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TAKE THE GUESSING OUT OF MUTUAL FUNDS
BY SCOTT MACMILLAN
Casting a glance at recent surges in local mutual
fund values, a dabbling investor might be tempted to dump all their
savings into these funds, take a long holiday and wait for the returns.
But investment experts warn that despite their hard-to-match returns,
investing in mutual funds requires a bit of savvy.
Egyptian stocks are booming, and mutual funds are
the easiest way for the non-professional investor to get a piece
of the action. Egypt’s mutual funds are performing phenomenally
well, with most posting gains of 30 percent or more in 2005, and
some topping 80 percent. Yet analysts say small investors should
look closely both at their own expectations and the fund manager’s
performance history before selecting a fund.
“Before choosing a mutual fund, define your objective,”
says Suzan A. Awad, managing director of Concord International Investments,
a fund management firm. “There’s always a trade off between
risk and return. Most investors don’t care. They just follow
the others.”
Investors should define their goals, then find a fund that matches
them, she says.
For instance, some investors – especially those who are younger
and more willing to take risks – may want to invest some of
their savings in the hope of a payoff years down the road. For them,
a growth fund can deliver high-yield growth over time. On the other
hand, more cautious investors may prefer funds that offer regular
returns in lieu of growth. An income fund, consisting of a high-yield
mix of stocks and bonds, would suit them. Investors should also
consider whether they are willing to risk their savings on a fund
that may witness short-term explosive growth, yet may under-perform
or even lose value in the long run.
Rather than jumping at the annual highest rate of return, a smart
investor will look beyond the market’s recent upswing and examine
the long-term performance of a fund before buying into it, say analysts.
An exceptionally high rate of return may mean the fund manager is
an aggressive investor – with other people’s money. While
this strategy offers clients rich rewards in a bull market, it can
mean dismal or even disastrous results when the boom ends.
“Some mutual funds have experienced exceptional growth in years
when the stock market soared, [but] they used the same aggressive
strategy when the stock market was going down,” says Mohammed
Fahmy, a research analyst at Prime Securities, which manages five
closed-ended funds.
Investors should not judge a fund’s performance solely on its
recent returns, says Yasmin Ibrahim, a fund manager at Hermes Fund
Management. “It’s good to compare over a long period of
time, because it’s easy to perform well in an up market.”
This means knowing your fund manager’s performance history.
As Egyptian mutual funds trade in a relatively small pool of companies
compared to other countries, the investment acumen of the individual
charged with deciding what stocks to buy and sell is what differentiates
one fund from another. “The difference [between funds] is in
the management itself and in the performance of the fund manager
rather than what types of investments they do,” says Fahmy.
Some fund managers are performing so well, in fact, that they have
been plagued by short-term buying and selling, in which customers
try to cash in on the fund’s daily jumps. This can create liquidity
problems for the fund management company, since the firm needs a
ready pool of cash for the large number of investors that might
want to cash out at any one time. “This is not investment,”
says Concord’s Awad. “This is speculation.”
Winners, she adds, are picked according to their long-term growth,
not their short-term fluctuations. Smart investors know how to recognize
the difference.
For instance, if you look at the five-year history of a fund and
compare its results with the overall performance of the market –
or better, the 10-year history, if the fund goes back that far –
you might actually find some of the “hot” funds are less
appealing than they initially appear, while some of the drowsier
ones might actually be good long-term bets.
Take, for instance, a fund that posted a 45-percent rise in its
net asset value (NAV) – the combined value of all the shares
in the fund – in the last 12 months. This may sound like a
good return on investment. But when compared to the CASE 30’s
rise of over 57 percent since the end of 2003, it is not a particularly
impressive performance.
On the other hand, look at how the same fund performed five years
ago when most stocks prices were falling. If a fund’s value
was rising annually at a steady 15-percent gain during the sluggish
1997-2002 period, when most funds were struggling to break even,
then this fund (assuming it has the same manager) could be a more
reliable long-term buy than one of today’s star performers.
Another important question to ask when buying a mutual fund is how
it distributes its clients’ cash among various stocks. One
of the advantages of a mutual fund is that it distributes risk across
a broad spectrum of companies on the market. If a fund is invested
too heavily in any one company, that means risk, even if that stock
is performing well at the moment. “If they have 25 percent
in one stock, is this a good thing? Of course not,” says Awad.
By law, a fund cannot invest more than 10 percent of the fund’s
capital in any one company. The market regulator, the Capital Market
Authority (CMA), has lately been taking a hard line on violations
of this rule, says Awad, though she declined to give details.
Funds are also expected to report a “top 10” list of stocks
on a quarterly basis, says Fahmy. “You see what they’re
investing in. Are they aggressive stocks? Are they safe stocks?”
Stocks that have soared in today’s bullish climate may be the
first to plummet when the market’s mood turns sour.
Those shopping for the most suitable fund are likely to make a better
choice with even a passing familiarity of the financial pages. For
instance, a fund that is heavy on investments in large-cap stocks
– that is, the stocks that lead the tables in trading volumes
each week – is less prone to volatility than one dominated
by smaller companies. Small and medium-cap stocks “may experience
a correction at one point – not necessarily now – but
large-cap stocks are stable,” explains Fahmy.
Even though there are no sector-specific Egyptian mutual funds,
it pays to know which sectors have been performing well. Experts
caution, however, that companies should be judged on an individual
basis rather than lumped together with other companies in the same
industry. It is also a good idea to keep an eye on overall performance
in other markets, as you may one day want to expand your portfolio
beyond Egypt.
Overall, says Awad, Egyptian stocks are still relatively cheap compared
to other Middle Eastern equities. Price-earnings ratios for Egyptian
stocks are moderate, on average below 20:1, compared to Saudi Arabia
and Dubai where P/E ratios often reach 50:1, she says. Good fundamentals
have been bolstered by confidence created by the Nazif government,
which has established credibility on the market. “They do what
they say, which is very important.”
Among companies that have been driving growth in the market are
those in the chemicals and telecom sectors, says Awad. She warns,
however, of some undue enthusiasm in this area, marked, for instance,
by the near frantic interest in Telecom Egypt’s recent £E
2.5 billion IPO, which was 60 times oversubscribed.
Fahmy, meanwhile, sees the banking sector as a good bet. The sector
“is expected to perform very well in the [next] three years
as a result of government reforms and the stability of the Egyptian
pound,” he said, adding: “we believe that in time, investors
will start requiring more loans, so banks will become more effective
in management of funds.” He also expects solid performance
from cement companies for at least the coming two years.
All of this may sound daunting. Fear not: mutual fund customers
are not expected to spend all their spare hours perusing company
reports. After all, that is what fund managers are for. With a good
fund manager combined with some extra homework, you never know –
that long holiday might still be coming.
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