We continue on our earlier discussions on financial institutions and investments. In this article, we look at collective investment schemes as ways of investing in financial instruments in the equity and debt markets.
Collective investment schemes
Collective investment schemes are pools of funds that are managed on behalf of investors by a professional money manager. The manager uses the money to buy stocks, bonds, or other securities according to specific investment objectives that have been established for the scheme.
One can also invest in stocks/shares through collective investment schemes such as the mutual funds and unit trusts. Mutual funds are investments that are made up of pooled money from investors, which hold various securities, such as bonds and equities. The company accepts funds from investors and uses those funds to buy a portfolio of securities and other financial assets and employs a professional fund manager to manage the investment. The company issues shares which represent pro-rata share of the pool of fund assets to investors. A mutual fund in Ghana may either be open-end or closed-end.
Open-end funds repurchase their shares from the holders in any quantity and at whatever time the holder desires to do so. This means that at whatever time an investor feels like they want to buy or sell shares in the funds, the open-end fund will be ready to do so. This results in fluctuating number of shares as purchase and sale of shares happen continuously. When it comes to closed-end funds, they issue a fixed number of shares at a point in time, and unlike open-end funds, do no repurchase their shares from their shareholders at whatever time. However, existing shareholders can trade their shares on an organised exchange where the fund is listed as required by The Securities Industry (Amendment) Law in order to provide liquidity to the shareholders. These shares are traded at prices determined by the laws of supply and demand.
There is also what we call a unit trust which is also a collective investment scheme, but is an arrangement whereby funds of investors are pooled together and used to invest in a portfolio of securities and other financial assets, with the beneficial interest in the assets of the trust divided into units. The funds are managed by a professional manager. A unit trust is constituted by a document known as the trust deed. Under the Securities Industry (Amendment) law, Act 590, unit trusts are open-end funds and their managers stand ready to issue new units or redeem outstanding units on a continuous basis.
Mutual Funds and Unit Trusts are generally categorised according to their investment objectives and their investment policies. Some mutual funds focus on stocks, others on bonds, money market instruments, or other securities. On the international scene some funds invest primarily in their countries, others invest internationally, and some specialise in specific countries.
Common types of funds are money market funds. The financial market can be categorised into money market and capital market. Money market deals in short term financial instruments such as treasury bills and certificates of deposits. Capital markets deal in long term financial instruments such as stocks and bonds. With money market funds, their investment from the pool of resources are in short-term (less than one year to maturity) corporate and government debt securities such as treasury bills and corporate notes. Some money market funds specialise in or invest only in Treasury Bills. These are generally very low-risk funds offering moderate returns. Fixed Income Funds; like the name implies are funds whose focus is on debt securities such as bonds, debentures, and mortgages that pay regular interest, or in corporate preference shares that pay regular dividends. The goal, typically, is to provide investors a regular income stream with low risk.
Growth or Equity Funds are funds which whose primary objective is to place their funds in common shares (equities) of local or foreign companies (if allowed). They may however also hold other assets. They seek long-term growth through capital appreciation of the assets they have invested in. Some growth funds focus on large blue-chip companies, while others invest in smaller or riskier companies. Blue chip companies are the mature firms that represent the stalwarts of an industry. These stable, profitable, and long-lasting companies are relatively safe investments. The term “blue chip” comes from the game of poker, where blue chips are the highest value pieces. A company must be well-known, well-established, and well-capitalized to be a blue chip. Membership in certain stock indexes is important for determining blue chip status. Performance of these funds, will be affected by the success or failure of specific investments and by the performance of the stock markets where these stocks invested in, are listed. We also have Balanced Funds which invest in a balanced portfolio of equities, long-term debt securities and money market instruments with the objective of providing reasonable returns with low to moderate risk.
There are also Global and Foreign Funds which may be fixed income, growth, or balanced funds that invest in foreign securities. They provide the prospects of international diversification and exposure to foreign companies, but are subject to risk associated with investing in foreign countries and foreign currencies. Specialty Funds also invest primarily in a specific geographical area (e.g. Africa) or in a specific industry (e.g. high-technology companies). As a result, specialty funds are subject to a certain risk-level related to the market in which it specializes. Types of risks speciality funds face include foreign exchange, political, geographical or sectoral (industry) risk. Finally, we have Index Funds which invest in a portfolio of securities selected to represent a specified target index or benchmark, such as the GSE All-Share Index. The associated risk is directly related to the risk of the market that the index is measuring, such as the stock market.
Collective investment schemes provide many advantages. Diversifying one’s investment to grow their money through a single purchase of any mutual fund, allows their money to be allocated among a professionally managed mix of investments and the risk of any single security in the portfolio is reduced. Mutual Funds are managed by portfolio managers with valuable expertise and talents one may not be able to access as an investor buying individual securities on your own. They are also affordable in that an investor can buy shares/units with a relatively small amount which couldn’t have been possible if they were to buy stocks of companies which require some minimum number of shares to be bought.
The difference between the debt and equity market is not that complicated. It is very simple that equity markets are riskier but can give higher returns whereas the bond market is more subtle on both factors. Within the bond market corporate bonds are riskier than government bonds. Based on your goals and risk profile you can allocate your capital towards both asset classes to achieve optimal diversification.
Abel Mawuko Agoba
Lecturer, University of Professional Studies
External Research Fellow, Tesah Capital
Elikplimi Komla Agbloyor
Senior Lecturer, University of Ghana Business School
Chair of Research Committee, Tesah Capital