Your Beginner’s Guide To Investing in Equity Funds
Have you ever wondered how to tap into the potential of the Kenyan stock market but felt overwhelmed by the process? Equity funds might be the key you’ve been searching for. They offer an easy way to participate in the stock market’s growth, even if you’re a complete beginner.
By the end of this article, you will understand how equity funds work, the types of equity funds, the benefits, and risks as well as what to consider in an equity fund.
Equity funds are a type of unit trust that primarily invests in stocks. These funds pool money from many investors to create a diversified portfolio of shares from various companies. When you invest in an equity fund, you are essentially buying a small part of many different companies, rather than putting all your money into a single stock.
Like other unit trusts, equity funds are managed by professional fund managers. These managers analyze the market, perform research, and make decisions about which stocks to buy, hold, or sell within the fund. Their goal is to maximize returns for the investors while managing risk.
The value of an equity fund is determined by the performance of the stocks it holds. When the prices of these stocks increase, the value of the fund rises, and conversely, when stock prices fall, the value of the fund decreases. This means your investment in an equity fund will fluctuate with the market, which can offer growth potential over time but also comes with risks.
Types of Equity Funds?
There are several types of equity funds, each designed to meet certain investment needs. From the management strategy to investment style, and market capitalization, among others.
Management Approach
An equity fund can have an active or passive management style. Active equity funds are managed by professional fund managers who actively make decisions about which stocks to buy, hold, or sell. The goal of these funds is to outperform a specific market index. Fund managers use their expertise and research to select stocks they believe will provide the best returns.
Passive equity funds, on the other hand, aim to replicate the performance of a specific market index, such as the NSE All Share Index. These funds do not actively select stocks but, instead, hold all or a representative sample of the stocks in the index. Passive equity funds typically have lower fees compared to active funds due to their straightforward investment strategy.
Investment Style
Equity funds can also be categorized based on investment style:
- Growth funds – these funds invest in companies expected to grow at an above-average rate compared to other companies. They focus on stocks with strong potential for capital appreciation.
- Value funds – these funds invest in undervalued companies that the fund manager believes are trading below their intrinsic value. The goal is to find stocks that may be currently overlooked by the market but have the potential for significant gains.
Market Capitalization Funds
Market capitalization funds invest in companies of different sizes based on their market capitalization. These funds can be categorized into:
- Small-cap funds – invest in smaller companies with high growth potential but higher volatility.
- Mid-cap funds – focus on medium-sized companies, offering a balance between growth and stability.
- Large-cap funds – invest in large, established companies that are generally more stable and less volatile.
Focus Area
When it comes to the focus area, the fund manager can be investing in a certain sector or based on the geographical locations of the target equities. Sectoral funds concentrate their investments within a specific industry or sector of the economy, such as banking, technology, or healthcare. This focus offers the potential for higher returns within that sector but also exposes you to the specific risks within that industry.
On the other hand, regional funds invest in stocks of companies from a particular geographic region, such as domestic markets or regional and international markets. This allows you to tap into the growth potential of a specific developing market while also diversifying beyond just the domestic market.
Benefits of Investing in Equity Funds
Investing in equity funds offers several advantages that make them a popular choice among investors. Understanding these benefits can help you make informed decisions about including equity funds in your investment portfolio.
1. Diversification
Unit trusts, like an equity fund, offer you one of the key factors you should have in your investment portfolio: diversification. Fund managers are able to invest in a variety of equities, thanks to the funds pooled from many investors. This helps spread your investment across multiple companies and sectors, reducing the risk associated with individual stock’s poor performance, as losses in one area can be offset by gains in another. Diversification helps to stabilize your portfolio and can lead to more consistent returns over time.
2. Professional Management
Equity funds have a fund manager who is in charge of the fund’s day-to-day activities. This ranges from analyzing the market, researching and selecting the equities to invest in, allocating the weights, and rebalancing the portfolio. This saves you the time it would take to do the research, analysis, and even portfolio creation and rebalancing. Not forgetting you will be benefiting from the expertise of the fund manager.
3. Potential for High Returns
Historically, the stock market has offered higher returns compared to other asset classes like bonds or savings accounts. By investing in equity funds, you have the potential to benefit from the growth of the stock market. Although there is no guarantee of returns, equity funds can provide significant growth opportunities over the long term.
