Types of Mutual Funds and UITFs (Part 1)

Labels: Mutual Funds, UITFs on Wednesday, June 3, 2009 at June 03, 2009

In my previous post "Investing in Mutual Funds and UITFs," I talked about what funds are and the advantages and disadvantages of investing in Mutual funds and Unit Investment Trust Funds. I was elated to see that one of my readers left a comment on the said post (You're comments are very welcome ^^). He said that a problem with Mutual Funds is that investors don't have control as to where the money will be invested. And that after buying your shares, all you can do is sit back and cross your fingers and hope that the value go up. While I generally agree that investors have no control as to where the money will be invested that really is not the whole story. In this article I will be discussing the different types of investment funds available. I have also included snapshots from different BPI investment funds to help explain the different types of investment funds more clearly. I hope this article will help expand your knowledge about Mutual Funds and Unit Investment Trust Funds. (Even my MBA professor recommends these for investors who don't have the time to monitor the market)

In general, there are 5 basic types of funds: Money Market Funds, Fixed Income Bond Funds, Equity Funds, Balanced Funds, and Index Funds.

Money Market Funds

Money Market Funds invest in short-term debt securities. This is why it is sometimes referred to as Short-Term Fund. Short-term debt securities are fixed income instruments with remaining lifetime of (/maturing in) less than a year. Usually these funds aim to perform better than short-term time deposit rates in the market.

The key terms here are "fixed income" and "short-term." Since these types of funds are limited to investing in fixed income instruments they are not allowed to invest in equities (stocks). Fixed income securities are securities that offer a fix rate of return. They are called "fixed income" because the investor receives a fixed amounts of interest over a period of time. Among these are Treasury Bills, Corporate Bonds, Notes, Commercial Paper, and Regular and Time bank deposits, to name a few. The term short-term signifies that these securities are maturing in less than a year. Given their short-term nature, the securities are less affected by fluctuations of interest rate in the market. That means their rates are pretty much stable.

To illustrate this further, look at the Portfolio composition of the BPI Short-Term Fund (UITF) as of April 31, 2009 below. As you can see, 64% of the funds are invested in Cash and Deposits while the remaining 36% are invested in short-term Government securities. 21.3% of the fund is invested in a BSP Special Deposit Account with an interest rate of 4.9375% p.a. maturing on 5/31/2009 (short-term).

Investing in this investment fund is really just like putting your money in a savings or time deposit account. However, in addition to that, you get the benefits of being able to invest your money in BSP Special Deposit Accounts, Treasury Bills, and other investment instruments with higher yields that may not be available to you due to a limited amount of money for investing. BSP Special Deposit Accounts and Treasury bills are relatively risk-free as they are guaranteed by the government. Therefore in theory, this investment fund should guarantee returns for you. And I tell you, it really will. The risks involved are very low. However, BPI won't tell you that because being a UITF, BPI is obligated to inform its investors that returns are not guaranteed. They are also obligated to tell you that UITFs are not insured.

The year-to-date (YTD) return of BPI Short-Term Fund as of April 30, 2009 is 1.26%. If the fund continues to perform the same way, the projected return for 2009 will be 3.78% (1.26% x 3), which is about the same or higher than 1 year bank time deposit rates. Furthermore, this return is already after-tax (after management fees as well) as opposed to the time deposit rate which will still be taxed.

Fixed Income Bond Funds

Fixed Income (Bond) Funds, like Money Market Funds, invest in fixed income instruments. The main difference between the two is that Fixed Income Bond Funds not only invest in short-term securities but also medium-term and long-term instruments. Being long-term in nature, these investments are much more affected by interest rate fluctuations compared to short-term instruments. However, being able to invest in long-term instruments means much higher interest rates as well. Fixed income instruments are also less risky than stocks.

To illustrate this further, please refer to the Portfolio Composition of ALFM Peso Bond Fund (Mutual Fund) as of April 30, 2009. As you can see, majority of the fund is still invested in government securities. In addition, a portion of the fund is invested in Corporate Loans and Receivables. In this fund, investing in Corporate Loans present an additional risk. There is always the risk of the corporation going bankrupt and not being able to repay the loan. Therefore it would be good to check which corporations your fund manager has decided to invest in. If you don't like the list, you can always opt to switch to a different mutual fund.

The YTD return of ALFM Peso Bond Fund as of April 30, 2009 is 1.79%. If the fund continues to perform the same way, the projected return for 2009 will be 5.37% (1.79% x 3), which is higher than the projected return for the BPI Short-Term Fund.

If you are looking for a UITF instead of a Mutual Fund of this type, BPI offers the BPI Premium Bond Fund. The YTD return of this investment fund as of April 30, 2009 is 1.89%.

You might want to opt for UITFs because in most cases, UITFs have lower Minimum Investment requirements, shorter Holding periods, and lower Early Redemption Fees. Based on my experience though, Mutual Funds appear to be more stable and better managed compared to UITFs.

Please note that the Holding period doesn't mean you won't be able to withdraw your investments during that period. The holding period only signifies the period where in you will incur an Early Redemption Fee if ever you decide to withdraw your investments. Investment funds implement this because too much early withdrawals affect the fund's investment portfolio. If a lot of money is withdrawn from the fund at the same time, the fund managers will be forced to sell investments even before their maturity date, possibly incurring losses in the process.

This completes part 1 of this article. The other types of investment funds will be discussed in the next part which will be posted in the coming days. In order not to miss part 2 of this article, please subscribe to my newsletter for free.