Risk of investing in Unit Trusts
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Is there risk in investing in unit trusts?
For every investment vehicle, there are risks involved. So does investing in unit trust. Most investors thinks that unit trust offer good diversification but investors have to note that diversification reduces unsystematic risk. There are still systematic risks borne by unit trust investors. As part of investors' education is to know what is the risk involved when they invest in unit trusts. The objective of this article is to list the risk involved in when investors invest in Country- Specific or Sector-Specific Unit Trusts and also define the differences and the extent of each risk to each type of unit trust.
Types of Risks
Repatriation Risk
As most of the unit trust need to repatriate their cash back, they may meet with regulations and restrictions on these funds. For example, a limit on the amount of funds that can be repatriated, long approval process for repatriations and so on. Example of countries that have controls and regulations are China and Malaysia. These would reduce the ease of moving funds out of these countries.
Like political risk, Country-Specific Unit Trusts that invest in emerging markets are unlikely to be able to diversify the risk away like Sector-Specific Unit Trusts.
Regulation and R&D Risk
For Sector-Specific Unit Trusts that invest in H & B companies, this sector faces more regulations than other sectors. Thus any major changes in the regulations like lengthening approval process or ban on certain chemicals can have adverse effects on these companies. Most of the biotech firms invest a lot of funds in their R&D, thus a single change in regulations may result in many years of R&D effort down the drain.
There may be R&D setbacks. For a drug to be put on the shelves for sale, it has to go through a lot of testing and at the end it has to passed the human testing stage before sending to relevant authorities for approval. This whole process takes 12-15 years. Thus a drug may be able to pass all initial tests but if it fails at human testing or not approved by relevant government agency, all efforts will be wasted. Statistics have shown that from human testing to approval from authorities, it is only one out of five drugs that will reach the shelves, that is after screening 5000-10000 drugs at the start.
Obsolescence Risk
This risk is cited in the prospectus of UOB Global Internet Fund, which is applicable to other Sector-Specific Unit Trusts that invest in technology companies. A well-known law, Moore's Law states that processing power will double every 18 months. Given that rate of change of technology, new technology will be able stay relevant for a short period of time. Prices of technology or technology related securities could be adversely affected by it.
Interest Rate Risk
Like default risk, this is a risk that is associated with debt securities. We know that interest rate has an effect on the price of debt securities. The longer the maturity, the greater is the effect on the price. Thus this may affect the price of unit trust to some extent.
Disclaimer: This article above merely reflects the personal views of the writer and does not constitute investment advice. All readers are advised not to place any undue reliance on the article, and to consult their own professional advisors where relevant. Neither the writer nor MyMonies.com shall be liable for any losses incurred by any readers who make investment decisions based on the information above.
