Investment Risk and Unit Trusts

All investing entails a greater or lesser degree of risk. It is useful to analyse the risk factors in your investment class and be clear on what weight they hold in your investment decisions.

The Risk Spectrum of Unit Trusts

Risk Factors Include :

• The higher the risk, the more likely that the  investment can decline in value.
  Many unit trust managers would be satisfied, in a declining market, if their unit trust declined less than the market as a whole.  My approach is to avoid significant declines altogether if possible by switching funds and making clients aware of what funds to switch too, even if it means that they change their risk profile.
• The lower the risk, the more likely it is  that you do not participate in a significant up move in an asset class. 
  This holds true particularly for equities. Much of the total return by the JSE over time comes from a few relatively short and sharp movements. Should you miss these, not only can your returns suffer, but investors are then often sucked into increasing their equity exposure when the market is more highly valued and more risky. Returns are then often hard to come by.
• The risk that the unit trust you invest in under performs the market as a whole, which is why I tell my clients to contact me every 6 months to reassess our fund choices.
• Sector or theme based unit trusts are generally higher risk than general equity unit trusts (refer to the graphic above), because their investment mandate encourages a narrow focus, and will often not allow the fund manager to move out of their sector if it is underperforming. 
• Money Market unit trusts are often viewed as risk free. However, if interest rates are low, there is certainly risk of losing out on better returns elsewhere. If the money market instrument involves an entity that goes insolvent, the fund can underperform. A Money Market fund that is diversified across money market instruments from different institutions lowers this risk considerably.
• Market volatility (rapid up and down moves) is a risk, particularly for investors who need a regular income, or need to realise capital at short notice. This risk can be exarcerbated by the tendency to panic and sell investments at the bottom of the decline. In making the selections for our Managed Portfolios, we attempt to give preference to unit trusts which have lower volatility, all other factors being equal.