Mutual fund attractions

The investment industry is undergoing a silent but significant revolution. As consumers watch inflation nibble away at their savings deposits, financial institutions are rolling out higher-yielding alternatives to satisfy demand.

Financial advisers say money is flowing into the numerous offerings at an unprecedented rate. Mutual funds, better known here as unit trusts or unit-linked funds, are the most popular choice.

According to the Irish Association of Investment Managers (IAIM), mutual or unitised funds were the fastest growing segment of the retail investment market in 1999 with growth of 329 per cent over the previous year. In contrast, net flows into with-profits investments grew by 43 per cent and tracker bonds by 15 per cent.

Mutual or "pooled" investments are one of the easiest and least costly ways to invest in the stock market. In practice, unitised investors combine their money to gain the advantages usually reserved for larger investors - reduced costs and the services of an investment manager.

Unit trusts are indirect investments in either a number of assets types or equities alone. Unit-linked funds are similar to unit trusts but have a life assurance dimension. Investment in both types of funds is measured in units rather than pounds. The value of each unit is determined by the value of the underlying assets. In general, these unitised funds fall into three categories - secure, balanced and specialist funds. As their names suggest, each type is based on a particular risk profile.

Secure funds invest in low-risk investments such as bonds, while balanced funds suit medium-risk investors with a mix of equities, bonds and cash. Specialist funds invest in a particular geographic area, industry sector, or asset type and are considered a higher risk investment for their lack of diversity.

The popularity of these products is no surprise as they match the safety and convenience criteria preferred by Irish investors. Compared to other Europeans, Irish investors are traditionally risk-averse and although some still prefer the security of deposits, funds with protection or property-based investments, many are now accepting additional risk, says Datamonitor's analyst for savings and investment, Mr Gerard Breen.

An individual's willingness to take on risk may be measured by the percentage they have invested in equities. In 1999, unit fund investors were willing to take on more risk as 62 per cent of Irish retail mutual funds were invested in equities, he said. This figure does not include offshore funds in the IFSC for non-residents.

Although growth in mutual fund investment is greater than any other investment vehicle in the Republic, penetration throughout the population is not as high. In fact, mutual fund investment per capita here is among the lowest in Europe, says Mr Breen. These statistics may change dramatically next year when a new tax regime is introduced for investment funds operated by investment banks and insurance companies. This change, which is occurring throughout Europe, is known as tax equalisation, said Mr Breen.

The move scraps annual tax at source for domestic funds. For consumers, this means tax is not payable year-on-year but when they exit the fund. At that time, tax is owed at the standard rate of tax (currently 22 per cent) plus 3 per cent for tax deferral.

Some investment industry sources believe this gross roll-up of tax, which leaves more money in the fund, will mean greater gains over the life of the fund.

The same structure is proposed for overseas funds - currently subject to a 40 per cent capital gains tax. This places domestic and overseas fund providers on an equal footing and creates more competition and choice in the market.

Increased distribution of mutual funds over the Internet and across European borders may also increase mutual fund sales next year. Some of the companies selling unitised funds in the Republic are: Aberdeen Asset Managers, AIB, Bank of Ireland, Irish Life and Ulster Bank, says Mr Breen.

Mutual funds are a good way for investors to experience the stock market while reducing risk through professional portfolio management and a selection of products rather than a single stock. Before investing, it is important to understand the product and its fee structure, and to discuss your risk profile with an independent investment adviser. As with all investments, past performance does not guarantee future returns.