Everything you need to know about investment funds.
Updated: Feb 4, 2021
Without any doubt, investing is the best way through which you can accumulate wealth and secure your financial future. But maybe you don’t have enough time to learn about stock trading, to study so many public companies that are listed on a stock exchange or to follow prices every day. If that’s the case, investment funds might be the right instrument for you.
1. What are investment funds?
An investment fund is a way of investing money alongside other investors in order to benefit from working as part of a group. The money raised is invested by professional investment managers in liquid financial instruments such as stocks, bonds or short-term debt and operates on the principle of risk-spreading and prudential management. The combined holdings of the investment fund is known as its portfolio. Investors can buy fund units, which are equivalent to stocks, each unit represents an investor’s part ownership in the funds and the income it generates. Unlike the finite number of stocks a company can issue, fund units are issued on an ongoing basis and can be purchased and sold at any time.
2. How are investment funds managed?
Amounts accumulated by an investment fund through selling funds units are managed by the Fund Manager, who is the employee of an asset management company (S.A.I.) that need to be authorized by The Financial Supervision Authority (FSA), and the investment management shall be carried out under the control and supervision of FSA.
Asset management companies are using their expertise and resources to research, select and monitor financial instruments according to a series of mandatory documents like Prospectus or Key Investor Information, so investors know where their money will be invested. Based on them, you will be able to choose the proper investment fund that fits your needs and wants.
3. What types of investment funds are there?
An investment fund can be Open-end funds (also called: Undertaking for the collective investment in transferable securities) or closed-end funds (also called: Alternative Investment Funds). The main difference between those two types of funds is related to their availability.
Open-end funds allow the subscription (purchase) and redemption (sale) fund units at any time and usually, an investor will purchase units funds directly from the fund itself, rather than from the existing shareholders. This type of investment funds are available in most developed countries but their terminology might be different, for example in the USA are known as mutual funds, in the UK as unit trust and in Romania as fonduri deschise de investiții or organisme de plasament colectiv în valori mobiliare.
A closed-end fund is an investment model based on issuing a fixed number of fund units which are not redeemable from the fund. Unlike the open-end fund, new fund units are not created by Fund Managers to meet the demand from investors. Subscriptions and redemptions can be made only at certain predetermined time intervals and usually have a limited lifespan. At the end, the fund is liquidated and the money divided among investors. In the USA, closed-end funds are known as closed-end companies, in the UK as investment trusts and in Romania as fonduri de investiții alternative.
Types of Open-end funds
Most of them fall into one of four main categories - money markets funds, bond funds, stock funds and mix funds. Each one has different features, risk level or expected yield.
Money market funds have the lowest level of risk because they usually invest 90% of their portfolio in relatively low risk financial instruments like deposits or government securities. Because of this, the reward for investors will most likely be around the level of inflation. These funds are well suited for defensive or convervative investors that want to maintain their purchasing power.
Bond funds invest mostly in fixed income financial instruments like corporate bonds, municipal bonds or government securities. Because there are many types of bonds, the risk and reward are higher than the one offered by money market funds. A bond represents a loan from the buyer (the bond fund) to the issuer (a company or a government), and they agree to pay back the loan on a specific date and pay periodic interest payments along the way. Those bonds can be traded on stock exchange but their price will not fluctuate as much as stock prices. Bond funds are subject to interest rate risk, meaning that their value will decrease when the generally prevailing interest rates rise. Because the payments are usually fixed, a decrease in the market price of the bond means an increase in its yield. When the market interest rate rises, the market price of bonds will fall, reflecting investors' ability to get a higher interest rate on their money elsewhere. This does not affect the interest payments to the bondholder, so if the fund manager wants to keep the bond till maturity date, he will not worry about interest rate risk. Instead he will focus on the issuer to make all required payments.
Stock funds invest mostly in corporate stock, but not all funds are the same. Growth funds will focus on stocks that have potential for above-average gains in the future, even if for the moment those companies don’t pay regular dividends. Income funds will invest in companies that pay regular dividends, and index funds will track a particular market index EURO STOXX 50. Other funds may specialize in particular industry segments. The value of stocks owned by the fund will depend on profitability or the financial health of the issuer company. If the perspectives are good, the value will increase, but if the company will pass through tough times, the stock value will probably decrease. Publicly traded stocks are also subject to market risk, meaning that their price can go up or down for reasons unrelated to the issuer. Because stock funds have the highest level of risk, their reward must be also the highest.
Mix funds are probably the most used funds by investors. Those funds hold a mix of stocks, bonds or other financial instruments and over time the mix gradually shifts according to the fund’s strategy. The risk level can vary based on each fund portfolio allocation.
4. How to buy and sell open-end funds
Investors buy units funds directly from the fund or through a broker. The price paid by the investor is the fund’s net asset value per unit plus any fees charged at the time of purchase. Open-end funds are redeemable, so the investor can sell his units back to the fund at any time.
To prevent any fraud or speculative operations, the exact price of buying or selling units funds is unknown at the moment you place the order. The reason is that the net asset value of the fund is unknown exactly until the following day, after all markets are closed and the prices of financial instruments are known.
All the assets held by the fund are kept by a financial institution called depository. Their task is to verify and certify the correct record of fund units and gross and net assets value. Based on depository data, the exact value of the subscriptions and redemptions will be determined. As the fund and the asset management company, the depository has to be authorized and supervised by authorities.
5. What are the benefits and risks of open-end funds
There is not a single investment that can guarantee you a reward, and all of them carry a certain level of risk, higher or lower, even as much as losing all of your money.
Open-end funds offer professional investment management and assets diversification
You can easily buy or redeem your units at any time.
The amount invested can be lower and you can create investment plans to invest regularly a certain amount of money, for a time periode you want, directly from your bank account
You can invest online and easily track your investments
You can be charged with fees or commissions regardless of the fund performance. Make sure you have been informed in advance about the costs.
Investment management may not be the best, that’s why it’s important to be able to compare different funds, from different asset management companies, and to easily switch to another fund that you consider to be better for you.
A fund’s past performance is not as important as you might think because past performance does not predict future returns. However, it can tell you how volatile or stable a fund has been over a period of time.
Should you place your money in investment funds? You are the only one who can answer this question. At the end of the day, anyone has the possibility to invest in an open-end fund and become a shareholder of that fund that fits his investor profile.
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