Fund investments have traditionally been perceived as a safer way to invest than selecting shares to make up your own portfolio. However, whilst a limited number of funds do regularly perform well, many more make a loss and numerous investors have been left out-of-pocket on their fund investments. Here are the basics you will need to know before considering making a fund investment:
What is a fund?
A fund is a type of collective investment, whereby your capital is pooled with that of other investors. This pooled capital is then invested in accordance with the fund’s investment strategy. This type of financial instrument is professionally-managed using software such as that provided by Sungard.com/APT/.
The main types of fund include:
- Mutual funds are one of the main types of fund available to small investors. They are operated by money managers who invest the fund’s capital in a portfolio set up as stated in the prospectus. An investment in a mutual fund enables a small investor to diversify his or her investment across asset classes including stocks, bonds and other asset investments.
- An exchange-traded fund (or ETF) is a security that operates much like other funds by tracking a particular index. However, an ETF’s price changes throughout the day as it is traded on an exchange in the same way as stock.
- An open-end fund allows new investors to join the fund with no upper limit. Open-ended funds also buy back shares when an investor wishes to sell. The majority of mutual funds operate in this manner.
- A closed-end fund is a publicly-traded investment company which raises capital through an initial offering of shares. This stock is traded on an exchange and represents a professionally managed portfolio of securities which normally focuses on a specific industry or geography.
What should I look for in a fund?
The first thing to do when investigating a fund is to read its prospectus. This is the legal document which sets out the stated aims of the fund: what it invests in, how the fund is managed and how any profits (or losses) will be shared.
You should also check out the performance of the fund over time. This does not guarantee further success but if a fund has never made a profit then you should have serious misgivings about the fund managers.
Are funds a high or low risk investment?
Funds are incredibly varied – different industries, different geographies and a variety of financial instruments. Funds are generally considered to be lower risk than stocks and shares as they do provide some diversity and are professionally-managed. The risk profiles of different funds are as varied as the funds themselves. Once you have decided how much risk you want to take on, you will then need to do some research and find a fund that meets your needs.
What should I beware of?
When you are reading the fund’s prospectus make sure that you check the following:
- If the fund is performing well then investors will not normally object to the management fees payable. Professional asset managers will have the benefit of sophisticated financial risk management software. However, when a fund is making a loss, this fee will still be payable and can be a sting in the tail when you have already made a loss on your investment. Make sure that any management fees are reasonable.
There has been adverse press recently about extortionate performance fees which are charged by some funds. These fees are triggered when the fund performs better than a given benchmark (measure of success of the fund). Make sure you understand the impact of these charges before investing – they can sometimes eat up as much as a fifth of the profits which exceed the benchmark.