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Understanding
investment funds

This chapter sets out a basic understanding of investment funds. Other factors may need to be taken into account before making an investment decision.

Speak to a financial adviser who will be able to offer further advice about investment funds and whether they are a suitable investment for your needs.

What are investment funds?

The majority of investors lack the time or experience to closely manage a portfolio of individual shares, bonds and/or other investment instruments. For such investors, a diversified portfolio of investment funds, together with the ‘know-how’ of a financial adviser, can present a sound, individually- tailored solution.

Investment funds, under the management of a fund manager, pool together money from many investors to collectively invest in a selection of shares, bonds, cash or other financial instruments. You can achieve diversification across a range of assets by simply investing into one fund.

Each investment fund has an objective outlining what it aims to achieve for its investors. This allows you to choose funds that meet your investment objectives and that are appropriate to the level of risk you are prepared to take. The objectives can be found on the fund factsheet, key information document, or prospectus.

It is the fund manager’s job to create a portfolio that blends different types of shares, bonds and other financial instruments to achieve the objectives of the fund.

As with all investments of this nature, the most important thing to remember is that investment funds should be viewed as a long-term investment, meaning at least five years but preferably longer.

Types of
investment funds

Specialist funds

No matter which sector you are interested in investing in, there is likely to be a fund that invests in it

Specialist funds invest in a specific sector of the economy. Examples of sectors include: health, telecommunications, IT and technology, property, or natural resources.

Global funds

Global funds offer a convenient solution to achieve a geographically diverse portfolio

A truly diverse portfolio should take advantage of global diversification opportunities. If you do not have any specific preferences of countries or regions to invest in, global funds are the easiest way of gaining exposure to global companies or markets.

Equity funds

Investing in a portfolio of shares of different companies/across different industries

Depending on the investment strategy of the fund, some funds may only invest in large companies and some only in medium-to-small companies. There are also funds that will only invest in particular sectors, such as health or telecommunications – offering a diversified investment into a particular industry or theme.

Balanced funds

Balanced funds have the advantage of investing in a mixture of assets including both shares and bonds

It would be common for a balanced fund to have the majority of the portfolio invested in a mixture of these assets, with the remainder held in other classes such as property or cash. However, this varies depending on the objectives of the fund.

It is important to be aware of the asset allocation between shares, bonds, and other assets, in order to fully understand the risks and potential rewards inherent within a particular fund.

Bond funds

Bond funds invest in a portfolio of fixed-interest securities

In general terms, bond funds invest in a portfolio of fixed- interest securities, for example, government bonds or corporate bonds (bonds issued by companies). The bonds held in the fund will typically generate an income (or coupon). The fund is able to distribute some, or all, of the income received.

Funds that invest in government bonds are generally considered to be less risky than funds investing in corporate bonds. However, rates of return, whether in terms of capital growth or income paid, are not guaranteed and can still go down as well as up.

Emerging markets funds

Developing countries have the potential for very high economic growth

An emerging market fund invests in shares or bonds issued by companies or governments in developing countries. Examples include Brazil, Russia, India, and China. This high growth potential may be due to a number of factors, such as political and structural changes in the country, for example: privatisation, liberalisation of trade, or providing better access to capital. The main risks, on the other hand, are political instability, volatile economic conditions, and generally less structured markets and regulatory regime. The financial markets in such countries can therefore fluctuate dramatically.

Risk and return

As with all investments, there is a degree of risk. Of course, investment funds can go down as well as up in value. It is important that you are comfortable with an investment fund’s risk profile and susceptibility for short-term volatility.

Additionally, you should consider ‘currency risk’ – a risk associated with funds investing in foreign assets. For example, even though an investment might have grown by 50%, if the local currency were to halve in value compared with your domestic currency, you would be no better off if you sold the investment.

Performance figures are available from the fund manager, or alternatively are often made available in the financial press or more widely on the internet. The figures will typically show cumulative investment performance over a range of different time periods.

The performance or return from a fund is often compared against a benchmark index or sector average performance. A benchmark index is a target against which investment performance can be measured. The benchmark index will be based on the values of a group of securities or other assets, such as property. It is used to determine the relative rate of increase/decrease. Sector averages denote the average performance of all funds within that particular sector.

The ranking of a fund within a particular sector is an indication of how well a fund is performing in comparison to funds with similar investment objectives. However, you should note that past performance is not a guide to the future.

Investing in funds is generally considered to be a long-term investment, and it is therefore more important to look for funds and fund managers that consistently outperform the sector average over a sustained period of time. Remember, a fund may outperform its sector but if the sector average is negative, the actual return on the fund could also be negative.

Charges

Investors in a fund typically pay an annual fund management fee of between 0.5% and 3% a year. On top of this, they will also pay the fund’s ‘additional expenses’ such as costs relating to buying and selling underlying assets.

All these charges are combined to produce what is termed the Total Expense Ratio (TER) or Ongoing Charges Figure (OCF). These charges are deducted from the fund price on a daily basis rather than as an annual charge.

and finally...

There is no doubting that investment funds offer the potential for growth and a convenient way to diversify risk. However, with such a wide choice available, all with varying performance, objectives and risk profiles, it is important to choose wisely.

To become adept at analysing investment funds and various fund manager strategies, you must have a broad understanding of how investment works.