Mutual Funds: 'Peace of mind' or 'Nightmare', the need for

Mutual Funds: 'Peace of mind' or 'Nightmare', the need for
education

Frank van Lerven
Jakarta

The Indonesian mutual funds industry is suddenly faced with a
crisis in confidence. This time not caused by the stock market
but by the fixed interest market, also knows as the "bond market"
(obligasi).

It all started with the significant hikes in interest rates by
Bank Indonesia over the last couple of months as it attempted to
protect the rupiah and keep inflation in check in the wake of
higher fuel prices. Simply said: A few months ago "money in the
bank" would produce about 6 percent in interest, now we are
looking at approximately 10 percent.

Holders of a 7 percent fixed interest security (bond) which
was attractive a few months ago (earning 1 percent more than
"money in the bank"), now start to wonder whether it would not be
better to liquidate the 7 percent bond, and just keep their money
in the bank, earning 10 percent.

One may think that the relationship between bond prices and
interest rates is easy to comprehend, and so should not be "such
a big deal". The truth is that the intricacies of fixed interest
securities, and their complexities are widely underestimated!
Bonds are difficult to understand, and even in the U.S. and the
UK, where there is a long history of investing in financial
markets, most investors will readily admit that they do not fully
understand how bonds operate.

So, many Indonesian investors were in for a surprise this
summer, to find out when instructing to sell their bonds, they
suddenly were looking at losses. Were not bonds to be "safe",
"secure" and low-risk or no-risk?

Where these dropping bond prices seemed to have hit most was
not with individual investors owning bonds outright, but with
investors owning bond funds: Mutual funds investing in fixed
interest securities.

Mutual funds! Do we have mutual funds in Indonesia? Oh, yes we
do! A quick look at one of the financial pages in Bisnis
Indonesia daily will tell us that 24 insurance companies offer
mutual funds or reksadana, and another 80 banks & investment
companies, comprising together to well over 400 funds! Banks
market funds, sometimes using the American word "mutual fund" as
everyone traveling south down Jl. Sudirman can witness everyday.

Virtually every bank now has a "wealth management" department,
and a quick review of their services will undoubtedly reveal an
offering of various reksadana. Stock funds, fixed interest funds,
money market funds. The "new kid on the block" is sharia funds,
and it will not be long before hedge funds make their entry.

Mutual funds, as one of the leading international banks here
in Indonesia correctly states on its website, are "A pool of
money invested in stocks, bonds and money market instruments,
managed by an independent fund manager in order to maximize
returns and diversify risk for investors".

Mutual funds are common in the U.S. (an estimated one out of
every three American families own mutual funds), and also widely
owned in the UK (an estimated one out of four UK families own
"unit trusts" the equivalent of the American mutual funds).
Mutual funds are widely marketed as the "common man's tool" to
invest in financial markets. This refers to the fact that
investors can participate with small amounts in the financial
markets, receiving "management by an expert" and
"diversification".

So, are Mutual funds as an investment concept easy to
understand? Well, in fact the answer again is no! How units are
priced, what happens when you want to sell, who "guards" the
fund, who is responsible for investment results, are among the
topics that are far from straightforward, let alone trying to
understand the markets in which these funds invest.

When reading marketing material on mutual funds, we see
pictures of "happy and satisfied" people at retirement, enjoying
the fruits of "years of investing" in mutual funds. The words
"professional", "expertise", "management" are all over the pages,
and the heading "Peace of Mind" is not just used by Indonesian
mutual fund companies, but is widespread worldwide.

The facts are that mutual funds are as risky as their
underlying assets. Mutual funds can be totally speculative, high
risk, medium risk or low risk: It all depends on how risky the
market is in which the fund invests! This risk factor,
unfortunately, is not properly understood by investors and too
often also not by the people who sell these funds.

When one puts two fairly complicated concepts together, "fixed
interest securities" and "mutual funds", we find ourselves at the
outset of a potentially diabolic mix! An example of this is the
fact that one of Indonesia's leading banks has seen the total
asset value of one of its bond funds collapsing from Rp 8
trillion to Rp 1.5 trillion in a matter of two months!
Indonesian investors, for various reasons, tend to take a
short-term view as regards investing in the financial markets
and, in addition, demand high returns. This forces the hand of
financial institutions wanting to sell mutual funds and looking
for quick sales. Asked for high returns with little risk, it is
easy to overemphasize the return and underemphasize the risk.

This leaves investors ill-informed about what they are
investing in. As said before, the sellers of mutual funds,
especially in the case of fixed interest funds, often do not
fully comprehend these investment vehicles themselves

This leads me to one of the main contributors to the mess we
are currently facing: The lack of proper knowledge on the part of
the people who market mutual funds to the public!

Some elements of a learning curve are unavoidable, but we can,
and must, learn from experience elsewhere. Initiatives currently
undertaken to introduce financial diplomas and qualification
standards for "introducers of financial products" deserve full
support by governmental authorities and financial institutions.
One of them is the introduction of the CFP certification in
Indonesia by the FPAI (Financial Planning Association
Indonesia), which is expected to materialize in late 2006.

In the meantime, mutual fund companies and life insurance
companies should take it upon themselves to increase the
knowledge of their sales staff as regards investment instruments
and the financial markets, recognizing that truly professional
selling is a long-term winner, where all will benefit.

The writer is CFP and FPC qualified financial planning
professional.