charge, before listing a prospectus regarding mutual funds have come
minded investors. unscrupulous. Each GCC country (information memorandum) in a long way, they are likely to further
According to research by the has its own regulatory framework Arabic and English. develop as the market continues
Zawya Mutual Funds Monitor, regarding mutual funds. The UAE Such a prospectus would contain to expand. Overall, there is much
the GCC mutual fund industry Central Bank, for example, has the necessary information for room for growth in the mutual funds
is estimated to grow to US$160 published these rules that must be potential investors to make an market, which is set to benefit from
billion by 2010, with the UAE adhered to: informed assessment of the fund and talent and innovation. MW

50 Investing in Mutual funds Investing in Mutual funds 51


Fund Terminology holding a range of securities
directly. Investing in a fund of funds
arrangement will achieve even
What’s the difference between
multi-manager and fund of funds? greater diversification.
An investment manager may

B efore we list fund and fund-


associated terminologies,
I’d first like to deal with two
actively manage your investment
with a view to selecting the best
securities. A FoF manager will try to
terminologies that are increasingly select the best performing funds to
used by fund distributors in the invest in based upon the manager’s
region. Let’s first take Fund of past performance and other factors.
Funds. If the FoF manager is skillful, this
Fund of Funds (FoF) is a mutual additional level of selection can
fund that invests in other mutual tried to show how a fund of funds of units held in y fund of funds provide greater stability and take
funds. The investment fund uses a works: investments. on some of the risk relating to the
strategy of holding a portfolio of decisions of a single manager. As in
other investment funds, rather than FUND OF FUNDS Fettered or Unfettered all other areas of investing, there are
investing directly in shares, bonds or Some investment managers no guarantees.
other securities. These funds were UK equity fund offering retail FoFs may limit the Since a fund of funds buys many
Property fund
designed to achieve even greater fund selection to only include different funds which themselves
US equity fund
diversification than traditional the range of funds they manage; invest in many different securities,
Europe equity fund
mutual funds. Commodity fund this type of arrangement is called it is possible for the fund of funds
There are different types of Emerging markets fund a fettered fund of funds. Most to own the same stock through
FoFs, each investing in a different Etc. FoF offerings include funds from several different funds, and it can be
type of collective investment various investment managers and difficult to keep track of the overall
scheme (typically one type per are called unfettered fund of funds. holdings.
FoF). Examples are ‘mutual fund’ As you can see, all the different Funds of funds are often used
FoFs, hedge fund FoFs, private funds are held within one overall Advantages when investing in hedge funds, as
equity FoFs and investment trust fund, and it is that which the Investing in a collective investment they typically have a high minimum
FoFs. investor holds units in. The scheme will increase diversity investment level compared to
In the following diagram, I have statement would show x number compared to a small investor traditional investment funds, which

52 Investing in Mutual funds Investing in Mutual funds 53


preclude many from investing As you can hopefully see, with a
directly. multi-manager fund, the investor
Pension funds and other actually owns a share in each of
institutions often invest in funds of the various funds, with a manager
hedge funds for part or all of their actually deciding which funds to buy.
“alternative asset” programs (i.e.
investments other than traditional Advantages
stock and bond holdings). The advantages are very similar
to the fund of fund approach in
Disadvantages that investors are able to place their
Management fees for funds of premise that not all investment The objectives of multi-manager money into a potentially wider range
funds are typically higher than those managers are good in all markets funds will vary, but one of their key of assets and sectors than they would
on traditional investment funds and that not all managers are aims is to produce a well-diversified be able to otherwise. This increases
because they include part of the successful at all times. Spreading the portfolio ensuring you are not diversification and should reduce risk.
management fees charged by the investment money across different exposed to a single area and the This type of investment can
underlying funds. asset classes or markets allows the associated risks. No one company be useful for UK residents to
Now let’s take a look at Multi- investor to achieve the necessary has a monopoly on investment talent, assist them with utilising their
manager products. diversification and reduces risk so it makes sense to spread your tax allowances. However, this is
without sacrificing the return. investments between them. Multi- obviously not applicable to residents
Multi-Manager Funds A multi-manager fund is a manager funds are also constantly of the Gulf region.
A multi-manager investment is managed portfolio of funds. monitored and changes are made
an investment product that consists When you invest in one, you are when necessary, with the aim of Disadvantages
of multiple specialised funds. Each actually buying into a collection of producing the best results for investors. Again, the disadvantages are very
specialised fund may invest across individual unit trusts and OEICs In the diagram below, I have similar to the fund of fund in that
different sectors and markets, or managed by a professional fund tried to show how a multi- the costs can be higher to pay for the
have managers investing in the manager. Each of the underlying manager fund works. extra layer of management. MW

same asset class but have different unit trusts and OEICs will, in turn,
investment styles. For example, have their own manager, usually Fund Manager
large-cap value fund versus large- investing in a blend of equities
cap growth fund. (shares) or fixed-interest securities UK equity US equity Europe equity Commodity
Property fund
fund fund fund fund
This theory is founded on the (company and government bonds).

