Mutual Funds

Whether you are a current or potential mutual funds investor, an understanding of a mutual fund’s prospectus is key to profitable mutual fund investing.

What is a mutual fund’s prospectus?

When we buy electronics, cars, or other electrical, electronic or mechanical appliances, they come with owners’ or operating manuals. These manuals provide information on the how, the when and where of such appliances. In the same way, a mutual fund prospectus is an investor’s owner’s manual for a mutual fund. It provides detailed information on a fund’s goals, investment strategies, risks, performance history, fund management, fees, and expenses. Prospectuses come as abridged or full.

The abridged prospectus provides a brief summary of the key information about a mutual fund. Though concise, the abridged version of the prospectus covers the basic information required to allow an investor to make an informed investment decision. The full or detailed prospectus as the name implies is the long-form prospectus that has information about the mutual funds in a more detailed form than the abridged.

Mutual Fund Prospectus: Need to know

Though the information contained in mutual funds prospectuses may seem overwhelming at first, the good thing is that they are presented in a format that provides key information in the same order, written without confusing legal jargons but in plain, easy-to-read and understandable English. This uniformity of presentation, format, and simplicity of language enables investors to make apples-to-apples comparisons of the mutual funds they may be considering. While it may not be possible to read line by line, it is important to pay attention to the following:

Investment Objectives

Because objectives or goals differ from one fund to another, it is important that an investor or potential investor understands each fund’s goals or objectives. While some funds attempt to generate income for their shareholders, others concentrate on capital appreciation. There are still some funds that focus on a combination of income and capital appreciation. It is the understanding of the objectives of a mutual fund that will help an investor chose those funds that are better aligned to his or her investment goal. So, try to understand the fund’s objective.

Fees and expenses

It is essential that investors pay attention to the fees section of a prospectus. It is good to find out the type of fees and when they are payable. While some funds are load funds, others may be non-load funds. Non-load funds are those mutual funds in which shares are sold without a commission or sales charge. The reason for this is that the shares are distributed directly by the investment company, instead of going through a secondary party.

On the other hand, a load fund charges a commission at the time of the fund’s purchase, at the time of its sale, or as a “level-load” for as long as the investor holds the fund. Nigerian mutual funds are load funds, they charge flotation costs which are amortized over a five year period in most cases. It is, therefore, important to compare these charges among funds.

Investment strategies

Every fund manager has his or her investment strategy which is reflected in the investment strategy section of the prospectus. An investor needs to understand the strategies in order to figure out if such strategies will lead to the investor’s goal or not. In addition, knowing a strategy enables the investor to properly evaluate performance, adopt reasonable expectations, and build a portfolio of funds that work together to achieve the desired goal.

Principal risks

Every investment, including mutual fund investments, come with different risks. The investment risks section of a prospectus explains the primary types of risks associated with the securities in a particular fund. It is important for an investor to understand or familiarise himself with the risks as the information helps to decide what level of risk an investor is comfortable with having in his or her investment portfolio.

Performance

Though it is said in the investment parlance that historical or past performance doesn’t predict future performance, it may be worth the while for investors to pay attention to how a fund performed in past market environments. Depending on the age of the mutual fund, investors should look at a fund’s one-, five- and 10-year average annual returns including a comparison with a fund’s benchmark index over the same period. If available, investors should also look at the monthly performance over time for consistency.

Investment and portfolio managers

The management section of the prospectus which provides a brief biography of the mutual fund’s managers should be meticulously examined by investors with extra attention to how long the fund manager has managed the fund or other funds.

Unfortunately, Nigerian mutual funds prospectuses do not provide information on the persons managing the funds rather the available information about the fund manager is at the management company level. Investment management company biography may be used as a proxy for the personalised biography assuming that there is little or no employee turnover rate in the company and there is continuity among the investment managers.

Lockup Period

A lockup period is a window of time in which investors of a mutual fund or other closely-held investment vehicles are not allowed to redeem or sell shares. The lock-up period helps portfolio managers avoid liquidity problems while capital is put to work. Investors should, therefore, pay attention to the section of the prospectus that details information on lockup periods. Most mutual funds in Nigeria have lockup periods of 90 days and charge a penalty of 1 to 2% if an investor breaks the lock.

Purchase and sale of fund shares

This section provides information on how to buy and redeem shares of the mutual fund, along with initial minimum purchase information and information on subsequent investments. Paying attention to this helps the investor know how much to invest and for how many units of the fund in question.

Asset Allocation

A mutual fund is as good as the securities it holds, and asset allocation plays a very important role in the profitability or otherwise of a fund. It is, therefore, important to pay attention to the asset allocation that is proposed in the prospectus. Asset allocation also helps an investor access if the risk of a fund suits or fits an investor’s risk appetite or tolerance.

Where to find mutual fund prospectus

Fund prospectuses are readily available from the fund managers, if otherwise, you can freely request for them from the fund manager, especially during the IPO months for new issues. Prospectuses for Nigerian mutual funds can also be found on the website of Quantitative Financial Analytics Company, Ltd, www.mutualfundnigeria.com.

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