Welcome to our Education series that aims to explain various investment concepts in a friendly, clear, and precise format.
Here, we dive into another popular asset class, collectives, otherwise known as funds.
What is a fund?
A fund is actually a fairly simple concept even though the underlying structures can be varied and complex.
Simply put, a fund will invest in a variety of different underlying investments, and then you as the end investor buys units of that fund.
What does a fund invest in?
There is no easy answer to this question, as it completely depends on the purpose of the fund and for that reason there are thousands of different funds available to you.
For instance, an equity growth fund may invest in a range of companies (please see our note on equities) around the world that the managers think have scope to grow their earnings quickly.
On the other hand, a fund that aims to achieve a slow and steady return with limited risk may invest in gilts (please see our note on government bonds) or cash equivalents.
It is then down to the individual investor to decide what fund is most appropriate for their own situation.
There are safeguards in place to prevent funds straying too far from their agreed objective, although there have been instances where fund managers have ventured into territory that they shouldn’t. A good example was the Neil Woodford affair in the late 2010s.
For instance, Neil Woodford made his career as a “boring” investor, buying well-established companies such as GSK and BP. However when he started his own funds, he started buying smaller higher risk healthcare companies.
Although this was technically allowed, it marked a complete change in strategy and should have raised red flags to investors.
Since inception the trust has lost 90% of its value.
Disadvantages of funds
This brings us on nicely to one of the main disadvantages of funds, which is that you often don’t know what a fund invests in.
You may be given the top ten holdings and the objective, but you don’t know the entire portfolio. There are ways of finding this out, but it is time consuming and involves plenty of digging.
Therefore while you may end up having several funds that you like in isolation, but you don’t know how they will work together.
Another disadvantage of funds is that you have to pay a fund manager for the privilege of managing the fund. Although fund manager costs have fallen over the last few years, some can still be expensive and can eat into your returns. We will discuss passive vs active management in a future article, but for now we will leave it there.
Advantages of funds
Funds do have their benefits and we believe that they have a place in portfolios.
For individuals who are just starting out in their investing journey, it may not be appropriate to pick individual companies, and funds can often be a less risky approach than a direct equity approach.
Furthermore, we appreciate that there are some areas of the market where we simply don’t have the ability or expertise to invest in directly, such as emerging markets or funds that specialise in more complex products.
Summary
Funds can provide a one stop shop for investors to start their investment journey. However, they do come with certain limitations that you should be aware of. As always, Dasha and myself are always here to chat about anything you may read here.
Risk warning: With investing, your capital is at risk. Opinions constitute our judgement as of this date and are subject to change without warning. This article is intended for informational purposes only and no action should be taken or refrained from being taken as a consequence without consulting a suitably qualified and regulated person.