Page 111 - Profile's Unit Trusts and Collective Investments 2021 issue 2

Investment Risk

Rising interest rates can generate improved
income yields from bonds but investors risk capital What is Side-Pocketing?
erosion. On the other hand, falling interest rates can Side-pocketing is the process of
create opportunities for capital gains in the bond separating part of a fund’s assets
market. Similarly, there are times when property from the main portfolio. This most
demand generates capital gains and improved rental often happens when an asset can no longer be
yields; there are other times when property assets traded (which also hinders updating the fund’s
lose value and battle to cover their costs. daily market value). Side-pocketed assets are held
pro-rata on behalf of unit-holders until the
In short, the weighting of asset classes in a investment becomes tradeable or is written off.
portfolio of investments has a huge impact on the Side-pocketing protects investors who remain in
risk profile of the portfolio. Collectibles and the fund (from progressively greater exposure to
exotics like fine art, Persian carpets and vintage the dormant asset in the event of a sell-off), and
cars tend to increase riskiness. Alternative allows new investors to enter the fund without
investments like gold and crypto might have a taking on exposure to a dormant and potentially
place as a hedge against worst-case disaster worthless asset.
scenarios like war or economic collapse, but under
normal circumstances they tend to be highly
volatile and speculative assets. Derivatives – unless Liquidity
used specifically to hedge long positions – also
tend to increase portfolio risk profiles. This word has two related but distinct
meanings in the investment world.
In addition to asset class variation, there are
large discrepancies across equity market sectors. (1) A liquid asset is one that can be
bought easily and sold easily – converted into cash
Different sectors of the market perform well or at a fair market price (ie, without the buy or sell
poorly under different circumstances and at order materially changing the market price of the
different times. During the spectacular asset). A liquid asset usually has high trading
information technology bull run of the late 1990s, volumes. An “illiquid” asset, by contrast, trades
for example, it seemed that it was not possible to infrequently, so that a large order may not only be
buy an infotech stock that did not rise in price – difficult to fill, but might drive the price up or down.
often for no fundamentally good reason. For nearly (2) Liquidity also refers to the amount of cash in an
three years after the bubble burst in early 2000, investment portfolio. A South African equity fund
however, it was almost impossible to find an which has 10% or 15% of total assets in cash would
infotech share that did not decline steadily. be described as having “high levels of liquidity”.
On several occasions over the decades, gold
mining companies have enjoyed the double benefit of a weakening rand and rising gold price –
under such circumstances, gold mines can make huge profits. At other times the same gold mines
have suffered the difficult operating conditions of a strengthening rand and falling gold price, a
scenario which can put marginal mines out of business.
Certain economic conditions favour banking shares and fixed-interest products. There have been
periods when bond funds have topped the ranking tables quarter after quarter as a result of falling
interest rates. In times of rapid and steadily rising bond rates, however, the prices of bond funds will
fall in spite of the best efforts of portfolio managers.
These are just some examples of the tremendous variation which occurs in the performance of
different sectors under different market conditions.
To maximise returns over the short-term, the portfolio manager of a multi asset fund obviously
needs to concentrate his investments in the best performing sectors. But doing this means he runs
the risk of being in the wrong sectors at the wrong time. For this reason, having all of the assets of a
portfolio in any one sector (as happens with a theme fund) is considered high-risk.
Nevertheless, more aggressive funds may choosetoexploit thesemarkettrendsbyswitching
their investments into sectors that they feel are due for a re-rating. “Playing” the market in this way
demands a much more active approach to investment management – and while it increases potential
returns, also increases risk.

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Profile’s Unit Trusts & Collective Investments — Understanding Unit Trusts