Risk Associated With Unit Trust Funds

There are many possible outcomes associated with an investment and all investments involve some degree of risk. Different classes of assets generally exhibit different levels of risk. It is important to note that it is not always possible to protect your invesments against all risks, as events affecting investments cannot always be foreseen. When investing into unit a unit trust fund, one should be prepared to accept some level of risk and should consider the following risks:

a. Market Risk – The risk of fluctuation in the performance that affect the prices in a particular market. The risk factors such as political change, economic and financial market climates, fluctuations in the interest rate, overseas capital market performances, fiscal policies of the respective countries and inflation will shape the movements of the values of the underlying instruments in the investment portfolio. This will cause the NAV or prices of unit to fall as well as rise.

b. Management Risk – The securities selected by the investment manager may perform better or worse than the overall stock market or as compared to the portfolios selected by the competitors. As a result, lack of knowledge, experience, expertise and poor management techniques may result in an adverse impact on the performance on the fund and thus, the investment to unit holders.

c. Liquidity Risk – Liquidity risk is define as the ease with which a security can be sold at or near its fair value depending on the volume traded on the market. The various securities that are purchased by a fund may encounter liquidity risk. Liquidity risk relates to the fund’s ability to quickly and easily trade, at a reasonable price, in and out of positions. Should a fund comprise a security that has become temporarily or permanently illiquid or difficult to sell, the investment manager may need to sell the security at a discount to its fair value, which eventually affects the fund’s value.

d. Inflation Risk – Ideally the purpose of any investment is to secure returns that are greater than the inflation rate. While a fund will constantly seek to maximise returns and exceed inflation rate, it may occasionally experience losses, which result in returns that will not keep pace with inflation in the short run.

e. Stock or Bond Market Risk - For a unit trust that has stocks or bonds in its portfolio, fluctuations in the market performance due to factors such as fluctuation in interest rates, changes in economic climate, political and social environment that will affect the stock or bond market as a whole, will also affect the value of investment either in a positive or negative way.

f.Interest Rate Risk – Debt securities and fixed interest securities are sensitive to movements in the interest rate. Interest rate fluctuations may be attributed to market risks that affect the level of risk free rate. A rise in the general level of interest rates may result in a decline of the value of debt securities and fixed interest securities. This would lead to a decrease in the bond fund’s NAV. Fluctuations in interest rate that affect the general market may also have impact on the Syariah bases fund. A rise in the general level on interest rates may have an effect on the rate of returns of Islamic debt securities. This could cause the decline of the value of the Islamic debt securities and the fund.

g. Compliance Risk – This is the risk that the manager and others associated with the scheme will not follow the rules set out in the scheme’s constitution and internal policies, or the law that governs the scheme, or will act fraudulently or dishonestly. However, this risk is greatly reduced via stringent internal controls and constant cross-departmental checking employed by the manager. In addition, a yearly or any unscheduled internal audit exercise will be conducted to check any compliance matters that might have been inadvertently overlooked by compliance department. The presence of the trustee whose duty is to ensure that the fund’s investment mandate is complied with will further add to the reduction of such risks.

h. Loan Financing Risk – Investors who take end-financing loans to purchase units in a unit trust fund must be prepared to accept gearing risks as the prices of the units can go down as well as up. The investor may be required to top up the difference in the event the unit price goes below the margin of advance.

g. Credit / Default Risk – Credit risk refers to the possibility that the issuer of a fixed income security or bond may not be able to make interest payments or repay the principal in a timely manner. This will translate to losses that will reduce the value of a fund.

i. Currency Risk – Currency risk is also known as foreign exchange risk. It is risk associated with investments that are denominated in foreign currencies. When the foreign currencies fluctuate in an unfavorable movement against Ringgit Malaysia, the investments will face currency losses in addition to the capital gains/losses. This will lead to a lower NAV of the fund.

j. Country Risk – It is a risk associated fluctuations in foreign securities due to changes in the country’s economic fundamentals, social and political stability, currency movements and foreign investment policies. These factors may have an impact on the foreign investments portion of the fund and the prices of the securities that the fund invested in.

Source
i. http://www.arutm.com.my/The%20Basic%20of%20Unit%20Trust.pdf
ii. http://www.ambmutual.com.my/risk.htm