As financial markets evolve, investment choices multiply. In the Philippines, nothing exemplifies this better than the number of unit investment trust funds (UITFs) available to the local investor. While certainly a sign of progress and, arguably, of increasing financial sophistication, the proliferation of choices could also be a challenge to someone who simply wants to earn some money on his investment. Here we provide a way to differentiate the UITFs in terms of the underlying assets.

EQUITY FUNDS

The objective of Equity Funds is to maximize returns by investing in equities or stock investments that bear the potential of delivering higher returns from capital appreciation, as well as dividend earnings. However, this potential for earnings carries with it the potential for losses, not only of income, but of principal. Clients investing in this type of fund should be aware of this. They should be risk takers and should be willing to take the risk or volatility associated with investing in equities. A long investment time horizon is recommended when investing in equity funds.

BALANCED FUNDS

The objective of Balanced Funds is to provide its investors with capital appreciation over the medium-term through a portfolio mix of equities and fixed-income securities. Fixed-income investments of Balanced Funds should comprise 40% to 60% of the total Fund. The equity component is aimed at spicing up potential returns through gains on stock investments. The allocation of investments between equity and fixed-income securities is a product of how the fund managers read market conditions, as long as they stay within the prescribed asset allocation range. Balanced Funds are for investors who are risk takers. These investors should be aware that the potential for high yields from a portfolio that includes stock market investments also carries with it a higher probability of capital losses that equity investments entail.

FIXED - INCOME FUNDS

Fixed-income UITFs, on the other hand, are classified according to a parameter called Macaulay duration. Macaulay duration, expressed in time units,  is a technical term in finance that measures the average time to receipt of all the cash flows of a security weighted by their present values. A portfolio’s Macaulay duration may be derived by getting the average of the Macaulay durations of all the securities that make up the portfolio, weighted by their market values.

In simple terms, Macaulay duration reflects a security’s or a portfolio’s sensitivity to changes in interest rates. For example, a bond with a Macaulay duration of three (3) years will roughly behave similarly to a bond with a maturity of three (3) years in terms of sensitivity to changes in interest rates. Since Macaulay duration is a measure of the average time to receipt of cash flows, it follows that bonds that have long maturities have high Macaulay durations, which in turn translates to higher interest rate sensitivity. By simple deduction then, longer-term bonds are more sensitive to interest rate changes than shorter-term bonds. Therefore, a class of funds with a high Macaulay duration will be highly sensitive to interest rate changes and will exhibit high volatility. Corollarily, a class of funds with a low Macaulay duration will be less sensitive to interest rate changes and will exhibit low volatility.

Using Macaulay Duration, the following are the classifications of fixed-income UITFs:

 

 

MONEY MARKET FUNDS

The objectives of Money Market Funds are capital preservation and income generation from low risk investments.  These funds are invested principally in fixed–income securities and have a portfolio duration of less than a year. These are suitable for risk averse investors who are looking for safe and liquid investments with yields that are relatively modest due to lower risk exposures.  The returns on these funds, however, are usually higher than the returns on savings accounts or time deposits.

BOND FUNDS: INTERMEDIATE-, MEDIUM- and LONG-TERM BOND FUNDS

The objectives of Bond Funds are capital appreciation and higher yields over the intermediate, medium or long-term, as the case may be.  These funds are invested in higher yielding bonds and are suitable for risk tolerant investors who have a longer investment time horizon and who are willing to take on the risk of a more volatile portfolio in exchange for higher yields due to the longer term nature of the fund’s investments.

By now, the practical importance of classifying fixed-income UITFs is evident. Notice in the above table that as we move from Money Market Funds to Long-term Bond Funds, the portfolio Macaulay duration, and therefore, interest rate sensitivity and portfolio volatility, increase. Thus, a client with a low tolerance for volatility, and therefore risk, should invest in a fund that has a low duration. Corollarily, a client who has a high tolerance for volatility, and therefore risk, should invest in a fund that has a high duration.

There is, however, a caveat to this classification. Although a number of UITFs may belong to the same UITF classification, it does not follow that all these funds will deliver the same returns over a given period. Fund management is a complex undertaking and there are a multitude of other factors that affect a fund’s performance other than duration, such as amount of management fee, other charges, etc. The investor is therefore advised to be cognizant of this fact. He is also advised to scrutinize, among other things, the quality of and the proportionate exposure to the securities that make up a specific UITF. It may serve an investor well to first study the monthly or quarterly reports of the UITF he is interested in. These are readily available in the websites of the particular trust entities. You may also click here for the NAVpus of the UITFs.

INDEX FUNDS

The funds that would fall under this classification could be equity funds or fixed-income funds. Essentially, these funds would aim to shadow the performance of existing equity or fixed-income indices. As such, their portfolios would attempt to mirror those that make up the chosen indices. For example, the PSEi is an index of the Philippine equity market. An investor whose objective is to have the same return as the PSEi may therefore invest in an Index Fund that is “indexed” to the PSEi. Proponents of Index Funds point out the following advantages: a) Index Funds generally have lower management expenses compared to other types of funds and b) Index Funds have better returns as majority of actively managed funds fail to beat broad indices in the long run.

Ultimately, what investors should bear in mind is that while the reward for taking risk is a high return, the cost of taking risk may be loss of principal. The correct investment is thus one that is suitable to an investor’s tolerance for principal loss primarily and desire for returns secondarily. In this light, the TOAP classification helps investors identify the fund that is best suited for them.

Type of UITF	Portfolio Macaulay Duration
Money Market Funds	Up to a maximum of one (1) year
Intermediate-term Bond Funds	Up to a maximum of three (3) years
Medium-term Bond Funds	Up to a maximum of five (5) years
Long-term Bond Fund	About five (5) years