Looking where to invest: Mutual funds

Mutual funds have become a pivotal part of every investor’s portfolio due to their potential for generating decent returns and lowering risk through diversification. They offer a convenient way for novices and experienced investors alike to invest in a diversified portfolio of bonds, equities, or other securities. According to Statista, the value of mutual assets under management in the Philippines in 2020 was estimated to be worth 40.6 billion U.S. dollars¹, indicating a growing and vibrant mutual fund industry. This development has been supported by an increase in financial literacy, digital platforms granting easy access to mutual fund investments, and a favorable economic environment.

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So What are Mutual Funds?

Mutual funds pool money from multiple investors to invest in a diversified portfolio managed by investment professionals. They come in various forms – equity, fixed income, money market, balanced, index, and specialty funds, each with unique characteristics, risk profiles, and potential returns.

By spreading the investment across a range of securities, mutual funds help to mitigate risk while providing the potential for substantial returns. Whether for novice investors looking for a straightforward entry into securities investment or experienced investors aiming to diversify their portfolio, mutual funds represent a versatile and accessible option.

Advantages of mutual fund investing include: 

• Advanced Portfolio Management: Mutual funds are managed by seasoned professionals who make business decisions based on extensive market research.
• Diversification: With mutual funds, your money gets spread across a wide range of investments, which can mitigate risk.
• Dividend Reinvestment: Most mutual funds provide the option to automatically use dividend payouts to purchase more shares.
• Convenience: Mutual funds are easy to buy and sell, making them convenient for many investors.
• Liquidity: Mutual funds, unlike some other investment vehicles, can be bought or sold any business day, offering high liquidity.
• Fair Pricing: Mutual funds are priced at the net asset value (NAV) per share, which ensures fair pricing.
• Range of Choices: There are thousands of mutual funds available in the market targeting different sectors, themes, and risk levels.

Mutual funds in the Philippines are regulated by the Securities and Exchange Commission (SEC), ensuring that they operate under strict guidelines and that investor interests are protected. However, just like any other investment, investing in mutual funds also involves risks, and potential investors are always encouraged to thoroughly research and understand these risks before investing.

Types of Mutual Funds

Equity Funds

Equity Funds are a type of mutual fund that invests in stocks or equities. As part of their investment strategy, they can be either actively or passively managed, the latter often referred to as index funds. These funds typically gather money from a multitude of investors to purchase shares in different public companies, and by doing so, enable the investors to hold a diversified portfolio of equities

The purpose of Equity Mutual Funds is to offer investors the opportunity for long-term capital appreciation from a portfolio dominated by equity investments. Since these funds are invested in stocks, they have the potential for higher returns compared to debt funds or money market funds, making them suitable for investors with a higher risk tolerance

Passive vs Active Management

Equity funds can be managed either passively or actively. Passive management, often associated with index funds, follows a “buy and hold” strategy. The primary goal of a passively managed equity fund is to mimic the performance of a specific market index. Because these funds require less frequent trade decisions, they tend to have lower management fees

On the other hand, actively managed equity funds involve fund managers making strategic decisions about which equities to buy or sell with the goal of outperforming a certain benchmark. This approach necessitates a more hands-on style of management and often results in higher fund fees due to the activity and expertise required for managing the fund

Fixed Income Funds

These funds invest in bonds and other debt instruments, such as mortgages and corporate notes. They’re typically safer than equity funds but don’t offer the same growth potential over time.

The primary purpose of Fixed-Income Mutual Funds is to provide regular and steady income to investors while aiming to preserve the principal. They can be an excellent tool for portfolio diversification due to their different risk-return characteristics compared to equity funds. The stability of income and lower risk relative to equities makes them suitable for conservative investors or those nearing retirement.

Types of bonds

Government Bonds: These are issued by national governments and are often referred to as “sovereign debt.” Government bonds are typically backed by the faith and credit of the government concerned, making them generally considered to be low-risk investments. 

