Fixed Income Fund NAV determinant: Simplified

Assume last year inflation rate is at 3%. You bought a 6% coupon bond with $ 10,000 which repays you in 2 years. So your real net return was (6-3) = 3% annually. 


This year, inflation rate goes up to 6%. . No one wants to buy the same bond you have now for $ 10,000 because the real net return is 0%. 

3 basic must-ask questions to a Unit Trust Consultant

1. How much could I possibly lose?
2. What are the upfront and hidden costs?
3. How long can I double my money compared to FD rate?


WHY?


1. Test your agent's honesty. If he/she guarantees you not to lose money, you can ask him/her if he/she is going to compensate you with his/her own money when you DO lose money. The point is, I expect the agent to give me honest info on the performance of the fund, especially in 2008, without sugar-coating or with manipulated marketing material. As an investor, I know I got to be realistic; for instance, no equity fund will make money during recession. But if you are an agent with integrity, I might end up buying the same fund from you than someone who's misleading me or giving me empty promises.

Be calculative of your unit trust investment return

Say, you invest $ P in the best unit trust exactly for 1 year. You read that your unit trust profited by A % per annum the same year.

Digest this...

Your profit is A LOT LESS than A%

The Grim Reaper Investment Fund

...aka the controversial Life Settlement Fund.

What happens is this:

1. A life insurance policy owner has coverage of $1 million, and has paid a total of $200k premiums for the last 20 years.
2. The policy owner offers to sell his policy at $500k.
3. A third party pays the policy owner $500k cash, and essentially becomes the legal beneficiary of this policy.

Motivation for policy owner to do this

1. No longer need the policy, but instead of letting it to lapse, which essentially means insurance company pocket up the $ 200k premium, he can make immediate cash out of it.
2. The surrender value of the policy is way lower than its sale value or total premiums paid.
3. No longer can afford to pay the premiums - but reselling it for quick moolah is better than letting it lapse.
4. Need additional, immediate cash for medical treatment after exhausting every financial channels.

Imagine you are the third party who purchased this policy - you rate of return is directly related to how soon the policy owner dies. I was like "WTF?, there is not other investment more ghoulish than this!" And this is actually near to risk-free, say if he dies after 1 year, your rate of return is (1 mil/0.5 mil) x 100% = 200%!. Even if he dies after 5 years, your rate of return would have been 14.9%, guaranteed! 

They say, there are only 2 things in life are certain- death and taxes!

Seems like a win-win situation? Not so.In most investments, either the seller or the buyer will be the loser in a zero-sum game but here, the biggest loser is the rightful beneficiaries of the policy owner - the spouse (if still alive) or the children (that's if the policy owner intends to leave the $1 mil as an estate to them). Still, I think if there's no surviving spouse or children, then this could be close to a win-win scenario. However, another argument is, if there's advancement in medical technology which prolongs the life expectancy of the population, then investors' rate of return would be drastically reduced. In other words, the key to profitability is an accurate projection of life span.From investor standpoint, the risk is reduced if the policy owners are those in their twilight years. Ah, how morbid!

Again, Malaysia being a conservative nation, you don't have this. Then again, would you be able sleep to sleep at night knowing there is someone out there who is eager to see you kick the bucket ASAP so he can reap a profit? That's why it is almost irrational to trade these investments Over The Counter; in reality, they are managed as mutual funds. Hey, those funds are somehow as good as high grade corporate bonds, but with higher yield! Better yet, they are absolutely negatively correlated with the business cycle. You still get your ROI, albeit variable - due to one and only factor - how soon people die! Widespread, unexpected early deaths (a pandemic of sorts, more deadly swine flu anyone?) will result in windfall for life settlement funds investors.

I bet if this is legalized in Malaysia, Ah Longs' drastic shift in their modus operandi would be to buy their borrowers' policies, and when borrowers failed to pay up, they will happily chop you up, no questions asked! No more taunting or splashing red paints or hanging pigs head!

Investment Diversification

The concept of diversification in investment can mean in terms of asset class or sectors.

To simplify things, let's take local mutual fund as an example.

Funds classified as "Mixed Asset" or "Balanced" type are essentially diversification in terms of asset class and sectors. See the excerpt from OSK-UOB Smart Balanced Fund. Asset class here consists of Cash/Deposits, Real Estate Investment Trust (REIT), Bonds, Equities and derivatives. In terms of sectors diversification, there's construction, consumer products, industrial products, and trading/services.

Equity Fund, as the name suggests, mostly consist of shares and derivatives only - hence, only sector diversification, not so much on asset class diversification. From OSK-UOB Smart Treasure Fund Fact Sheet, observe there are various sectors where the money is invested.

Fixed Income Fund focuses primarily on fixed income securities - mostly on Government or Corporate Bonds. This is mainly asset class diversification - bonds having the lion's share of the pie chart per fund investment objective, followed by 3 equities sector and derivatives.

A more advanced type of diversification can refer to geographic diversification. It often means investing in foreign assets - most commonly, international share market. However, speaking from experience, there is a limitation on how much you can diversify investments, especially in non-local scenario due to limited budget. On top of that, there's currency exchange risk involved.