HOW MUTUAL FUNDS WORK IN NIGERIA – A SIMPLE GUIDE
What is a Mutual Fund?
A mutual fund can be defined is an entity that pools cash from a variety of investors for the sole purpose of investing the cash in shares, bonds, treasury bills etc (all together called a portfolio of investments). The profit derived from the diversified pool of investments are shared to investors in the funds annually or semi annually or as stipulated in the fund prospectus.
Who Operates a Mutual Fund?
Mutual Funds are operated by professional investment firms made up of people who are savvy with the money and capital market. Mutual Fund, like in Nigeria can be operated by the Investment arm of banks, stock brokerage firms, investment banks etc.
How is it different from a stockbroking firm?
A stockbroking firm is simply a company that on your behalf and instruction uses its license to buy and/or sell shares on the stock market. With a stock brokerage firm you give them an instruction to buy or sell shares of your choice. You also keep tabs of the performance of your stocks on a daily basis and monitor its performance independently. For a Mutual Fund however, they determine which Investment decisions to make rather than you giving instruction as to what shares should be bought for you or which you intend to sell. The shares you buy with the Mutual Fund is that of the fund and not that of the companies quoted on the stock exchange or indeed any quoted investments.
Do they only invest in stocks?
Off course not. Mutual Funds mainly invest in broad and diversified pool of investments. However these can be grouped into two;
A – Money Market
B – Capital Markets
Money Market – Example of Money Market instruments are Treasury Bills, Certificate of Deposits, Commercial Paper etc. These instruments are mostly debt note with a promise to pay a stipulated interest rates and the principal at a predetermined date.
Capital Markets – Capital Markets are markets where Bonds, Stocks (Shares) are traded on a daily basis. So, a Mutual Fund can also use your money to invest in stocks and bonds. For example, when they invest in shares they hope that the value will appreciate thus increase the value of their fund or making them a nice profit when they sell the shares.
But please note, most mutual funds usually outline the type of investments they hope to invest your money in. This can be found in their prospectus.
Do All Mutual Funds invest in the same categories of funds?
There are mainly 3 categories of funds they typically invest in
I. Fixed Income Funds – These are funds that are meant mostly to invest in fixed income securities. Fixed Income Securities are investments that pay a fixed return on an investment. For example, treasury bills offered by the Government are issued at a coupon (rate) of say 10%pa. Meaning, they pay an interest of 10% on any amount invested. Mutual Funds that are Fixed Income Related look out for safe investments that can guarantee a good income stream. They mostly suited for investors with a long term view towards returns. Fixed Income Funds are safe investments as it mostly involves securities in government securities. Due to the nature of government securities their returns are typically low.
II. Equity Funds – These are Mutual Funds that invest mostly in stocks and shares of companies are quoted. Some funds can also use fund assets to subscribe shares for private placements. Equity Funds offer high returns but are associated with high risk.
III. Mixed Income Funds – Mixed Income funds are a hybrid of Equity Funds and Fixed Income Funds. Because of their diversified nature, they often offer low risk for investors. Low risk as usual is associated with low returns.
Why Should I even Invest in them?
Mutual Funds afford people who do not have the time to invest in the money and capital market or do not know much about the business of buying and selling securities an opportunity to invest and make money. It also gives them an opportunity to save for the futre. By investing in mutual funds you have an opportunity of investing in a portfolio of heterogeneous instruments rather than having your money in just one basket. For example, your N100k investment in a single mutual fund can represent an investment in bonds, stocks, treasury bills etc.
How Much Can I Give them?
Mutual Funds typically have an investment band depending on the nature of the fund. Some can be as low as a minimum of N5,000, whilst some can be N100,000 and others N1,000,000.
Is it Profitable?
Like a every other business Mutual Funds are also exposed to the same risk and rewards that can determine whether they make or loose money. But since no business originally sets out to loose money they will often tell you that they are profitable. However, you can know how profitable a mutual fund is or can be if the fund owners already have a history. Most of the managers already have experience in running funds and so must have track records of their performance in the past. It is also important that you look at what type of returns they intend to offer to their investors.
What kind of returns can I expect?
This depends on the your risk appetite. For example, if you have N100k and think you can invest it in any business of your choice and get a profit of N20%, then investing in a mutual fund that promises 14% returns may not be a good idea for you. The return a mutual fund promises you should also be compared to returns one can get on risk free investments such as treasury bills etc. For example, if a Mutual Fund promises a minimum return of 12%pa and Government Pays interest of 14% on Treasury Bills, then investing yourself may just be a better idea. In general mutual funds will typically offer minimum returns that are benchmarked above inflation rates.
Are my returns tax free
No. The profit derived from investing in Mutual Funds are not tax free. Hence you will be taxed on the profit obtained by the relevant tax authority. Losses from Mutual Fund investment can not also be used to offset taxable profits.
What are open and closed mutual funds?
Open Ended Mutual Funds are funds that are open to continuous issuance of shares to investors. Operators of the fund continue to issue shares to the public to buy into the fund. Investors in the fund who do not wish to participate any further will simply resell their shares to the fund at the subsisting Net Asset Value. They can also reinvest in the funds whenever they want. Some Open Ended Funds also mandate you to keep your money with them for a specified period of time before you can sell or request for your money back. Open Funds are very common.
Closed Ended funds on the other hand are funds that have limited number of shares that are sold at the initial public offering (IPO). Once the IPO is over, the fund closes sale of its shares to the public. Being a regulated fund, the shares are traded on the stock exchange like the shares of any quoted company. So, if an Investor decides he want his money back he will simply put up his shares for sale. The share price of a closed fund are determined by both the Value of the Portfolio as well as the sentiments of investors towards demand and supply. This is unlike the Open Funds that are determined by simply dividing the value of the portfolio by the number of shares issues by the fund.
Which is best for me?
This is a matter of personal choice and risk appetite. Closed Ended Funds are regulated by the Securities and Exchange Commission as well as the NSE. They play by the rules set by the regulatory authorities. Their share price are also published daily on the pages of Newspapers and can also be found on the internet. Open Funds are mostly unregulated and are not traded on the floor of the stock exchange. They are mostly floated by reputable organisations with a track record for performance.
What is in it for the fund managers?
Fund Managers are in it for the fees they charge you for helping you invest your money. They sometimes charge you fees upfront when you invest and also charge you a fee when they make a profit on your investment. Remember, profits are declared after deducting from revenue, cost of investments, statutory expenses, taxes, etc. Managers can charge fees ranging from 2% – 5% of the Value of the Portfolio