Corporate Bonds: These are debt securities issued by corporations or businesses to finance their operations, expansions, or other ventures. The risk and return profile of these bonds can vary widely and is primarily based on the creditworthiness of the issuing company. They may pay higher interest rates than government and municipal bonds, reflecting the higher risk.

Credit quality & duration

Fixed-income funds hold a range of bonds that are differentiated by two primary factors: credit quality and duration. Credit quality relates to the creditworthiness of the issuer, in other words, the issuer’s ability to meet its debt obligation while duration is a measure of a bond’s sensitivity to changes in interest rates. In general, the longer a bond’s duration, the greater its sensitivity to interest rates. These factors can significantly influence the risk and return profile of the fund. Investors should consider these aspects in accordance with their risk tolerance and investment goals.

Money Market Funds

These funds invest in short-term debt instruments that have relatively low risk but also low returns compared to other types of investments like stocks or bonds; money market funds are often used by investors looking for a safe place for their cash while it’s not being used for anything else right now (for example if you’re saving up for something).

They are intended to generate better returns compared to conventional bank savings or money market savings accounts. These funds invest in debt securities characterized by short maturities and minimal credit risk.

Investors often use MMFs for different purposes, such as holding money they’ll need soon, whether it’s for an upcoming purchase or as part of a spending fund. Money market funds could also form part of an emergency fund since they’re generally both safe and easily accessible.

Characteristics

Safety and Low Risk: MMFs invest in short-term, high-quality debt securities like Treasury bills, commercial paper, or certificates of deposit.

High Liquidity: Money market funds are focused on short-term debt securities, so investments typically have maturities of 13 months or less.

Stable Net Asset Value (NAV): MMFs aim to maintain a stable NAV, typically at $1 per share.

Lower Returns than Long-term Fixed-income or Equity Investments: Due to the low-risk nature of MMFs, they usually offer lower returns than long-term fixed-income or equity investments.

Variability in Yields: With money market fund yields closely tied to short-term interest rates, changes in these rates directly impact fund returns.

Taxable and Tax-exempt Funds: MMFs can be divided into taxable and tax-exempt categories.

Balanced/Hybrid Funds

Balanced or Hybrid Funds are a type of mutual fund that invests in a mix of asset classes, such as equities and fixed-income securities. Their purpose is to provide a balance between risk and reward and to offer diversification benefits to investors within a single holding. By investing in both debt and equity securities, balanced funds can generate income and capital gains while mitigating the risks associated with investing solely in one asset class.

These funds aim to achieve long-term capital growth and also provide regular income through a combination of equity and debt investments. They are suitable for investors looking for an intermediate level of risk, as they can diversify their portfolios by investing in both asset classes simultaneously.

Depending on the fund’s equity exposure, the taxation of capital gains may be similar to either equity or debt funds. Balanced funds, also referred to as hybrid funds, are typically more tax-efficient than purely debt-based investments

Index Funds

Index Funds are a type of mutual fund or exchange-traded fund (ETF) designed to replicate the performance of a specific market benchmark or “index”. They follow certain preset rules to mirror the holdings and performance of the specified index. For instance, BPI Asset Management offers a BPI Philippine Equity Index Fund. This fund is designed to closely represent the performance of the Philippine Stock Exchange Index (PSEi).

The primary purpose of an index fund is to passively track an index’s performance, rather than attempting to outperform the market by active management. It works on the idea of diversification, aiming to reduce risks this way. Since they are designed to match the market rather than beat it, their expense ratios tend to be lower than those of actively managed funds.

Investors generally use index funds for their low costs, broad diversification, and the potential for long-term growth. These advantages make index funds a popular choice among investors for retirement savings and other long-term goals.

Specialty or Sector Funds

Specialty or Sector Funds are a type of mutual fund or exchange-traded fund (ETF) that focuses on a specific industry, market sector, or region. These funds invest exclusively or predominantly in companies within certain segments of the economy or specific types of businesses.

