Alternative to Bonds and Shares
During these times various investors are questioning where they can invest their money in order to generate a reasonable return whilst at the same time keeping risks as low as possible. It is quite a demanding task to identify and regularly monitor individual securities. In most cases, for those investors seeking lower volatility and peace of mind, investing in collective investment schemes or funds, would be more suitable.
A fund is a type of investment product where the monies of many investors are pooled together to invest in a predefined strategy which has an investment objective to achieve. The fund then focuses on the use of capital to invest in a group of assets to reach the fund’s investment goals. There are many different types of funds available, including equity funds, income funds or multi-asset funds.
Equity funds generally do not pay high or any dividends. Usually, the objective of equity funds is to generate capital growth. If you, as an investor, are looking for dividends to supplement your current earnings from your portfolio, then an income fund or a bond fund may be a better choice. These funds usually buy debt securities and other similar instruments that pay interest regularly.
Government bonds and corporate debt are two of the most common holdings in an income fund. When a fund invests in high quality bonds, the fund will be exposed to less volatility. High quality bond funds often have a low or negative correlation with the stock or equity market. This means that these two types of securities move in the opposite direction. The fund will be structured in a way that can better withstand volatility and smooth out returns. Investors can use this to diversify their portfolio. A multi-asset fund or portfolio exploits this advantage and in return will allow the investor to enjoy the best of both worlds.
The act of investing will always carry an element of risk. Investing in funds is no different. In this case you are choosing to trust your money with a fund manager and his or her team of professionals.
The major reason why a fund is beneficial for the investor is because of the diversification it provides in a portfolio and the resulting lower concentration risk. Certain investment strategies provide the investor with diversification through the selection of different renowned global investment managers, investment strategies, regions, and asset classes. Diversification aims to lower the concentration risk through an investible portfolio of bonds or equities or a mix of different asset classes. Hence, funds allow investors to gain exposure to a wide range of bonds or equities rather than exposure to a single issuer. Despite the many benefits of diversification, risks cannot be completely diversified away but diversification does reduce it. Although funds enhance protection, this does not mean that the value of investments will not fluctuate.
Having said this, investing selectively in an actively managed fund in all probability is more suited in today’s market rather than a passive fund. An active fund tries to outperform its benchmarks through mechanisms that give the fund manager and team a better view of which stock or bond is best to either hold, buy, sell or avoid all together. On the other hand, a passive fund simply mirrors the index by investing in the same assets and proportions which make up the index.
In the current market situation, various active funds are taking a more defensive approach by investing in high quality-rated bonds with a low duration while on the equity side they are opting for more defensive stocks such as utilities, health care and consumer staples.
Overall, when investing in funds the investor benefits from having his capital invested in numerous companies rather than putting all his eggs in one basket. That way, if a company is facing financial difficulty or goes bankrupt it will only represent a small portion of the overall capital invested in the fund, if a position is held by the fund.
It is of the utmost importance that prior to investing in any type of investment, you should first identify your objectives. It is also imperative to identify your time horizon, meaning that you have to answer the question; am I investing for a short period or for the long-term? Every advisor will indicate that the ideal time period should be at least three to five years. You also need to identify the scope of your investments – are you investing for capital gains or for income? You should also consider personal risk tolerance. Can you accept dramatic swings in portfolio value or do you consider a more conservative investment to be more suitable for you? Risk and return are directly related, so you must balance your desire for returns against your ability to tolerate risks.
The answers to these questions are fundamental for a financial advisor to be able to build the client’s profile in terms of risk, time horizon and investment objective. Following this an investment recommendation can be drawn based on all the factors taken in to consideration.
Matthew Miceli Donnelly, ICIWM, B.Com Banking & Finance & Management (Melit.), B.Com (Hons.) Management, MBA (Melit.), is an Investment Advisor at Jesmond Mizzi Financial Advisors Limited. This article does not intend to give investment advice and the contents therein should not be construed as such. The Company is licensed to conduct investment services by the MFSA and is a Member of the Malta Stock Exchange and a member of the Atlas Group. The directors or related parties, including the company, and their clients are likely to have an interest in securities mentioned in this article. Investors should remember that past performance is no guide to future performance and that the value of investments may go down as well as up. For further information contact Jesmond Mizzi Financial Advisors Limited of 67, Level 3, South Street, Valletta, on Tel: 2122 4410, or email [email protected]