Funds are investment vehicles that allow a large number of people to pool their money together for investment in a basket of assets ranging from stocks and bonds to property and commodities.
When you buy units in a fund, you are buying an ownership stake in a range of investments that are managed by a fund manager who combines your money with that of other investors to buy and sell various investments.
EYE ON THE PRIZE
The goal is to grow the value of the fund and either enable investors to grow their money, preserve capital or generate income.
The investments held within a fund, which can include combinations of different types of assets, are referred to as the fund’s ‘holdings’, while the combined holdings are called the ‘portfolio’.
The many thousands of funds available to investors are differentiated by their investment strategies and their investment holdings.
While some funds are focused on buying bonds issued by large corporates, others might be specialists in backing specific types of companies. Investors should be aware that a fund’s investment strategy will have an impact on its risk profile and performance too.
One of the key advantages of a fund is that it often enables you to create a varied portfolio even if you don’t have huge amounts of capital readily to hand.
OPEN AND CLOSED-END
Two types of pooled funds containing a portfolio of investments which are often grouped together are unit trusts and open-ended investment companies (OEICs). These baskets generally invest in one or more of the main asset classes - shares, bonds, property and cash.
Both kinds are classed as ‘open-end’ investments, meaning their size isn’t limited and varies according to supply and demand. Open-end funds have no maturity date and can grow larger or smaller depending on the number of investors wishing to buy or sell their units which can rise and fall in number.
Investment trusts also sit in the funds arena and are a form of closed-end investment company traded on the stock market.
The number of shares issued by an investment trust are fixed (unless they issue more to raise money or buy some back), so rather than being inextricably linked to the value of the underlying portfolio, investment trust share prices are driven by the stock market. The total value of the shares can therefore be worth more or less than their underlying assets.
The shares can trade at a premium to net asset value for several reasons. For example, this can happen when the fund manager has a formidable track record of making money for shareholders, while they can trade at a discount if there has been poor investment performance or if the fund’s sector focus is unloved by investors, for example.
ACTIVE VERSUS PASSIVE
When investing in funds there are two broad options available. The first is to use actively managed funds, where a market professional will manage your investments alongside that of your fellow investors and make decisions on what to buy and sell.
In return for the fund manager’s expertise, you pay a fee and to justify the expense the portfolio should at the very least outperform its benchmark and provide consistent premium returns.
For those unwilling to pay the fees or who do not like the risk associated with backing the judgement of even proven professional fund managers, there is an alternative. You can buy passive index-tracking funds.
These are designed to follow a particular benchmark and deliver the index return, whether it refers to a stock market, a bond market, a commodities group or a geographic region. Index-trackers are generally cheaper to hold than actively managed funds.
This is the latest in a series of guides on the basics of the financial markets to appear on our website in the coming weeks.
