The objective of the portfolio of a fund is to generate returns over a period.
The team works hard to ensure that the portfolio generates as high returns as possible. They research the market, analyze trends, make forecasts and accordingly choose where to invest the money to extract the most of it.
There are expenses associated with running the fund: fund management fee for the team of managers and researchers, operational costs, marketing expenses, etc.
After deducting these expenses, the remainder belongs to the investors in the fund.
So, the return you earn in a fund depends on two factors: (a) return the portfolio generates, and (b) the expense of running the fund.
Let’s look at a simple illustration:
AUM: EGP 100 million
Gross return over one year 10%
Fund management fee: 0.5%
Sales expense: 0.6%
Other fixed expenses: EGP 0.3 million
So, the total expenses are EGP 1.4 million (= 100 * 0.5% + 100 * 0.6% + 0.3)
Hence the total expense of running the fund as a percentage of its AUM: 1.4% (= 1.4 / 100)
Net return to the fund investors: 8.6% (= 10% - 1.4%)
MATCHING MUTUAL FUNDS WITH NEEDS & WANTS
Depending on your investment objective, you may choose the type of mutual fund(s) you wish to invest in. Each type carries its own pros & cons.
Types of mutual fund
An equity fund invests in shares.
Its value swings, based on the prices of these shares.
These funds carry the highest market risk among the three asset classes(Equity; Bond; Money Market Instrument).
In the long run, equity shares are likely to give the highest returns, but their short-term ups & downs mean that they are not suitable for short investment horizon (say less than three years).
A bond fund invests in bonds issued by the government or a company.
Its value is the agreed upon the agreed upon interest or return; their price may also go up and down due to change in interest rates. If the market rate fluctuates erratically due to market factors, the short-term returns may be affected.
Depending on the bond different bonds carry different credit risk according to the probability of default.
Typically, the bond funds are less risky than equity funds, but they may also earn less returns in the long term. Bond funds are more suitable for people with less risk appetite or a medium-term investment horizon.
A money market fund is the safest asset class, as it invests in short-term debt instruments and typically in T-Bills issued by a government. Hence, they carry negligible credit risk (as they carry the sovereign risk) and minimal market risk (i.e. their prices don’t move wildly with a change in interest rates).
A balanced fund, as the name implies, has portfolio which is a mix of equity and bonds. its potential returns are between a bond fund and an equity fund, and so is the potential risk.
The above is just a high-level primer to different types of funds. As we go further, we would talk about the next level details, such as different types of equity funds, etc.
HOW TO CHOOSE A MUTUAL FUND
Your choice of mutual fund(s) depends on your investment objectives and your risk appetite.
Time Horizon and Risk Appetite
Short term investment: If you wish to invest your money for a short period, say less than one year, then you may like to go for a money market fund. It is the lowest risk asset-class and offers substantially better return than a typical bank account.
Medium term investment: If your investment horizon is medium term and you have low risk appetite, you may like to go for a bond fund or money market fund, depending on your desired liquidity and risk appetite.
Typically, a bond fund may offer slightly higher return than a money market fund, but it has its cons too. The first is the liquidity feature, it may not be as convenient to purchase or redeem a bond fund as a money market fund. The second is that as the general interest rates go up, the bond fund prices may come down (the price of a bond moves in inverse direction to the interest rate).
Long term investment: If your investment horizon is long term, say over three years, and you have medium to high-risk appetite, you may go for an equity fund. Though shares prices swing a lot during a short period, in the long term they are likely to earn higher returns than other asset classes.
You may discuss with your fund-manager and even consider balanced fund – a mix of equity and bonds. The potential returns are between a bond fund and an equity fund, and so is the potential risk.
Your fund manager might suggest a mix of equity fund, bond fund and money market fund in your portfolio. You can calibrate their proportionate composition depending on your changing risk appetite and investment horizon.
Other Things to Keep in Mind
Ease of accessing your money: Learn the exact time required to purchase or your certificates. This key element would dictate how quickly you start earning return on your deposits, and how quickly & conveniently you can access your money when you need it. Some funds may allocate the certificate on purchase, and return your money on redemption, after as much as one week if not more.
Service Quality: The fund manager must be accessible to discuss your requirements and facilitate processes accordingly.
Expense ratio of the fund (i.e. the cost of running a fund): There are different types of expenses associated with running a fund such as fund management fee, sales fee, etc. Ultimately your net return depends on two things: a) the gross return earned by the fund on its assets and b) the expenses that would be deducted. So lower expenses mean higher net return for you.
Credibility and track record of the fund manager: All fund managers in Egypt are licensed and regulated by the FRA, so you can have peace of mind on that front. Still, you would like to check their track record, the size and types of funds they manage, before entrusting your money with them.
