Investment in a mutual fund involves an array of costs in the form of fees paid to the asset management firm, apart from the obvious price or the net asset value (NAV) at which one buys units of a mutual fund.
These charges differ as per the type of funds (equity, debt or money market fund, close-ended or open-ended funds, etc), performance of the funds in terms of returns over a period of time, the fund manager behind the fund, and the asset management firm, among others.
Let's first run through the various charges or fees related to mutual funds in the GCC market. There are broadly six types of fees related to a mutual fund, says Firas Mallah, Head of Middle East, Dexia Asset Management, Manama, Bahrain.
These are administration fee, custodian fee, subscription fee (or upfront charges or entry load or entry fee), redemption fee (or exit load) and management fee. In rare cases, there is a performance fee as well charged by a few fund houses.
However, not all types of fees or charges are generally imposed by all funds in the region. There are some funds that don't impose any entry or exit charges, he added.
Besides, investors may be charged a sales fee, which is intended to compensate the sales agent. In addition, there are various minor fees like trading costs, says Deon Vernooy, Head of Emirates NBD Asset Management.
The total expenses associated with mutual funds are represented by a formula called the expense ratio, which is derived by accumulating all the expenses or fees of a fund and dividing them by the total value of the fund. The total expense ratio captures all the expenses charged by the fund manager and the higher the expense ratio the more expensive the fund is.
The best way to summarise all expenses of a fund is to calculate the expense ratio. It's basically summing up in one figure the total amount of money that it costs to invest in a particular fund, says Mallah.
Analysts, however, add that the expense ratio could be critical in terms of impacting one's investment goals.
It's very critical for an investor to be well aware of the fee structure because commissions or fees can destroy his/her investment performance over time, says Vernooy of Emirates NBD.
However, experts say a fund with low expense ratio doesn't necessarily indicate that it's good for investment. Likewise, a fund with high expense ratio doesn't mean it's bad for investment.
Usually the cost of the fund is not an indication of whether it's good or bad. Rather, it just indicates what the fund manager has decided to charge. The costs are also a function of the type of asset class of the fund or the geographic focus of the investment, says Mallah.
An investor should not necessarily pick a cheaper fund. He also needs to check the performance of the fund, the fund management team, the integrity of the asset management firm, its history, etc. The fee is just one of the measures on which you judge a fund and you should never judge a fund just based on the fee, he adds.
Normally higher-risk funds have higher expense ratios, while low-risk funds have lower expense ratios. So an investor needs to study and make sure whether what his fund manager is charging is right for the type of product he is providing. For instance, a low risk/low return fund shouldn't be carrying high expenses, says Vernooy.
According to the finding of a recent study by Dexia Asset Management, Manama, regional funds generally have a higher fee structure than that of international funds, and the variability is still high. In case of equity funds, for example, the study found that management fees of local equity funds can vary a lot, ranging from 0.45 per cent to 2.5 per cent, with an average of 1.5 per cent of the worth of the fund.
Another characteristic of the regional mutual fund market is that the net asset value of mutual funds is calculated on a variety of basis ranging from daily, weekly, fortnightly, as well monthly basis. Usually, for funds that are more liquid, the NAV is calculated on a daily or weekly basis, while for funds that are less liquid, the NAV is calculated on a biweekly or monthly basis, say analysts.
Nevertheless, they add that a daily NAV calculation gives a better view of a fund's performance. It is also more preferable because it gives more liquidity and an investor can evaluate his position daily and can even exit daily, says Mallah.
Choosing the right fund
One of the factors investors need to know before investing in mutual funds is the objectives and the performance of the fund, experts say.
Investors need to understand where the fund is investing in. So it's important to keep it within the limits of one's financial understanding, says Firas Mallah, Head of Middle East, Dexia Asset Management, Manama, Bahrain. Secondly, it's also important to look at the size of the fund, its track record and its performance.
Besides, it's also important to know the asset management firm and its shareholders. The last, but not the least is the diversification, he adds. Following a diversification strategy pays in the long term and the more diversified you are, the more you are protected against any major losses due to market fluctuations, he says. Understanding one's risk appetite also plays an important role in selecting the right fund, say experts.
The most important factor for an investor is to assess what his risk and return expectations are. Once an investor has worked out his risk and return expectations the next step is to look for funds that match his expectations. For instance, a low-risk investor may look for money market funds or fixed-income funds or even managed balanced funds, while equity funds may not be a good fit for his appetite. The next step is to look for a well-regarded fund management company as well as a good fund manager with solid, consistent returns, says Deon Vernooy, Head of Emirates NBD Asset Management.
Take a SIP
Discipline is a great virtue and when it comes to investing, it is no exception. Following a regular and periodic investment plan such as systematic investment plan (SIP) is one of the ways for disciplined investing, say experts.
Based on dollar cost averaging principle, SIP has emerged as one of the popular ways of investment. However, mutual funds don't normally offer SIP products on their own. Rather, they are offered by bigger platforms or distribution channels, such as banks or insurance companies, where one can select funds and start investing a fixed amount on a monthly basis.
They could be invested in a basket of mutual funds not just one fund, says Firas Mallah, Head of Middle East, Dexia Asset Management, Manama, Bahrain.
Nevertheless, one of the advantages of the SIP approach is that it greatly helps in saving money, say experts. "SIP is an excellent way to save money because of the average cost of your investment. Because of that, an investor is not exposed to the volatility in the stock market. SIP also helps to discipline one's investment pattern and helps to avoid investing all your money at the high point of the market, thus making it a relatively secure method," says Deon Vernooy, Head of Emirates NBD Asset Management.
By Sunil Kumar Singh
© Emirates Business 24/7 2010
