Investment Education Series

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1 Investment Education Series Types of Investment Funds Introduction Investment fund basically refers to a pool of funds, but our focus in this edition of GTBAM education series is to highlight the features, types and benefits of some investment funds and how investors can use the available platform to invest in the Nigerian capital market. Investment Funds Investment funds are investment vehicles created for the principal objective of collecting assets and resources from investors and channeling those resources and assets into a portfolio of financial instruments such as stocks, bonds and other market securities. An investment fund is a vehicle that allows a number of separate and unrelated investors, a group of individuals or companies, to make investments together. Investment funds are often set up to offer small retail investors the chance to have their investments managed by professionals via a diversified basket of investment vehicles and instrument at an affordable cost. It also offers wealthy individuals who may for several reasons which will be discussed later; choose to deploy their investment into a fund to be managed. By pooling their capital, investors can share costs and benefit from the advantages of investing larger amounts, including the possibility of achieving a broader diversification among a number of different assets and thus spreading their risks. There are many possible arrangements in the way an investment fund can be set up and operated, generally depending on the needs of the fund s investors. Features of Investment Funds Diversification In order to reduce the risk, fund s assets are allocated to different investment types. Fund s assets may be distributed in investments in various securities, economic sectors, countries, regions and by other criteria, in this way reducing the influence and protecting investors from the collapse of any single class of investment or company. Professional management Funds have skilled and competent full-time professional managers who research and spot suitable investment opportunities. The time, effort and expertise they devote to investments far exceed those affordable to a single investor and this ensures that the portfolio is managed efficiently. Taxes in accordance with the Personal Income Tax Law, the yield of private individuals from transactions in investment fund certificates are not subject to the individual income tax; and investment funds are not legal entities, which means that no income tax is applied on them.

2 Cost efficiency Since funds manage a large number of investments, the trading and research costs are spread among investments. High liquidity Investments in investment funds (open-end funds) can be made every day, and the invested assets can be obtained within just few days, depending on the fund. Access to investment platform Offers investment platforms without requiring a lot of money to enjoy profits from dynamics of securities markets. A small investor has access to practically any securities market worldwide through making an investment in a respective fund. TYPES OF INVESTMENT FUNDS Mutual Funds A mutual fund is a type of professionally managed fund consisting of stocks and/ or bond. It is also known as a collective investment scheme. Money is pooled from many investors to purchase securities. Under the scheme, the assets of the fund are held in trust by a trustee on behalf of the investors. The assets are managed by a fund manager. Investors have a right to share in the assets of the scheme proportionate to the number of units they hold in the scheme. Mutual funds are regulated by law and available to the public. Types of Mutual Funds - Open-end funds Open-end funds are the most common type of mutual fund and they are readily available through several investment firms in Nigeria. Most open-end funds also sell units to the public every business day on the secondary market on the Nigerian Stock Exchange (NSE); these units are also priced at net asset value. A professional investment manager oversees the portfolio, buying and selling securities as appropriate. - Closed-end Funds Closed-end funds have been declining in popularity because investors who no longer wish to invest in the fund cannot sell their units back to the fund (as with an open- end fund). They must find another investor in the market willing to buy their units from them. The funds generally issue units to the public only once through initial public offering and they are managed by professional investment managers. Index Funds An index fund is made up of a collective investment scheme (usually a mutual fund, or exchange-traded fund) that aims to replicate the movements of an index of a specific financial market (i.e. Nigerian Stock Exchange s ASI, New York Stock Exchange s S&P 500), or a set of rules of ownership that are held constant, regardless of market conditions.

3 An index tracker is designed to beat market returns by holding all of the securities in the index, in the same proportions as the index. Other methods include statistically sampling the market and holding "representative" securities. Among its prominent features, index fund is said to provide broad market exposure as it covers a comprehensive segment of the market, is simple and easier for investors to follow and understand, low operating expenses due to less transaction cost and cost of sales. Balanced Funds A balanced fund combines a stock component, a bond component and sometimes, a money market component in a single portfolio. The objective of these funds is to provide a balanced mixture of safety, income and capital appreciation. The strategy of balanced funds is to invest in a combination of fixed income and equities. A typical balanced fund might have a weighting of 60% equity and 40% fixed income. The weighting might also be restricted to a specified maximum or minimum for each asset class. Several investment companies are currently offering this type of funds in Nigeria. The fund is suitable for investors who desire to enjoy a balanced exposure of their investment to both long term growth and income producing assets, with minimal exposure to capital erosion. It is very liquid, readily available and can be purchased and sold on all business days on the Nigerian Stock Exchange. Bond Funds Bond funds describe a type of investment that invests primarily in bonds or other types of debt securities. Depending on its investment objectives and policies, a bond fund may concentrate its investments in a particular type of bond or debt security such as government bonds, treasury bills, corporate bonds, Eurobonds, bankers acceptance, commercial papers or a mixture of types. The securities that bond funds hold will vary in terms of risk, return, duration, volatility and other features. All bonds are subject to two market risks: the risk of individual default on a bond, and interest rate risk. Bond funds have no identifiable maturity date and tend to be extremely liquid. This means that a market to purchase the fund back from the investor almost always exists. Investors can purchase bond funds through banks, brokers, fund managers, or even pension and retirement plans and pay annual management fees. Bond fund are currently being offered by a few investment fund managers in the Nigerian market. Unit Investment Trusts Funds Unit investment trusts or UITs issue shares to the public only once, when they are created. Investors can redeem shares directly with the fund (as with an open-end fund) or they may also be able to sell their shares in the market. Unit investment trusts do not have a professional investment manager. Their portfolio of securities is established at the creation of the UIT and does not change. UITs generally have a limited life span, established at creation.

