Does your unit trust fund portfolio have risk reduction mechanism in a volatile market?
IN view of the recent market volatility and turbulence, some unit trust fund investors may start to get jittery and worried about how their unit trust funds are performing, particularly those invested in equity funds.
When you experience turbulence during a flight, the captain will switch on the ‘fasten the seatbelt sign”; with a “bing” sound followed by an announcement from the air stewardess, sometimes hastily, asking all the passengers to go back to their seats and put on the seat belt. The use of lavatory is at your own risk.
That’s a risk reduction SOP when there is a turbulence on the air. How about the situation when there is a market turbulence?
The pertinent question to ask now: is there a risk reduction mechanism being built into your unit trust fund investment portfolio?
The popular way many unit trust fund sales promoters are telling their clients is to put your money is multiple unit trust funds, in the name of diversification. The popular idea is ‘putting your eggs in different baskets” to spread out the risk. Diversification
Diversification only works when the funds in a portfolio do not correlate perfectly with each other.
If your money is invested in multiple equity funds of the same market, then it will not work well. For example, if you have Company A Malaysia Growth Fund, Company A Malaysia Equity Dividend Fund; Company B MY Select Opportunity Fund; and Company C Dana Dinamik, then when the Malaysian stock market is down, all the above fund price will come down as they all hold malaysian stocks.
I give you another common example which I have seen in some previous fund reviews for my clients. For example, if you have Company A Asian Equity Fund, Company B ASEAN Equity fund, and Company C Greater China Fund, all these fund prices will drop when emerging markets are impacted negatively. That’s what happened recently when the foreign funds exit the emerging markets due to the rise in USA interest rate.
In other words, When you have funds which are exposed in similar stock markets, then diversification or holding a basket of funds will not work well for you. For diversification to work well for you, the funds must have low correlation with each other.
As I have mentioned in my previous articles, there are basically two types of averaging strategy: Dollar Cost Averaging (DCA) and Value Averaging (VA). VA is ideal because it can take better advantage of market volatility. Moreover it is more versatile whether one invests in lump sum (cash investment) or is using EPF quarterly withdrawal scheme. Value averaging
In the value averaging strategy I am using a combination of both strategies: portfolio diversification as well as value averaging. It is easier to illustrate with an example.
In Table 1, the fund portfolio is down 17.62 per cent in the past one year. However, the VA portfolio of my client is only down 9.86 per cent. thus by combining both diversification – using two funds with low correlation – as well as VA, the downside risk is reduced. The correlation between the two funds I am using is between 0.22 and 0.38.
With VA, my client can take better advantage of the market volatility, especially in a market down trend. When the volatile fund price continues to go down trend, VA method will help to value average the volatile fund.
This will continue to further bring down the average unit price of the volatile fund. When the market is on the uptrend again in future, there will be an opportunity to take profit when it reaches the pre-set profit target.
For your unit trust fund review, contact Lee Khee Chuan ChFC,CFP,CLU,FLMI,B. A.(NUS),aBankNegaraMalaysialicensed financial adviser representative and Securities Commission-licensed financial planner (CMSRL/B1602/2011) at 016-888 0138 or leekheechuan@ gmail.com.