Unit trusts have equally been attractive to investors particularly individuals and households based on the double digit returns on offer from the funds.
Sh300 billion and growing. That’s the combined value of all collective investment schemes in the country.
Money market funds (MMFs) lead, accounting for almost two-thirds of all funds under management, with some topping 18 percent in return. Can’t blame investors herding into MMFs. Who doesn't need the biggest bang for their buck?
But the CIS universe just got bigger with the recent introduction of special funds. There’s now more optionality and potentially better returns. Essentially, these are “pseudo” hedge funds with the licence to generate risk-adjusted returns in the global markets.
Essentially, there are no major differences compared to the traditional categories (equity, fixed income, MMFs, balanced funds) in structure, administration, operations, et al save for certain distinct flexibilities. For example, while traditional funds are capped at 10 percent investing in alternative investments, special funds can go up to 80 percent.
Further, special fund managers are allowed to use leverage ratios of their choice (so long as it's disclosed in the information memorandum and in their investment policy statements). All the other categories do not allow use of leverage.
In addition, the ability to access global markets adds an important diversification component that is lacking with the domestic alternatives. Altogether, these flexibilities explain why returns here may stand out above the crowd. But therein lies the danger.
“Style drift” - the divergence of a fund from its investment style or objective - has not been an issue locally but may arise especially with special funds having a high degree of market attention (obviously due to above-average returns). As a result of chasing returns, funds may end up having inadequate diversification or unintended overlap among its holdings, leaving investors under or overexposed to certain asset classes - a possible issue with current special funds marketed as “multi-asset” funds.
Now, although style drift may occur naturally due to capital appreciation in one asset class relative to another, investors need to check the schedule of rebalancing is followed. Ensuring that investment positions are in compliance with stated contractual terms will be essential.
Leverage will also be a concern. While advantageous, it can also be deadly. It can increase fund returns in good times, but it can also magnify investors’ losses and their response to bad performance. Investors should therefore monitor leverage (actual funds vis-a-vis gross fund exposure).
Currency risk may be an issue (although one may invest equally in both a USD and a KES denominated funds to neutralise the risk). Other concerns are fees and their potential impact on investor returns.
Charging five percent or more means all in management expense ratios (MER) sit somewhere north of 6 or 7 percent. This is exorbitant. A higher expense ratio means less money is compounded over time. Reasons why we’ll need more players in this space.
Overall, special funds are a great alternative. A much-needed pathway for the local investor to participate in global markets.
Hence, you should know where your money is going, how it is being invested, how you can get it back, what protections apply to your investment and what your rights are as an investor.