The primary purpose of sector funds is to offer investors targeted exposure to a particular industry or sector, allowing them to potentially capitalize on returns of that sector. This focused approach can provide investors with an opportunity for higher returns based on the performance of a specific sector. However, it’s essential to keep in mind that investing in a sector fund may also increase risk due to the lack of diversification and the fluctuations of the particular sector.

How to Start Investing in Mutual Funds

When you’re ready to start investing in mutual funds, there are several steps you should follow. Here’s a step-by-step guide to get your mutual fund investment journey started:

1. Identify your Financial Goals: Understand why you are investing. Your goals could range from buying a house, saving for retirement, funding your child’s education, or just growing your wealth. This step will help you determine how much to invest and the kind of mutual funds that align with your objectives.
2. Assess your Risk Tolerance: Different funds have varying degrees of risk. Assess your ability and willingness to lose some or all of your original investment in exchange for greater potential returns.
3. Research: There are numerous mutual funds available, each with different strategies, asset classes, and risk levels. Doing your research or consulting with a financial advisor can help you understand the different options available.
4. Choose the Right Fund: Based on your risk tolerance and financial goals, select the most suitable mutual fund. It can be equity or debt funds, index funds, balanced funds, or specialty/sector funds.
5. Decide on Investment Method: You can choose a lump sum investment or a systematic investment plan (SIP). SIPs allow investors to contribute a fixed amount at regular intervals, and it’s a popular choice for those looking for discipline and simplicity in their investment plan.
6. Open an Account: Register with a mutual fund company or through a broker/online platform. You’ll typically need to provide some personal details, identification, and link a bank account.
7. Buy Units: Once your account is set up, you can start buying units of the mutual fund. Monitor your investments regularly to ensure they are helping you reach your financial objectives.

Tips for Successful Mutual Fund Investing

Successful investing in mutual funds requires careful planning, research, and a level-headed approach. Here are a few tips:

• Understand Your Investment Goals: Identify what you’re investing for. Whether it’s long-term goals such as retirement, or short-term goals such as a down payment on a house. Your goals will guide your investment choices and timelines.

• Diversify Your Portfolio: Spread your investments across various types of assets and sectors to lower risk. A balanced portfolio reduces the impact if one sector performs poorly.
• Consider Your Risk Tolerance: Understand how much risk you’re willing to take. High-risk funds can yield higher returns but may fluctuate more in its value.
• Invest Regularly: Regular investments, often monthly through a Systematic Investment Plan (SIP), can be a good way to grow your investment over time.
• Focus on Long-Term Growth: Mutual fund performance can fluctuate in the short term. Be patient and keep a long-term outlook.
• Review and Rebalance Regularly: Regularly review your investments to assess their performance against your goals. Rebalance your portfolio as needed to maintain the asset allocation that is appropriate for your risk tolerance and investment timeline.
• Understand Fees and Tax Implications: Be aware of the expense ratio and any other fees associated with the fund. Also understand the tax implications of your investments.

Remember, while mutual funds can offer a relatively simple way to achieve diversification, they are not without risks. It’s always a good idea to speak with a financial advisor if you are unsure about making these kinds of investments.

If you are not happy with your investments, there are a few things that you can do. Consider investing in a different mutual fund. In addition to being able to choose between different types of funds (sector funds or income funds), there are also many different options within each type. For example, if one sector fund has performed poorly over the past few years but another has done well, then it may be worth considering switching from one to another.

If you have an advisor who manages your portfolio and they suggest making changes based on their analysis of the markets, then listen closely and consider following their advice–but don’t feel obligated! If something feels off about their recommendation or logic for making it (e.,g., “I think we should sell this stock so I can buy another one”), trust yourself enough not go along just because someone else told you so; instead ask questions until understanding is achieved before making any decisions about where money goes next.

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