Investment Risk | AES International

Overview

Any information provided on this website does not constitute investment advice based upon your personal circumstances, or a comment on the suitability of any investment, nor can it be considered a solicitation to adopt any particular investment strategy. The information provided is done so solely to help you make an informed decision. Any decision to hold, purchase or sell a specific investment is your own decision.

Before proceeding with an investment it is your responsibility to obtain and read the Key Investor Information Document (KIID) to help you make an informed decision about whether to invest, and whether any fund you choose is suitable for your own personal circumstances. The KIID is not advice but will include a short description of the fund’s investment objectives and investment policy, past performance figures, costs and associated charges, and a risk/reward profile of the investment. If you are unsure about the suitability of an investment, please contact us to ask about our advisory services.

All investment involves risk. Neither your capital or returns are guaranteed, and you may not get back the amount originally invested. The value of investments and any income derived from them will fluctuate; past performance is therefore not a guide to future performance. It should not be the sole factor of consideration when selecting a fund. Please note that the risk category of a fund may change over time. We consider any investment a long-term undertaking, and recommend that you regularly reassess the suitability of your investments to ensure they continue to meet your attitude to risk, your investment goals and the number of years you are investing for. Different funds carry differing levels of risk depending on the geographical region and industry sector in which they invest. You should ensure you understand the nature of any fund before you invest in it, and the potential investment risks.

The associated investment risks set down on this page are not exhaustive, and do not cover all of the potential and generic investment risks – some of which are unforeseeable. You must read all relevant literature before proceeding with any investment. Should you be in any doubts as to the suitability and/or risks of an investment, you should seek professional advice.

Typically referred to as ‘funds’...

Collective Investment Schemes

The term ‘fund’ refers to two types of arrangement: unit trusts and Open-Ended Investment Companies (OEICs). The main difference between them is in their legal structure – unit trusts are structured as a trust, and OEICs incorporated as a company. Beyond that, and a difference in the charging structure, the two are very similar.

Unit trusts and OEICs allow multiple savers to pool their capital. This helps to reduce costs, as they are shared among investors, and reduces each individual’s risk exposure.

As they are open-ended, there is no limit on the number of investors who can invest in the fund.

Funds are managed by professional fund managers, and therefore a fund provides an investor with access to specialist investment expertise.

Funds will typically invest in assets such as equities, bonds, cash equivalents, and alternative investments (and sometimes other funds depending on the investment objectives of the fund). These are referred to as the underlying assets. Funds may also hold higher risk and complex instruments such as derivatives.

A fund’s assets (such as stocks and shares) are divided into units of the same value. Investors in the fund receive units which represent their proportion of the underlying portfolio. The value of those units will change as the values of the underlying assets change.

Funds can be labelled as either accumulation or income. If a fund has an accumulation share class, any income that is accrued is kept within the fund, thereby increasing the value of the units. Conversely, income funds distributes any income directly to investors. To complicate matters, funds that are intended to provide income can also come in an accumulation share class – the income is reinvested back into the fund, so effectively the investment compounds.

Typically, funds are daily dealing funds. This means the fund is valued on a daily basis.

All funds have an ongoing charges figure (OCF) or total expense ratio (TER). This will impact upon potential investment growth.

There are many different types of fund and therefore risk. We will address some of the general and specific investment risks below.

Investment Trusts

Investment trusts, like unit trusts and OEICs, are collective investments and are managed by professional managers. They are publicly listed companies whose shares are traded on the London Stock Exchange (LSE). As they are closed ended there are only a set number of shares (and not units) issued. Because of this, sometimes the share price can be higher than the value of the underlying assets, or below the value of the underlying assets. This is commonly referred to as trading at a ‘premium’, or trading at a ‘discount’.

Unlike funds, investment trust managers can borrow money to invest. This is known as ‘gearing’. This can increase risk levels. Investment trusts are therefore typically considered more complex instruments than unit trusts or OEICs.

Exchange Traded Funds (“ETFs”)

An ETF is an investment fund and there are three types: fully replicated ETFs, partially replicated ETFs and swap based ETFs. ETFs trade like shares, and hold assets (typically bonds, commodities or equities). The fund’s shares are listed and traded on one or more stock exchanges. ETFs will, broadly speaking, try and reflect the performance characteristics of an index. ETFs may use derivatives and engage in short-term secured lending of its investments to certain eligible third parties.

Tracker Funds

Tracker funds are passive. They don’t try to beat the market, and simply aim to mirror the performance of an index. Therefore their underlying investments will replicate the components of a market index (the FTSE 100, for example). Due to this, tracker funds are typically far cheaper than actively managed funds (funds that have a manager who is aiming to beat a benchmark).

Now we will look at more specific aspects of investment risk. Just as funds are classified into different sectors (classified by the UK’s Investment Association (IA)), there are sector specific risks, geographical risks and industry risks. Different funds carry different level of risk dependent on the fund’s investment objectives, and the geographical region and industry sector in which they invest. Please note that this list is not a substitute for familiarising yourself intimately with the relevant fund literature.

Bonds: bonds are loans to governments and companies. Bonds issued by major governments and larger companies are considered to be more secure than those issued by emerging markets or smaller companies. Historic yields should not be used as an indication of future returns. Bonds are sensitive to interest rate changes.

Some bond funds may invest in non-investment grade debt – bonds that aren’t rated by a credit rating agency. Bonds may be downgraded by rating agencies.

In difficult market conditions reduced liquidity in bond markets may make it harder for a fund manager to sell assets at a quoted price.

Emerging Markets: emerging markets may be subject to increased political and therefore economic and regulatory instability. Emerging markets investments may therefore demonstrate high levels of volatility, and can be more difficult to sell than developed market securities.

Property: property valuations are generally a matter of opinion rather than fact. The amount raised when a property is sold may be less than the valuation. Property investments can be illiquid; that is, certain assets could become hard to value or sell at a specific time or price. Property investments can be more difficult to buy and sell than investments in bonds and equities.

Smaller Companies: smaller companies are generally less well researched and not as established as larger companies, and therefore shares in therefore their shares can be more volatile, and not as liquid as larger company shares. Investments into smaller companies are therefore generally said to be inherently more risky than investments into larger companies.

Specific Sector: focussed funds that invest solely in a specific sector (such as precious metals, technology etc.) are generally considered to be more risky than those which spread their investment across multiple sectors.

Targeted Absolute Return: absolute return funds broadly endeavour to generate consistently positive returns in all market conditions, but they do not guarantee a positive return. Some sector funds may also utilise hedge fund strategies, which can be highly risky, and employ complex investment instruments such as derivatives.

And now we turn to broader investment risks. As above, this list is not exhaustive.

General Risks

Currency Risk: any investments that expose an investor to a foreign currency might also expose the investor to risk due to foreign exchange fluctuations.

Inflation Risk: the risk that future purchasing power of your money will be eroded by inflation; that is, investment returns are lower than the rate of inflation, and so effectively you lose money.

Liquidity Risk: the risk that an investment cannot be sold in a timely fashion and without incurring a loss.

Shortfall Risk: the investment return will fall short of the required investment return; that is, your investment doesn’t make as much as you want or expect.

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