Investment funds are investment vehicles created for the purpose of collecting assets from investors and channeling those assets into a portfolio of financial instruments such as stocks, bonds and other securities. Investment funds offer small investors the chance to have a professionally managed and diversified basket of financial instruments at affordable costs. An investment firm invests the pooled funds of retail investors for a fee. By aggregating the funds of a large number of small investors into a specific investments (in line with the objectives of the investors), an investment company gives individual investors access to a wider range of securities than the investors themselves would have been able to access. Also, individual investors are not hampered by high trading costs since the investment company is able to gain economies of scale in operations. There are two types of investment companies: open-end (mutual funds) and closed-end (investment trusts). also called investment fund
Benefits of Investment funds
Investing in funds has several benefits:
1) Professional management: Funds have full-time professional managers who research and spot suitable investment opportunities. The time, effort and expertise they devote to investments far exceed those affordable to a single investor.
2) Cost efficiency: Since funds manage a large number of investments, the trading and research costs are spread among investments.
3) Diversification: Most funds invest in a variety of investment classes and companies, therefore protecting investors from the collapse of any single class of investment or company.
A mutual fund is a big pool of money from many investors. The mutual fund manager uses this money to invest in stocks, bonds and other investment instruments meeting the fund’s criteria. To invest in a mutual fund, you buy shares to become a shareholder of the fund. Most mutual funds have reasonable minimum investment requirements ($1,000 or less) and are affordable to the general public. Investors can choose different funds based on their risk-taking profile: Stock funds invest more heavily in stocks and have ups and downs over time; bond funds offer steady current income; and money market funds (investing in short-term debt) ensure that the invested principal does not decline in value in the short term.
Advantages of Mutual Funds
- Diversification. Mutual funds spread their holdings across a number of different investment vehicles, which reduces the effect any single security or class of securities will have on the overall portfolio. Because mutual funds can contain hundreds or thousands of securities, investors aren’t likely to be fazed if one of the securities doesn’t do well.
- Expert Management. Many investors lack the financial know-how to manage their own portfolio. However, non-index mutual funds are managed by professionals who dedicate their careers to helping investors receive the best risk-return trade-off according to their objectives.
- Liquidity. Mutual funds, unlike some of the individual investments they may hold, can be traded daily. Though not as liquid as stocks, which can be traded intraday, buy and sell orders are filled after market close.
- Convenience. If you were investing on your own, you would ideally spend time researching securities. You’d also have to purchase a huge range of securities to acquire holdings comparable to most mutual funds. Then, you’d have to monitor all those securities. Choosing a mutual fund is ideal for people who don’t have the time to micromanage their portfolios.
- Reinvestment of Income. Another benefit of mutual funds is that they allow you to reinvest your dividends and interest in additional fund shares. In effect, this allows you to take advantage of the opportunity to grow your portfolio without paying regular transaction fees for purchasing additional mutual fund shares.
- Range of Investment Options and Objectives. There are funds for the highly aggressive investor, the risk averse, and the middle-of-the-road investor – for example, emerging markets funds, investment-grade bond funds, and balanced funds, respectively. There are also life cycle funds to ramp down risk as you near retirement. There are funds with a buy-and-hold philosophy, and others that are in and out of holdings almost daily. No matter your investing style, there’s bound to be a perfect fund to match it.
Disadvantages of Mutual Funds
Although mutual funds can be beneficial in many ways, they are not for everyone.
- No Control Over Portfolio. If you invest in a fund, you give up all control of your portfolio to the mutual fund money managers who run it.
- Capital Gains. Anytime you sell stock, you’re taxed on your gains. However, in a mutual fund, you’re taxed when the fund distributes gains it made from selling individual holdings – even if you haven’t sold your shares. If the fund has high turnover, or sells holdings often, capital gains distributions could be an annual event. That is, unless you’re investing via a Roth IRA, traditional IRA, or employer-sponsored retirement plan like the 401k.
- Fees and Expenses. Some mutual funds may assess a sales charge on all purchases, also known as a “load” – this is what it costs to get into the fund. Plus, all mutual funds charge annual expenses, which are conveniently expressed as an annual expense ratio – this is basically the cost of doing business. The expense ratio is expressed as a percentage, and is what you pay annually as a portion of your account value. The average for managed funds is around 1.5%. Alternatively, index funds charge much lower expenses (0.25% on average) because they are not actively managed. Since the expense ratio will eat directly into gains on an annual basis, closely compare expense ratios for different funds you’re considering.
- Over-diversification. Although there are many benefits of diversification, there are pitfalls of being over-diversified. Think of it like a sliding scale: The more securities you hold, the less likely you are to feel their individual returns on your overall portfolio. What this means is that though risk will be reduced, so too will the potential for gains. This may be an understood trade-off with diversification, but too much diversification can negate the reason you want market exposure in the first place.
