Business

Diversify your investment portfolio to lower risk

SSL in the Money

Patrick Robins

Wednesday, July 18, 2012    

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PUTTING all your money into one financial product can prove to be very risky, because if that investment loses value so too will your entire portfolio. By investing in different options you mitigate the occurrence of losses and increase your chances of overall growth; hence, the importance of diversification. One such tool that can be used to diversify your investments is Managed Funds.

A Managed Fund is simply a pooled fund that is professionally administered by a fund manager who invests in a variety of assets. With managed funds, your money is grouped together with that of other investors to create a single, strong diversified fund that provides significant investor benefits, mainly an instant increase in buying power. The type and mix of the asset classes within the fund, which may include shares, bonds, real estate, etc, is determined by the fund manager in accordance with the fund's objectives.

Most large financial institutions, such as banks, and smaller investment companies operate managed funds. The common basis on how the fund works is by taking the combined value of the assets within the fund and dividing that into equal units. The number units you receive will depend on the amount of money invested and the price at the time of purchase. On a daily basis unit prices may fluctuate as the total value of the assets change due to market activity. Therefore, if the fund performs well on a given day and goes up in value, so does your unit price and vice versa.

If the fund invests in companies which pay dividends, then you might benefit from cash distributions depending on the fund's guidelines. If one can receive funds, then the investor has two options; either take the dividend in cash or receive it in units of the fund. Investing over a prolonged period of time and reinvesting any dividends received will benefit your portfolio in terms of compounding. Also, some funds will give the option to make regular contributions if you desire.

The fund's performance will greatly depend on the expertise and knowledge of the fund manager. Generally, there are two main types of fund management styles: passive and active. Usually this comes down to the individuals philosophies. With the passive investment style, the strategy involves limited ongoing buying and selling actions; there is no attempt to benefit from short-term price fluctuations. Instead, the reliance is heavily skewed to the long term with the intention that the investment will be profitable and involves limited maintenance. This requires a well diversified portfolio, good initial research and lots of patience. In some instances, a fund may be tied to an index, whereby the fund manager would invest in all shares in a particular index, in proportion to their allotment in the index. This is also known as "Index Fund". This subjects the portfolio to market swings, which can be rewarding or costly, depending on the direction of the index.

Conversely, with the active investment style, the strategy used is to consistently outperform the market. This is achieved by capitalising on what is perceived to be pricing inefficiencies in the marketplace. In-depth research is done on a company and its stock price. The majority of this analysis includes evaluating a company's past, present, and future earnings capability, and its management and fundamentals, in relation to its historical and forecast stock price. Its valuation is then compared to that of the market.

The intention is to buy a company's stock when it is believed to be undervalued, and to sell entirely or reduce the volume when it is overvalued. This approach transcends all other investments within the fund. This investment style will seek to profit from short and medium-term price fluctuations as well as trim losses on assets that are not performing as desired. The day-to-day decisions on how to invest the money is left solely to the fund manager (sometimes a management team), who is mandated by law to diligently manage the funds effectively.

There are advantages and disadvantages associated with investing in a managed fund. The main advantage is its ability to reduce the investment risk as the fund invests in various assets. Some funds require a minimum amount of money to start, while others require the purchase of one unit.

The main disadvantage of a managed fund is the fees associated with some of them. Fees are usually structured so that the fund manager receives a fixed proportion of the income generated. This fee, also called the "Management Expense Ratio" (MER) is paid to the fund manager even if the fund makes a loss. At times, these fees can be high, particularly if the fund is not performing well.

Generally, funds should not be picked based on fees alone, albeit important, but more specifically by establishing a strong investment objective and the level of risk that is suited to your needs. Also, when owning shares in a managed fund, investors do not have the right to vote on important matters relating to the fund at events such as an Annual General Meeting.

Once you have made the decision to start building a financial portfolio, whether for short, medium or long term, managed funds can help play a significant part in that goal. Before investing in a managed fund it is important to thoroughly research your selection and the fund manager should be able to provide you with a prospectus outlining objectives. Alternatively, there are other managed products whereby a manager may buy and sell various assets, based on their expertise and research, on your behalf. The investor relies on the prowess of the fund manager, helping to take away some of the worry in investing. In doing so, the investor usually gives the manager full discretion to trade funds in-line with some form of an agreement.

Patrick Robins is a Wealth Advisor at Stocks & Securities Limited and can be contacted via probins@sslinvest.com

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