54 Investing in Mutual funds Investing in Mutual funds 55


MUTUAL FUNDS
TERMS
ACCOUNT STATEMENT: A operations of a brokerage, The spread is often a surprise to BROKERS: In most financial
statement sent periodically, or at insurance company, etc. “Back customers who didn’t read the sales markets, brokers (middlemen or
the very least quarterly, showing the office problems” usually refers to literature and want to liquidate women) are professionals who
status of an account with a bank slow paperwork, payments and their holdings - how much? buy and sell shares on behalf of
or broker. other such intangible glitches. You their clients. Private individuals
will rarely get to speak with back BOOK VALUE: Generally and institutions are usually not
APPRECIATION: An increase in office personnel – perhaps not such speaking, this is the net asset value allowed to deal in shares directly.
the price or value of an asset - one a bad thing. of a company (NAV). The NAV is In the Gulf, financial advisers are
component of total return. arrived at by subtracting liabilities often called brokers because they
BEAR: Not a soft toy, but a person from assets. Dividing the result sell on behalf of financial product
ASSET: Any item of positive who thinks a market will soon be in by the number of common stock providers.
monetary value owned by an decline. The opposite of Bull. shares gives you the book per share
individual or corporation, value that can be used as a relative BULL: Not someone who doesn’t
especially that which could be BEAR MARKET: When the gauge of the stock’s ‘real value’. give the truth, but someone who
converted to cash. overall market loses value over thinks the market is going to go up.
an extended period of time. BOURSE: French term for stock You get the idea.
ASSET ALLOCATION: The Impossible to define exactly, though exchange. It is now used more
process of risk reduction by it’s often felt that a drop of at least generally for all stock exchanges, in CAPITAL: The total of your
diversification, not just between 10 per cent is needed. Anything particular European exchanges. deposits into your account, or the
different stocks and shares in one’s less is often called a “correction” original investment in your bond or
home market, but by allocating (although “correction” isn’t used BORSE DUBAI: Borse Dubai certificate.
proportions of assets between when the market moves up 10 per is the holding company for Dubai
different asset classes or different cent). Financial Market (DFM) and CAPITAL GAIN (OR LOSS):
countries. Or both. Dubai International Financial The difference between the price
BID/OFFER: Bid is the price a Exchange (DIFX). Borse Dubai at which you buy an investment
ASSET CLASSES: The three buyer is willing or has to buy at, was created August 6, 2007 to and the price at which you sell it.
major asset classes are cash, bonds while offer or asked is the price consolidate the Government of Adding the capital gain (or loss)
and stocks. the seller will take. The difference, Dubai’s two stock exchanges as to the income received from the
known as the spread, is the well as current investments in other investment tells you your total
BACK OFFICE: The support broker’s share of the transaction. exchanges. return.

58 Investing in Mutual funds Investing in Mutual funds 59


CLOSED-END INVESTMENT representing equity ownership in of the editors of The Wall Street the Footsie, this index monitors
COMPANY: A fund that issues a a corporation, providing voting Journal, most represent the the top 100 publicly quoted
set number of shares and no more. rights and entitling the holder to American economy. companies, by market value,
When sold out, the fund trades on a share of the company’s success on the UK stock market. It is
the secondary market at a price through dividends and/or capital EQUITIES: These are freely weighted to take account of
determined by investor supply and appreciation. Also called junior traded stocks and shares in publicly the largest and smallest sized
demand. equity. owned companies that do not carry companies within the hundred.
a fixed rate of interest. Instead, There is also the FT-SE Mid 250,
COMMODITY: A physical COMPOUNDING: When an they entitle their holders to a share the FT-SE 350 and so on.
substance, such as food, grains or investment generates earnings on in the growth of the company
metals, which is interchangeable reinvested earnings. through an annual dividend GILT EDGED BONDS: British
with another product of the same payment. government loans that carry a fixed
type and which investors buy or sell, CORRECTION: A short-term interest.
usually through futures contracts. drop in stock market prices. The FAMILY OF FUNDS: A group of
The price of the commodity is term “correction” comes from the mutual funds created by the same GLOBAL FUND: A mutual fund
subject to supply and demand. Risk notion that, when this happens, an company, with portfolios made or closed-end fund that invests
is actually the reason exchange overpriced individual stock, market of different securities or having in the negotiable securities of
trading of the basic agricultural segment or stocks in general are different investment objectives. corporations located in the US and
products began. For example, a returning back to their “correct” These are usually managed by abroad, also called a world fund.
farmer risks the cost of producing values. Never used when a stock or different investment managers.
a product ready for market at the stock market returns to a higher Shareholders in one of the funds GROWTH INVESTING:
sometime in the future because he level after momentarily visiting a can usually switch their money into Selecting a company in which to
doesn’t know what the selling price lower level. any of the family’s other funds, invest based on expectations of
will be. More generally, a product sometimes at no charge. Family strong growth in earnings.
that trades on a commodity DOW JONES INDUSTRIAL of funds with no sales charges
exchange; this would also include AVERAGE (DJIA): The oldest are called no load families. Those HEDGE: Any combination of a
foreign currencies, financial and most famed index of the US with sales charges are called load long and/or short position taken in
instruments and indexes. stock market, the Dow tracks families. securities, options or commodities,
the price movements of the 30 in which one position tends to
COMMON STOCK: Securities companies that, in the opinion FT-SE 100 INDEX: Known as reduce the risk of others.

