In these series, we aim to impart the basics of pooled fund investment within the framework of UITF, the salient features of UITF under the pertinent circular, and its impact on investors.
Concept of pooled fund. Pooled Funds are collective investments of numerous investors, pooled together with the aim of achieving a specific investment objective. Pooled Funds include common trust funds and mutual funds. These Funds provide investors with a simple and efficient way of investing their money in a wide selection of financial instruments and securities denominated in Philippine pesos or US dollars. By investing in Pooled Funds, retail investors can have a diversified portfolio managed by professional fund managers. They can also enjoy the higher yields from the larger placement power of the Fund, and the lowest commissions and fees possible.
Unitizing investment in pooled fund. Let us say that a fund manager is managing the money of various investors and invests said money in various securities/instruments. To account for the contribution of each investor, the Fund Manager can divides the Fund into UNITS and issues each participant a Unit Participation Certificate to evidence individual participation. The value of all the Fund’s investments less fees, taxes and other qualified expenses is called the net asset value (NAV) of the Fund. The value of each unit of participation is called the net asset value per unit (NAVPU). Thus, to determine the value of one’s investment at a certain point, the NAVPU is simply multiplied by the number of units one owns in the Fund.
Valuation of pooled fund investments. Traditionally, Pooled Funds are valued based on the accrual method where interest earned by the Fund is simply added to the principal. To illustrate, let us consider a P10,000 investment yielding six percent per annum. After 60 days, under the traditional valuation method, an investor would have earned P10,100.
The illustration above shows a transaction where a client gets the interest at the END of the period or term. Another way of looking at interest is by collecting it in advance, that is, interest will be deducted from the net proceeds. In this case, using the details above, the client will invest only P9,900 today to receive P10,000 after 60 days. This uses the PRESENT VALUE concept.
Another way of valuing investment is via marking-to-market (M2M). M2M is an internationally accepted investment valuation method wherein investments are valued based on the current market price. The entire M2M concept depends on three (3) major components: first is the availability of a "secondary market" or the presence of buyers/lenders willing to buy a certain paper or instrument. Second, is, of course the "negotiability" or "marketability" of the instrument sought to be transferred, that is. The ownership of the instrument may be transferred from one person to another without any technical hitches. And third, is the "liquidity" – as provided by the secondary market.
Since M2M uses market rate in valuing investments, volatility in interest rates can affect the value of your investment. During times of increasing interest rates, the present value of your investment is lower. On the other hand, during times of decreasing interest rates, the present value of your investment is higher.
The effect in the illustration above can be mere entries in a client’s book if there is no actual exchange. It is important to note that the volatility is only short term. If you keep an investment up to maturity date despite marking-to-market same during its entire life, you will end up with the ORIGINAL INTEREST RATE stated at the face of the instrument or investments held by the Pooled Fund.
You might ask, "if my investment will end up the same at maturity date, why mark-to-market? With the Pooled Funds "open-end" status, or where anyone participant can contribute or redeem his shares any day, M2M provides equitable treatment to investors coming in and out of the Fund. M2M provides both investor and fund manager a distinct indication of the real market value of the Fund any day, and fair price for buying and selling.
In the 2nd part of these series, we shall define a UITF and explain the recently approved UITF Circular. (To be continued)
Courtesy of BPI Asset Management