4 Exchange-Traded Funds A relatively recent innovation, ETFs combine characteristics of both closed-end funds and open-end funds. Like closed-end funds, ETFs are traded throughout the day on a stock exchange at a price determined by the market. To keep the market price close to net asset value, ETFs issue and redeem large blocks of their shares with institutional investors. The exchange traded fund is often structured as an open-end investment company. ETFs have been gaining popularity around the world and the Nigerian Stock Exchange recently launched a gold denominated ETF product in partnership with New Gold Issuer Ltd, a special purpose company registered in South Africa. Money Market Funds The money market consists of short-term debt instruments, mostly Treasury bills. This is a safer place to invest. The returns are low compared to other investment funds such as equity funds, but there is less risk of losing principal invested. A typical return is twice the amount you would earn in a regular checking/savings account and a little less than the average certificate of deposit (CD). Hedge Funds A hedge fund is an investment fund that aggressively manages portfolio of investments using advanced investment strategies such as including selling short, leverage, program trading, swaps, arbitrage, and derivatives in both domestic and international markets with the goal of generating high returns. Hedge funds are usually used by wealthy individuals and institutions (they are not sold to the public or retail investors). Hedge funds use aggressive strategies that may be unavailable to mutual funds. Hedge funds are exempt from many of the rules and regulations governing other mutual funds, which allows them to accomplish aggressive investing goals. They are typically open-ended, meaning that investors can invest and withdraw money at regular, specified intervals. Some offshore fund managers provide access to hedge funds. Equity Funds An equity fund is an open or closed-end fund that invests primarily in stocks, allowing investors to buy into the fund and thus buy a basket of stocks more easily than they could purchase on their own. Generally, the investment objective of this class of funds is long-term capital growth with some income. There are literally thousands of equity funds out there and each has unique characteristics. One of the greatest advantages of equity funds is instant diversification. Also, it is usually easier and less expensive to invest in equity funds than to buy each and every stock in a fund's portfolio. Equity funds are also cheaper; they are a way to avoid the often higher transaction costs and lower liquidity associated with trading individual stocks. Criteria for Accessing Investment Funds Managers Before entrusting your money to an investment fund manager or buying units of the funds, investors must critically analyze the following indices:

5 - Investment objective An investor must set parameters defining what investment objective is being sought, such as; is the fund for a specific project or event? Is it for short or long term? Is it income - or safety of fund drive. By clearly defining these questions, an investor will be better guided in selecting investment funds. - Risk appetite In view of the fact that an investor risk appetite is often dependent on age, position in life and other variables that are not common to all individuals, there is a need to consider in one s risk profile when choosing investment funds. Some funds are deliberately aggressive, investing more for equities, in the hope of higher returns, but by that fact, more risky than, say, a bond funds. - The Fund Manager Profile A thorough research on the profile of the investment fund manager is a prerequisite for any investor who desires to deal with only approved fund and licensed fund managers, and this can easily be obtained from the Securities and Exchange Commission (SEC). A back up to SEC listing is to search out fund managing companies with integrity and competence backed by good corporate governance and due process history. - The Fund's track record It is important to benchmark the performance of a fund with other funds in the market as well review the financial statement, literature and brochure materials to have an insight on the fund s overall performance. - Fee Structure Because some investment funds charge more than one cost line, it is important for an investor to have all the cost lines spelt out, read and understood before committing to invest in a fund. - Operating Modalities Investors must ask to know the details of how an investment operates so as to avert unnecessary difficulties that may arise in future. The above list of investment funds is not exhaustive, but has been highlighted based mostly on their availability in the Nigerian capital market. The choice therefore remains that of the investor and his ability to sift out the essential information requisite for making well informed investments decisions. Please call or visit qualified and professional investment managers who can partner with you to help you achieve your investment goals when next you seek to invest in any segment of the market. DISCLAIMER: The views expressed in this report are provided for information purposes only and are not to be considered as an offer or solicitation of an offer to buy or sell any financial instrument. The material herein is obtained from a variety of sources and we make no representation as to its accuracy or completeness. This material has been issued by GTB AM, which is regulated by the Securities and Exchange Commission. Further information on any security mentioned herein may be obtained by ing:

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