Interview with Jeevan Sukumaran, Secretary, Unit Trust Association, Sri Lanka

What does “risk” really mean in investing, and why should the public not be afraid of it?

At the mention of the word risk in terms of investing, especially in a Sri Lankan context, there can be a significant level of fear or stigma attached to it. To some degree, this is fair given the country’s history of civil war, investment company scams (such as Golden Key/Ceylinco and Sakvithi and in more recent times, the Easter Attacks, Covid and the Economic crisis. This has led to a large majority of potential investors being afraid to venture very far beyond commercial banking products and, therefore, losing out on the earnings potential of other asset classes.

In investing, risk means the possibility that the value of your investment might go up or down and not a guarantee of loss, but more a chance of fluctuation. For example, share prices rise and fall all the time. While those movements may look worrying in the short term, history shows that markets generally grow in the long run. As such, investors shouldn’t necessarily fear risk, but should instead understand the different types of risk (both in general and based on the asset class) as well as risk’s relationship to return.

What are the main types of risks (market, credit, liquidity) that investors should understand?

Several different types of risks affect investors in terms of capital markets (and unit trusts); however these can be classified into direct and indirect risks. The three most direct risk types that can affect investors are;

Market Risk – The broadest form of risk, which can be further subclassified into systematic and unsystematic risks. Systematic risks are high (macro) level risks that tend to affect the entire economy as a whole and are harder to diversify if all investments are within the country. Examples in Sri Lanka would be the Economic Crisis of 2022 with high inflation, currency depreciation, and political instability. Entire markets were affected, with even well-run and profitable companies seeing downturns. Unsystematic risks are connected to specific sectors/industries/companies that are affected by an industry/sector/company-specific issue and can be reduced through diversification. Examples of this could be the export sector being negatively impacted by tariffs.

Credit Risks – Credit risk is the risk that arises due to a counterparty being unable to meet their obligations on time or at a lower than agreed yield or not being able to settle at all (default risk). To a large extent, reports from rating agencies such as Fitch and Lanka Ratings will enable potential investors to gauge the level of credit risk they could potentially face by investing in a specific company/instrument. This, coupled with investing in companies with strong corporate governance, clear transparency and strong regulatory oversight, will enable investors to reduce their exposure to credit risk.

Liquidity Risk – deal with how easily investments can be turned into cash. Market liquidity risk appears when assets cannot be sold quickly at a fair price, which often happens in stressed or thinly traded markets. Funding liquidity risk is slightly different: it is the danger that an investor or institution cannot meet short-term payment or redemption obligations, even if they hold valuable assets. Both forms of liquidity risk can amplify market shocks, making them especially important to watch during times of financial stress.

Secondary or indirect risks may not be visible daily, but can amplify core risks. Operational risks include failures in systems, processes, or people, as well as fraud, compliance breaches, or cyberattacks. Event and external risks stem from political changes, regulatory shifts, wars, sanctions, natural disasters, or climate events. Behavioural risks arise from investor psychology, such as overreaction, herd behaviour, speculative bubbles, or reliance on flawed models. Instrument-specific risks relate to specific products, including reinvestment or prepayment risk for bonds, concentration risk from overexposure to one asset or sector, leverage and derivatives risk that magnifies gains and losses, and custody risk where assets held by a custodian could be lost.

How do Unit Trusts help reduce or balance these risks through diversification, and what safeguards are in place to help protect investors?

There are three main ways in which Unit Trust Investments help reduce/balance risk.

Diversification – Unit trusts enable investors to diversify their investments across various assets, reducing the risk associated with putting all their eggs in one basket. This can be particularly beneficial for smaller investors who may not have the capital to build a diversified portfolio on their own. By spreading investments across different sectors, companies, and asset classes, unit trusts can help mitigate the impact of poor performance in any single investment.

Regulatory Protection – Capital market regulators set rules on how Unit Trusts must operate. These include requirements for transparency, reporting, and fair treatment of investors. Unit Trusts are heavily regulated by the Securities & Exchange Commission of Sri Lanka with strict rules and regulations (CIS Code) governing investments and fund operations. In addition, all assets of the fund are held by and invested through an independently appointed Trustee whose responsibility is to safeguard the unitholders’ funds and prevent misappropriation.

Professional Fund Management – Managed by experienced (and SEC-approved) fund management professionals and backed by dedicated research/financial analysts. Advantageous to investors who may not have the time, resources or expertise to monitor global, macro and micro conditions regularly.

How can investors identify their personal risk appetite before choosing a fund?

Investors first need to understand the different risks applicable to different asset classes clearly. As such, knowledge of the various asset classes and the risks that can affect those assets is the most crucial step for an investor. After this point, the investor should identify their own risk appetite and how much of a risk taker they are (from conservative to aggressive). This should also be coupled with their investment horizon and both short- and long-term liquidity requirements.

What types of Unit Trusts are best suited for conservative, balanced, or aggressive investors?

Conservative investors – Money market funds or government security-based funds. These fund types are generally low risk and offer high liquidity whilst offering steady, regular returns.

Balanced – Longer-term Income/Bond/Corporate Funds as well as Balanced funds (Equity and Fixed Income). These funds offer better returns whilst attempting to reduce significant volatility and capital erosion.

Aggressive investors: Growth/ Equity funds/Sector Funds, which invest mainly in listed equities. Given the nature of the stock market, higher volatility is to be expected; however, significantly higher returns can also be obtained.

6. Why is investor education about risk essential for building long-term confidence in Unit Trusts?

Investor education about risk is essential because it transforms fear into informed decision-making. Many people avoid investing simply because they don’t understand how risk works, or they overreact to short-term market fluctuations. By learning about different types of risk, investors can gain a realistic view of what to expect and/or how to respond.

Education also helps investors understand how Unit Trusts mitigate risk through diversification, professional management, and regulatory safeguards. Knowing that their money is being managed according to clear rules and spread across multiple assets gives investors confidence that short-term volatility is normal and manageable.

Finally, educated investors are more likely to stick to their long-term investment plan instead of making impulsive decisions during market swings. This discipline is key to benefiting from the compounding effect of investments over time and achieving financial goals. In short, risk education builds trust, reduces anxiety, and empowers investors to make smarter, more confident investment choices in Unit Trusts.