4. Affordability
Not all company shares are affordable. For instance, some stocks at the Nairobi Securities Exchange can have a market price of over KSh.150 per share. Since you need to buy in lots of 100 shares, it means investing a minimum of KSh. 15,000 at any particular moment you are buying that company’s shares.
However, most equity funds have a lower initial investment amount. Additionally, it’s more affordable to achieve the level of diversification equity funds offer through an equity fund than building such a portfolio on your own.
Risks of Investing in Equity Funds
While equity funds offer several advantages, it doesn’t mean there are no risks. Like any investment avenue, you can expect to face a few risks, including:
1. Market Risk
Market risk refers to the potential for losses due to overall market fluctuations. The value of equity funds is tied to the performance of the stock market. If the market experiences a downturn, the value of the stocks within the fund can decrease, leading to a decline in the value of your investment.
2. Management Risk
Equity funds are managed by professional fund managers who make decisions about which stocks to buy, hold, or sell. Management risk arises from the possibility that the fund manager’s decisions may not always be successful. Even experienced managers can make poor choices or fail to anticipate market changes, which can negatively impact the fund’s performance.
3. Expense Ratios
Equity funds come with costs, known as expense ratios, which cover the management fees and other operational expenses of the fund. These fees can eat into your returns, especially if the fund’s performance is not strong enough to offset the costs. It is important to be aware of the expense ratios and consider them when evaluating the potential profitability of an equity fund.
Are Equity Funds Ideal for Me?
Wondering if equity funds are an ideal investing option for you? Here are a few factors to consider:
Are You a Beginner Investor?
If you are just starting your investment journey, equity funds offer a straightforward entry point. They allow you to benefit from the expertise of professional fund managers who handle stock selection and portfolio management. This means you don’t need extensive knowledge of the stock market to begin investing.
Are You a Busy Professional
For individuals with demanding careers and little time to manage investments, equity funds provide a convenient option. The fund’s manager takes care of the day-to-day investment decisions, so you can invest without needing to constantly monitor the market. This allows you to focus on your professional responsibilities while still working towards your financial goals.
Do You Have a Long Horizon?
Equity funds are geared towards long-term wealth creation. This makes it an ideal investment avenue for investors with an investment horizon of at least 5 years and above. The extended timeframe allows you to weather potential market fluctuations and benefit from the stock market’s growth potential.
You Need Portfolio Diversification
One of the significant advantages of equity funds is built-in diversification. By investing in a single fund, you’re essentially gaining exposure to a basket of companies, spreading your risk across different sectors and industries. This reduces your vulnerability to the performance of any single company.
How to Get Started with Equity Funds
Ready to add equity funds to your portfolio? Here’s a quick guide to get you started
Understand Your Risk Tolerance
Equity funds have a higher risk compared to their counterparts, like money market funds and fixed income funds thanks in part to the underlying asset—equities. However, they offer you a higher return over the long term. The question to ask yourself is, “What’s my tolerance?” Are you willing and able to take a high risk for potentially higher returns? Additionally, can you withstand market volatility or do you prioritize stability?
Research is Key
Don’t jump in blindfolded. Dedicate time to researching different equity funds available. For Kenyans, The Capital Markets Authority (CMA) website is a valuable resource for finding licensed fund managers and their respective offerings. Look for the fund’s fact sheet for details about its asset allocation, historical performance, the custodian, and the trustee. Finally, look for customer reviews about the fund and the firm from online platforms, like social media pages and other review platforms.
Consult a Professional
Consider consulting with a licensed financial advisor in Kenya. They can provide personalized advice based on your unique financial situation and risk tolerance. A financial advisor or wealth manager can also help you navigate the selection process and identify funds that suit your investment objectives.
FAQ
Are equity funds right for me?
This depends on your individual circumstances. Equity funds are suitable for investors with a long-term investment horizon (several years) and a tolerance for potential market fluctuations. If you prioritize stability and need access to your capital in the short term, other investment options might be more appropriate.
How much money do I need to start investing in equity funds?
The minimum investment amount varies depending on the specific fund you choose. Some funds have lower minimums, making them accessible to new investors. It's wise to start small and gradually increase your investment as you gain experience and comfort.
How do expense ratios affect my investment returns?
Expense ratios represent the fees associated with managing an equity fund. Higher expense ratios can reduce your overall returns, so it's important to consider these costs when choosing a fund. Look for funds with competitive expense ratios that do not compromise performance.
