Monday, March 31, 2008

Potential Risks of Investing in Unit Trust Scheme

Market Risks
As unit trust funds generally invest in listed securities, they may be susceptible to fluctuations in the performance of the stock market. Changes in the economic, political and sosiological environment will affect the stock market and changes in the share prices will then affect the price of the unit.

Specific Risks
Risk that are specific to individual companies or shares that a unit trust fund may have invested in rather than the market in general.

Fund Management Risks
The selection of the securities which make up the assets of the unit trust fund is a subjective process and hence, securities selected by the manager may perform better or worse than the overall market, or as compared to other unit trust funds.

Management Company Risks
This risk refers to the possibility that the manager may not adhere to the investment guidelines or restrictions of a unit trust fund. Poor management of the investments of the unit trust fund may jeopardise the investment of the unitholders.

Credit/Default Risk
Fixed income instruments such as bonds, term deposits and debentures constitute credit risk if the institution invested in is not able to make the required interest payments or repayment of principal.

Interest Rate Risk
The interest rate risk is particularly significant in bond funds as the investments made by the bond funds generally depend on forecasting movements of the interest rate. Prices of the bonds generally move inversely to the interest rate which means that as interest rate rise, prices of bond will decline and vice-versa.

Liquidity Risk
This refers to the fund's ability to quickly and easily trade, at a reasonable price into and out of positions. The bond and/or private debt securities market is not as liquid as the equity market.

Inflation Risk
This risk refers to the risk that the value of the unit trust investment may be eroded if inflation is constantly higher than the rate of returns on investments.

Financing Risk
This risk occurs when investors take a loan to finance their purchase of units of a unit trust fund. In the event that the value of their investments drop to a certain level, the financier may require additional collateral and the investor may be unable to meet the requirement.

Regulation of Unit Trusts
Only unit trust schemes which are approved may be offered for sale to the public. Such schemes must comply with requirements stated by government. In some countries it is primarily regulated by the Securities Commission.