Money: All funds carry risk

Compared with their more glamorous cousins - sharemarket funds - income-type funds are at the lower end of the risk scale. That means that while they are unlikely to produce dramatic gains, they are much less likely to produce any nasty shocks either. But that's not to say that even these funds are entirely risk-free.

After all, the institutions which run them don't lock their investors' money away in a bank vault; they lend it out in one way or another. That raises the risk that whoever borrows the money may not pay it back.

The size of that risk depends on the manager's strategy. A mortgage fund that lends to hundreds of carefully chosen home-buyers, for example, is less risky than one which lends to a few high-flying property developers. Similarly, bond funds which don't pay enough attention to the credit-worthiness of the companies they lend to may get a nasty shock.

Last month, Australian investors in Westpac's Mortgage and Income fund got the unhappy news that their $A1 units were now worth only 89Ac and the fund was closing to new investors, after it lost heavily on loans to US companies which defaulted on their obligations.

That shock came shortly after ratings agency Standard & Poor's warned investors to remember that fixed-income funds do have an element of risk.

That is true even for funds which invest only in the most secure fixed-interest investments, such as Government stock.

In times when interest rates are falling, existing Government stock and similar fixed-interest investments gain in value, but when rates are rising, their value falls.

Those gains and losses add to or subtract from the return the fund earns from interest payments.

The risk of a loss is more than just academic: Tower's BondPlus fund lost 0.98 per cent in the three months to the end of June, after fees and tax, while the ASB's Fixed Interest Trust was down 0.85 per cent.