60 Investing in Mutual funds Investing in Mutual funds 61


INFLATION: A rise in the prices MANAGEMENT FEE: A NET ASSET VALUE (NAV): estate properties or mortgages and
of goods and services. percentage of a mutual fund’s The company’s shareholders’ passes virtually all the profits on to
total assets that the fund’s portfolio funds divided by the number of its shareholders.
INCOME STOCK: The shares of manager charges for his or her shares/stocks in issue. The NAV is
companies that make regular and services. It is typically the largest the market value of a fund share, SECTOR FUND: A mutual fund
substantial dividend payments to expense of a mutual fund. synonymous with a bid price. In that invests its shareholders’ money
investors. the case of no-load funds, the in a relatively narrow market sector,
MONEY MARKET: Wholesale NAV, market price and offering e.g. technology, energy, the Internet
INDEX: A composite measure market for funds and marketable price are all the same figure, or banking.
of the movement of the overall securities, dominated by banks and which the public pays to buy
market or of a particular industry liquid funds of large corporations shares. Load fund market or offer SECURITIES AND
that consists of a large number of and rich individuals. prices are quoted after adding the EXCHANGE COMMISSION
stocks and is usually weighted by sales charge to the net asset value. (SEC): A US government agency
other factors, such as capitalisation. MONEY MARKET FUND: NAV is calculated by most funds responsible for the supervision
Open-ended mutual fund that after the close of the exchanges and regulation of the securities
INDEX FUND: A mutual fund invests in commercial paper, each day by taking the closing industry.
that invests in a group of securities bankers’ acceptances, repurchase market value of all securities
whose performance reflects the agreements, government owned plus all other assets such SECURITY: A transferable
performance of a particular stock securities, certificates of deposit as cash, subtracting all liabilities, instrument evidencing ownership
market index, such as the Standard and other highly liquid and then dividing the result (total or creditorship. Example: A
& Poor’s 500 Index or the New York safe securities, and pays money net assets) by the total number note, stock or bond, evidence
Stock Exchange Composite Index. market rates of interest. Cash of shares outstanding. The of debt, interest or participation
- i.e. dividend payments and number of shares outstanding in a profit-sharing agreement,
LARGE-CAP STOCK: A large sales proceeds - in a customer’s can vary each day, depending investment contract, voting trust
company whose outstanding brokerage account is typically on the number of purchases and certificate, fractional undivided
common shares have a total market invested in a money market redemptions. interest in oil, gas or other
value of US$5 billion or more. mutual fund. The fund’s net asset mineral rights, or any warrant
[Note: The dollar amount cited is value remains a constant US$1 a REAL ESTATE INVESTMENT to subscribe to or purchase any
generally accepted and subject to share, only the interest rate goes TRUST (REIT): A closed-end of the foregoing or other similar
change over time.] up or down. investment company that buys real instruments.

62 Investing in Mutual funds Investing in Mutual funds 63


SHARE: A stock certificate - a Additions:
unit of measurement of the equity
ownership of a corporation.

SHARI’AH: Islamic law derived


from three sources - the Qur’an, the
Hadith and the Sunnah.

SHARI’AH COMPLIANT: A
term used in the Islamic banking
industry as a synonym for “Islamic”,
essentially an act or activity
complying with Shari’ah, or Islamic
law.

VOLATILITY: The relative


amount or percentage by which a
stock’s price rises and falls during a
period of time.

YIELD: In general, a return on


an investor’s capital investment.
For bonds, the coupon rate of
interest divided by the purchase
price, called current yield. Also,
the rate of return on a bond,
taking into account the total of
annual interest payments, the
purchase price, the redemption
value and the amount of time
remaining until maturity.

64 Investing in Mutual funds