by Vasu Menon 04:45 AM Dec 24, 2011
Article from Today Online
The world has gone through dramatic changes since the sub-prime financial crisis in 2007. We are now at the onset of a "new normal" or a new global reality where significant changes to the global economic and investment landscape will be seen in the coming years.
Governments and banks in the United States and Europe are reeling from a mountain of mortgage and sovereign debts and large budget deficits. As they tighten their belts to deal with these issues, Western economies are likely to feel the strain and could turn in sub-par growth rates for several years. Financial markets are also likely to face greater uncertainty, which means that volatility will remain a fixture for several years.
All this means that investors have to tread carefully when making decisions in the "new normal". Between 2003 and 2007, making exceptional profits in equity markets was possible. Today, with a myriad of problems facing major economies, investors have to realise that the world will not grow as rapidly as it did and there are no quick fixes to the deep-seated problems facing the US and Europe.
However, the new global financial reality is not a doomsday scenario; neither is it a warning against making investments. On the contrary, people should not be too spooked by the recent downturns. Many investors are sitting on a pile of cash and are afraid to invest. Uncertainties will not go away any time soon but does that mean that investors should sit and wait? This is clearly not a time to trade excessively or time the market but perhaps a time to buy selectively and gradually over several months.
Unit trusts: can they help better manage risk?
One good way of investing in the "new normal" is through unit trusts which can offer several advantages that help investors to better manage risk.
Unit trusts are collective pools of funds that invest in different underlying instruments and appoint professionals to manage the investment decisions and risks.
The underlying instruments range from less risky investments like bonds and money market instruments to more volatile ones like equities. However, not all equities are equally risky. For instance, those that invest in shares that offer higher dividend payouts may be more resilient than the lower yielding ones.
So what are some of the key advantages of investing in unit trusts, especially in times of uncertainty and market volatility?
While it is impossible to remove investment risk, you can minimise it by diversification. Unit trusts typically invest in a pool of securities, which carries less risk than buying an individual security. In addition, you can choose to spread your risks further by investing in different types of unit trusts.
Another advantage of unit trusts is that they are affordable to most retail investors because you do not need a lot of money to invest in them. This allows for dollar cost averaging which is effectively time diversification, as investors stagger their purchases and buy gradually over time in volatile markets.
A key benefit of investing in unit trusts is that you have professional fund managers, with the expertise and resources, actively managing your money for you.
Unit trusts also allow retail investors to invest in overseas markets and certain assets that may be normally inaccessible to them.
For instance, most bond markets are institutional in nature and may not be directly accessible to retail investors, thus making unit trusts a good alternative route.
Most unit trusts are also highly liquid investments. You can buy and sell as much as you want of most unit trusts as unit trust managers are generally obliged to accommodate your needs. This is unlike buying and selling a stock which may be illiquid because it is not actively traded.
A few things to note
But when investing in unit trusts, remember that they are medium- to long-term investments.
Remember also that unit trusts are not immune to external shocks and other major global events, which affect almost all kinds of investments, including individual stocks, properties and other assets, and not just unit trusts.
Nevertheless, there are unit trusts that have made money even in difficult periods, which underlines the fact that unit trusts can offer good returns, provided you pick the right ones.
Ideally, you should also spread your investments across different types of unit trusts to further diversify the risks. Experts call it asset allocation, a strategy used to control risk in your portfolio, working on the basis that different asset classes react differently to changes in market conditions such as inflation and interest-rate volatility.
For instance, a unit trust that invests in bonds, although less rewarding, can provide a buffer against the risks of the more volatile asset classes like an emerging markets fund.
In summary, the headwinds that have affected financial market in recent years do not look like they will go away any time soon.
Politicians and policymakers in Europe and the US will have a significant bearing on the investment outlook for markets. How they react to problems in their regions remains a big uncertainty that promises more volatility in the coming years. Despite this, it is still possible for you to grow your wealth in the "new normal", if you invest carefully and prudently.
Vasu Menon is the head of content and research for Wealth Management Singapore at OCBC bank.
Article from Today Online
