How does an investment fund work?
How does an investment fund work?
If you want to gain access to assets that are difficult for ordinary investors to buy, or just don't fancy picking individual investments yourself, an investment fund can be a good option.
An investment fund pools together the money of many investors – often thousands - and gives each of them a stake in a portfolio of assets.
This portfolio could include any mixture of shares, property, bonds or cash.
If you invest in the fund, the value of your investment will then rise and fall in line with the combined value of those assets. Your income payments from the fund will also rise and fall, depending on how much those assets earn.
Active versus passive
The two key types of investment fund are actively managed and passively managed.
Active fund managers make investment decisions based upon their research and analysis and try to outperform the market or a specific index.
They do this by identifying and buying assets that they believe are underpriced, selling over-priced assets, and picking broader investment cycles.
By contrast, passively managed funds seek to match the investment composition of an index and thereby match its returns.
For example, a fund manager might buy all of the shares in the MSCI Australian Shares Small Cap Index, in order to track its performance. They will only make adjustments to better track the index.
Because there is less effort involved, the management fees on passive funds are typically lower than on actively managed funds.
What are the benefits of a managed fund?
Managed funds offer a number of advantages over going it alone which is why they are such a popular investment vehicle.
For a start, they give private investors access to markets and strategies that rely on economies of scale.
They can provide access to a wide range of investing opportunities that an ordinary investor would otherwise not be able to access, such as office towers and shopping centres, overseas investments, and high-value bonds.
For instance, a Residential Mortgage-backed Security is a bond secured against a pool of prime Australian residential mortgages.
RMBS notes buy hundreds of millions of dollars worth of home loans, and when the property owners make their mortgage repayments, they are passed through to the RMBS owner.
These bonds are worth tens of millions of dollars or more, they are usually the exclusive preserve of institutions.
A fund like Firstmac's High Livez gives you access to the RMBS market with a minimum investment of just $10,000.
Many investment classes, such as the above mentioned RMBS, require specialised knowledge to really understand. A fund manager like Firstmac, which issues billions of dollars in RMBS every year, knows how to properly value RMBS accurately in a way that a general investor cannot. Many investors would prefer to pay for expert investment management.
Another advantage of investing in a fund is diversification. By pooling money, you get access to a range of assets through a single modest investment, so even if some of them perform poorly, others might do very well, giving you an acceptable overall return. It would require a lot of money to get anywhere near that level of diversification yourself.
What are the risks?
Like any investment, there are risks to investing in a managed fund. Depending on the assets held by the fund, these can include currency risk, gearing risk, short-selling risk and emerging market risk. With any asset, there is the risk that its value will decline.
For this reason, it is important to carefully examine the investment strategy, asset allocation and the manager's track record before investing. Make sure you read the fund's Product Disclosure Statement, where you will find details of its manager, strategy, and fees.