Risks of Collective Investment Schemes

A collective investment scheme (CIS) pools money from many investors and invests it in a portfolio of assets managed by a professional fund manager. Pooling brings diversification, professional management and economies of scale, but it does NOT make the investment risk-free — the value of units can rise or fall and investors can get back less than they put in.

The risks a fund carries flow through from the assets it holds: an equity fund inherits the risks of shares, a bond fund the risks of debt, and so on. In addition, the fund's own structure and operations add risks (manager, counterparty, leverage) that a direct holding might not have.

Risk is usefully split into two kinds:

• •SYSTEMATIC (market) risk — affects the whole market or asset class and CANNOT be diversified away (e.g. recessions, interest-rate shifts, geopolitical shocks).
• •UNSYSTEMATIC (specific / non-systematic) risk — unique to a single company, sector or issuer, and CAN be reduced by holding many different investments.

A CIS chiefly tackles unsystematic risk through diversification; it remains fully exposed to systematic risk.

MARKET RISK (price risk) is the risk that the value of the fund's holdings falls because of broad market movements — falling equity prices, rising interest rates, wider credit spreads, or commodity-price swings.

It is a systematic risk: because it hits an entire market, diversifying across many securities within that same market does not remove it. A fully invested equity fund will still fall in a general market decline no matter how many shares it holds.

For bond funds, a key form of market risk is INTEREST-RATE RISK: when market interest rates rise, the prices of existing fixed-rate bonds fall, and the longer the portfolio's duration, the larger the fall.