This is the real difference between mutual funds and stocks
Many investors equate purchasing an individual stock as a high-risk proposition. Mutual funds, on the other hand, are considered to be a safer method of investment.
There is certainly truth in the argument that you are taking on a greater degree of risk if you buy a company’s share. If your research leads you to believe that, say, the healthcare sector is poised for rapid growth, you have the option of buying an individual company’s share or investing in a mutual fund that specialises in this area.
If you turn out to be right and healthcare stocks gain, your mutual fund’s net asset value would rise as well. But if you had opted to buy an individual healthcare stock instead, you would also have taken on a company specific risk.
Your shares in that company may not rise as much as others in the same industry because of various factors. There could be management problems or one of the firm’s hospitals may need to close down for some reason.
What can you do to avoid taking on individual company risk? One solution is to buy stocks of several companies in the sector that you favour. This approach is similar to buying units in a mutual fund. The only difference is that you can cherry pick the firms you believe to that have the best prospects.
You could also take an approach that utilises the advantages of both mutual funds and individual stocks. A certain portion of your investment, say 40% could be deployed in the healthcare company that holds the most promise. The remaining amount could be invested in a mutual fund that focuses on the healthcare sector.
Mutual funds are useful for unfamiliar areas
If you are unfamiliar with a certain sector or if you want to invest in an overseas market, investing in the units of a mutual fund may offer the ideal solution. You get the advantage of using the expertise of professionals who are specialised in the area or the country that you are targeting.
Take the example of the HSBC GIF Turkey Equity Fund. A minimum of two-thirds of its investment are in equity shares of companies that have their registered offices in Turkey and are listed on a stock exchange in that country. It also invests in those companies that have extensive business dealings in Turkey.
A recent OECD (Organisation for Economic Co-operation and Development) report states that economic growth in the country is expected to go up to about 3.5% in 2017 and 2018. The country is benefitting from an increase in goods exports due to rising demand from Europe helped in part by the depreciation in the Turkish Lira.
The HSBC GIF (Global Investment Funds) Turkey Equity Fund, which is denominated in Singapore dollars has performed exceedingly well. In the last one year, it has gained 35%.
If an investor is positive about the Turkish economy, investing in companies listed on a stock exchange in that country would be cumbersome. A mutual fund offers a convenient option.
Mutual funds make an investment simpler to manage
You may hold the view that a certain sector has great promise. For example, technology stocks have been registering rapid gains in the recent past.
The FAANGtastic five have outperformed the S&P 500 by a wide margin. Facebook, Apple, Amazon, Netflix, and Google show no signs of slowing down. Each of these companies has announced positive results and these are reflected in their share prices.
An investor based in Singapore can gain an exposure to this sector by buying the UOB United E-Commerce Fund. The minimum investment is only S$1,000.
Which companies has the UOB United E-Commerce Fund invested in? Almost 97% of its holdings are in information technology stocks. Over 43% are in US companies. Its top 10 holdings include:
- Alphabet (Google’s parent company)
- Alibaba Group Holding Ltd
- Taiwan Semiconductor
In the last one year, this fund has earned a return of almost 23%. Five-year returns total an impressive 120%.
Individual stocks can hold greater promise
As a general rule, the best performing individual stocks provide superior returns when compared to mutual funds. Take the case of Health Management International Ltd.
It owns the prestigious Mahkota Medical Centre in Melaka and the Regency Specialist Hospital in Iskandar. The HMI Institute of Health Sciences in Singapore was set up in 2001 and is a provider of healthcare training and education.
The company’s share, which was trading at S$0.33 in early 2016 is currently quoted at S$0.64, a rise of over 90%.
Similarly, Yangzijiang Shipbuilding Holdings, a China-based company that is engaged in shipbuilding, offshore marine equipment construction and ship design among other activities, has seen its share price increase from S$1.03 in early 2016 to S$1.57 in recent weeks.
The company is the largest and most cost-efficient private shipbuilder in China and has a healthy order backlog.
Investors who are able to identify opportunities like these stand to make large gains in their portfolios. Earning a similar return from mutual funds could be difficult.
Mutual funds are safer
Although an investment in a mutual fund will usually provide a relatively low level of returns, you can be fairly certain that when the market falls, your fund will lose less value than the stocks that suffer the biggest losses. In effect, a mutual fund acts as a buffer, preventing you from making large profits while also minimising your losses to a certain extent.
There is another factor that you should consider when investing in a mutual fund. The fund’s performance will depend to a great extent on the skill and expertise of the fund manager. It is necessary that you familiarise yourself with this person’s past performance and reputation.
This adds a layer of complexity to the investment process, but it is necessary that you consider this issue before finalising your decision.
Very often, the best approach that an individual can take is to invest directly in company stocks as well as mutual funds. In many ways, the two complement each other and could provide investors with the means to maximise returns while controlling the level of risk.