23/08/2019

Why Invest in Funds

Here are 5 reasons why investors choose to invest in funds as their route to the investment markets. This post looks at these benefits.

  • Economies of Scale
  • Risk Management
  • Professional Services
  • Convenience & Choice
  • Cost of Investment

Economies of Scale

Funds are collective investments. A collective investment enables people to buy part of the total investment portfolio of the fund. By grouping together, those of modest means benefit from the same investments as the better off.

Economies of scale enable them to invest in larger assets such as hotels, factories, warehouses and office buildings. Most people cannot afford to buy these assets on their own but they can via a fund.

Another advantage of economies of scale is the employment of professional services like lawyers, researchers and fund managers. Normally the cost of employing a professional on an on-going basis would be prohibitively expensive. By employing them via the fund, private investors pay in proportion to their holding in the fund via the fund fees.

Risk Management

The ownership of a share in a company entitles you to a share in the profits made by the company. The ownership of a unit or share in a fund entitles you to the performance of the fund.

Investors have limited capital. An investor needs to limit the number of individual investments made according to the amount of capital available and the cost of investing in these assets.

To take an extreme example, it is unlikely to be of any benefit investing in one share costing $1 if the cost of purchasing that share is $10, an investor would need to achieve a 1,000% return before he had even recovered his cost of investing.

When a person decides to invest in funds, this enables them to spread their investment over a wide variety of equities, bonds and property assets within just one unit.

So if the unit price is $1 within that unit an investor has exposure to all of the investments of the fund, which may be tens or even hundreds of different assets.

So as well as being cost-effective, funds help reduce risk by providing diversification. Fund charges are a percentage of the transaction rather than a fixed fee. Small and regular investors benefit from this form of charging structure.

Professional Services

Funds provide investors with safe custody of the title documents of the fund’s assets. Examples of title documents are title deeds to property and shares certificates where the are still issued.

Custodians collect dividends and interest from the assets held by the fund. Usually, the custodian of the fund is a large international bank.

Funds also use lawyers when transacting deals such as property purchase or buying some other off market asset, ensuring proof of title and other important aspects of the purchase or sale.

Of course, many funds undertake a great deal of research to investigate investment opportunities for the fund manager to select, if he or she feels it is appropriate for the fund. This research will often involve visiting companies around the world and discussing the prospects of the company with senior managers and the firms’ directors.

Convenience & Choice

Another reason to invest in funds is convenience. They offer access to many investment opportunities in one place. The fund manages the collection of dividends and interest from the investment as well as the safe custody of documents. This saves the investor time.

There are tens of thousands of funds from which an investor can choose. These funds cover many different markets, asset types and investing styles.

Cost of Investing

When a person decides to invest in funds. For funds regulated in the EU, there is a document called a Key Investor Information Document (KIID.) This is a 2-page document in a format prescribed by the fund’s regulator. It provides basic information about the fund, including information on risk, the fund’s past performance and charges.

The cost of investing via a fund depends on many factors but typically there are 2 main charges an investor will consider. Firstly, the cost of investment, how much it costs to buy into the fund (initial charge). As mentioned above, funds usually charge a percentage of the amount invested. Whilst 5% remains the industry norm for retail investments, I have seen this charge as high as 8% and as low as 1%.

The Ongoing Charges Figure (OCF) shows the drag on performance caused by most operational expenses associated with a fund. Expenses represented by this figure include payments to the manager, trustee, custodian and their representatives. The figure also includes registration, regulatory, audit and legal fees, and the costs of distribution. For actively managed funds a charge or between 1.5% and 2.0% is normal and for a passive fund like an ETF 0.5% or less is typical.

The OCF calculation does not include charges for performance fees, transaction costs and interest on borrowing for example. To understand these fees, an investor must consult the fund accounts.

For more information on funds and other investment opportunities contact us.

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