Risks Every Unit Trust Investors Should Know

In personal finance and investments, the term "risk" often evokes a sense of dread, much like the thought of a 10-year-old behind the wheel of a Perodua Kancil on a busy highway. But what if I told you that risk, much like driving, is not inherently dangerous—it's the lack of understanding and preparation that makes it so?

Imagine Lewis Hamilton, Formula 1's multiple-time world champion, cruising at an average speed of 223 km/h. It sounds perilous, but in reality, it's calculated and relatively safe. Why? Because Hamilton understands every nuance of his car, the track, and the conditions he's driving in. The biggest risk, whether in driving or investing, is not knowing what you're doing.

This article aims to be your Lewis Hamilton of unit trust investments. We'll navigate through the intricate turns and high-speed lanes of risks involved in unit trust investments in Malaysia. By the end of this read, you'll understand what you're getting into and how to lower the risks involved, ensuring a smoother and safer financial journey ahead.

Ready to put the pedal to the metal?

The Paradox of Unit Trusts: Safety Yet Risk

Unit trusts are pooled investments that are well-diversified and managed by professionals. The idea is not to put all your eggs in one basket, making it a safer investment option. However, despite these safety measures, many people still end up losing money.

Why is that? Let's delve deeper to find out.

The Number One Risk: Diving In Without a Life Jacket

The Malaysian unit trust industry is a behemoth, boasting over 700 funds and a net asset value exceeding RM500 billion as of September 2021. With top-performing agents raking in commissions and bonuses exceeding a million Ringgit annually, it's no wonder the industry attracts much attention.

However, this allure can be a double-edged sword, especially for the naive investor.

The number one risk in unit trust investment is diving in without fully understanding what it entails. It's too common for inexperienced investors to get swept up by persuasive sales pitches from seasoned agents. While these agents may be experts in their field, their primary goal is often to earn commissions, not necessarily to safeguard your financial well-being.

So, before you take the plunge, make sure you know how deep the water is.

Risk Number 2: The Emotional Rollercoaster of Investor Temperament

Investor temperament plays a crucial role in the success or failure of unit trust investments. The ideal strategy is to buy more when the market is down, but emotions often get in the way. Picture this dialogue between an agent and an investor:

Agent: "The market is down right now, making it an excellent opportunity to buy more units at a lower price."

Investor: "I'm hesitant. What if the market continues to fall? My portfolio is already down and you asked me to top up? for more losses?"

In such scenarios, agents find it challenging to make a sale, especially when their funds show negative returns.

The opposite is also true. When the market is high, buoyed by strong past performance, investors are more easily convinced to jump in. This is where the FOMO (Fear of Missing Out) effect comes into play. Everyone shows confidence, and no one wants to be left out of the 'winning streak.' But remember, what goes up must come down, and it's essential to keep your emotions in check to make rational investment decisions.

Risk Number 3: The Hidden Toll Gates of Fees

In the world of unit trusts, the saying "there's no free lunch" couldn't be more accurate. Every investment comes with its own set of fees, and these can quickly add up. Upfront sales charges range from 1-5%, meaning you're already at a loss before your investment journey begins.

But the tolls don't stop there. Ongoing recurring fees ensure that the agent's wallet gets fatter, regardless of how your portfolio performs. This misalignment in compensation creates a conflict of interest. It's like a game of heads or tails where the banker always wins, no matter the outcome.

Take, for example, Warren Buffett's famous bet against hedge funds, favouring a simple ETF instead. Buffett won the bet, and the reason was simple: the fees. Hedge funds, with their high expense ratios, were like toll gates on a highway, eating into the returns over time.

So, as you navigate the investment highway, be wary of these toll gates. High fees can significantly impact your returns, making it crucial to keep an eye on them.

Risk Number 4: The Unpredictable Waves of Market Risk

When it comes to unit trust investments, there's no immunity against market risk. Just as the sea is never still, market fluctuations are a given. Different funds come with different themes, exposures, strategies, and, consequently, varying levels of market risk.

For instance, if you invest in a fund focused on China, you're also buying into the risks associated with government interventions in businesses. These are elements entirely out of your control, much like a surfer can't control the ocean's waves.

Understanding that market risk is an inherent part of the investment landscape can help you make more informed decisions. While you can't control the market, you can manage your reactions.

Risk Number 5: The Shifting Sands of Management Risk

Good fund managers are a rare commodity, much sought after in the industry. They're often headhunted and may move from one fund house to another, chasing better opportunities. This presents a unique risk for investors: management risk.

You might invest in a fund because it has performed exceptionally well under a particular manager. However, by the time you invest, that star manager could have moved on to greener pastures, leaving your fund in the hands of a new manager whose capabilities are yet unproven.

In essence, the fund's past performance, which could have been a significant factor in your decision to invest, may not be indicative of future results, especially if there's been a change in management. Watching who's steering the ship is crucial, as it could significantly impact your investment journey.

Expected Returns: The Art of Managing Expectations

In the Malaysian unit trust landscape, expected returns can vary widely. Conservative funds may offer returns in the ballpark of 3-5%, while more aggressive, equity-based funds could aim for 8-12% or even higher. However, it's crucial to remember that these are merely ballpark figures, not guarantees.

A quick search on platforms like FSMOne as of September 2023 reveals some sobering statistics. Out of 267 funds with a 10-year track record available on the platform, only 17 yielded returns greater than 8% per annum. That's less than 6.4% of the total funds with a decade-long history.

So, if you're considering adopting a "buy and forget" strategy, the odds aren't in your favour. It's akin to attempting a 3-pointer in basketball without knowing how to shoot; the chances of hitting your desired returns are slim.

Therefore, active engagement and regular portfolio reviews are vital to achieving your financial goals.

Conclusion: The Roadmap to Satisfactory Profits

Navigating the complex world of unit trusts is not for the faint-hearted. However, with the right tools and mindset, you can elevate your chances of making a satisfactory profit.

Here's a quick recap of the essentials:

Be a Good Investor: Educate yourself and understand the risks involved. Knowledge is your best defense against making costly mistakes.
Right Temperament: Keep your emotions in check. Whether the market is high or low, a level-headed approach will serve you well.
Dollar-Cost Averaging: This strategy involves buying a fixed dollar amount of a particular investment on a regular schedule, regardless of its price. It's a disciplined approach that can mitigate some of the risks associated with market volatility.
Know Your Fund: Make sure you're comfortable with what your fund is buying. If you don't understand an asset, it's probably not a good idea to invest in it.
Be Fearful When Others Are Greedy: This timeless wisdom from Warren Buffett is especially relevant in unit trusts. When everyone jumps on the bandwagon, it might be time to take a step back and assess the situation.

By incorporating these principles into your investment strategy, you're not just playing the game. You're playing it wisely. And in the long run, that will set you apart on your journey to financial freedom.