- Cash Drag. Mutual funds need to maintain assets in cash to satisfy investor redemptions and to maintain liquidity for purchases. However, investors still pay to have funds sitting in cash because annual expenses are assessed on all fund assets, regardless of whether they’re invested or not. According to a study by William O’Reilly, CFA and Michael Persian, CFA, maintaining this liquidity costs investors 0.83% of their portfolio value on an annual basis.
A hedge fund is a private investment pool of capital which has few restrictions in what types of assets it can invest in. Hedge funds are often ran by a small team of experienced portfolio managers, traders and analysts. Hedge funds earn money by typically charging investors a 2% management fee plus 20% of positive returns past a set point which is often referred to as a hurdle rate. While the hedge funds you often here about in mainstream media are very large with over $10B in assets they represent only .5% of the total universe of well over 12,000 hedge funds.
Hedge funds have historically been the domain of wealthy investors. They are like mutual funds in that they typically invest in stocks and bonds; however, they take higher risks, such as short selling—i.e., selling borrowed shares in the hope that the price of the shares will drop later. Hedge funds charge a higher annual fee (1 to 2 percent) than mutual funds and also demand a typical performance fee of 20 percent. Hedge funds are not subject to the same regulatory oversight as mutual funds; therefore, their operations are usually considered more opaque.
In actively managed funds such as mutual funds and hedge funds, portfolio managers and analysts scour the market for investment opportunities. In index funds, managers passively invest to match the performance of a market index such as the Standard & Poor’s 500 index—i.e., stocks of 500 large U.S. companies. An index fund buys and maintains stocks in the same ratio that constitutes the target index.
Fund of Funds
A fund of funds is a fund that puts money into other investment funds or target funds. The basic idea is that the investors hand over the selection of funds to professional fund managers instead of choosing funds themselves. Funds of funds enjoy a double risk spreading—i.e., diversification at the level of target funds and at the fund of funds’ level itself.
Russia gives a boost to side-by-side investment fund
The Kremlin is on a charm offensive to persuade international investors to take a second look at Russia. But given the almost universal skepticism and Russia’s appalling investment image the Kremlin has eschewed words, plumping for something a lot more effective – helping foreigners make money.
Over the last year and half Russia has launched a disparate array of initiatives to make the country a bit more appealing to investors. But regularly rubbished in the international press and constantly shooting itself in the foot with one PR debacle after the next, the Kremlin has been forced to put its money where its mouth should be.
So on Tuesday, president Vladimir Putin ordered prime minister Dmitry Medvedev to add an extra RUB250bn ($8bn) to the Russia Direct Investment Fund (RDIF), headed up by Young Turk and former fund manager Krill Dmitry (pictured).
The RDIF was set up in June 2011 to co-invest in profitable Russian projects with some of the biggest funds in the world. The idea was that implicit state backing would offer foreign funds a measure of comfort; the hope is they will get used to making money in Russia and start going it alone without the Kremlin’s support.
The fund was formed with $10bn from state debt agency cum development bank Vnesheconombank (VEB) in tranches of $2bn a year. Putin is now proposing to increase the total by about $8bn paid in through to 2015.
Dmitry says the fund already has 12 prospective sectors into which it will invest $3bn of the new money. They include infrastructure, transport and logistics; investments into agriculture alone will reach $250m under this year’s plan.
Russia has a woeful record when it comes to investment. According to a paper about to be released by Aton, a leading Russian investment bank, some 70 per cent of all foreign direct investment into Russia comes from offshore havens – meaning it is Russian flight capital returning home. Things are not much better for portfolio investment, where Russian shares have always traded at a steep discount to those of its emerging market peers. (Russian shares are currently trading on a price to earnings ratio of 5.4, making Russia one of the cheapest major equity markets in the world).
Russia has recently spent $20bn on tatting up Vladivostok and hosting the APEC summit that was designed to showcase Russia to its “new” partners in Asia. It’s on the back of initiatives like this that the US–educated Dmitry, with a BA from Stanford and MBA from Harvard, is being positioned as a front man for selling Russia Inc on the western stage.
Nevertheless, he remains a relative lightweight. State-owned VTB Bank hired a real heavyweight last week to shore up the team: veteran investor Jim Rogers has become a consultant for VTB’s agriculture fund and has the ear of investors in New York. But speeches and big gun consultants are still not enough to turn the tide. Perhaps an extra $8bn will make Dmitry’s job that much easier.
To delve into the world of mutual fund investing requires you to first analyze your own situation, specifically, your needs and goals. Determine what you’re investing for and your comfort with risk to assess what types of funds to look at.
For example, if you’re choosing funds for your retirement account and have many decades until you reach retirement, a more aggressive mutual fund with low expenses would be ideal. Plus, you aren’t liable for capital gains tax on investments in qualified retirement accounts, so you could consider funds with high turnover that annually distribute capital gains.
On the other hand, if you’re saving to purchase a home within the next decade, you may prefer a fund that doesn’t often distribute capital gains and isn’t as aggressive as your retirement holdings.
1. How are hedge funds different from mutual funds?
2. Who ideally is best suit to invest in Hedge funds?