Fund management: A beginner's guide

With cash sitting in the bank returning next to nothing, inflation expectations on the up, and traditionally "safe haven" government bonds trading at historically low yields, many people will wonder where they can turn to to grow their wealth and provide income for the future.

Entrusting a professional investor with your cash is a daunting endeavour, particularly with a jungle of industry jargon to slash through; however, if you're willing to take on a little extra risk, there is certainly a case for putting your money to work in an investment fund.


What is a fund?

When financial services professionals refer to a fund, they are usually talking about a unit trust or open-ended investment company (OEIC).

A fund is a pool of cash which is used to invest in a collection of assets; most commonly company shares and bonds. The mixture of assets dampens the risk of holding a single one.

A fund will typically be made up of holdings in equities (stocks) and bonds, but can also include more specialised products such as property, passive investments and cash or cash-like products intended to dampen volatility.

The performance of a fund that invests primarily in equities and corporate bonds will be dependent on the performance of the companies it invests in.

Funds are also split into categories based on what assets they are invested in (bonds or equities for example), the regional bias (a North America fund will focus on stocks listed in North America), sector concentration (a commodities fund may centre on mining stocks).

A fund can also be classified by its perceived level of risk. For example, in the mixed asset sector (meaning the fund holds both equities and bonds), the funds that have a higher level of equity exposure are considered higher risk.

The majority of funds are actively managed, meaning an investment professional with significant experience will routinely research and analyse the holdings in the fund, aiming to deliver gains higher than a relative benchmark.

A retail fund will typically require a minimum investment of £1,000 and an annual management charge ranging from 1 to 1.5 per cent.

The total cost of the fund is expressed as a total expense ratio (TER), which in general ranges anywhere from 0.5 to 3 per cent.

The amount of income a fund returns to an investor is expressed as yield. The yield is the interest or dividend paid by an investment.

A fund’s yield is expressed as a percentage based on the investment’s cost, and varies depending on the type of fund. The yield on an income-based fund can range from 2 to 10 per cent.


Investment trusts

With impending regulation changes that will ban commission to advisers, many investors are expected to turn to investment trusts, which tend to have lower costs and similar returns to open-ended structures.

The primary difference between a fund and an investment trust is that the trust is a closed-ended listed company, meaning it issues a limited number of shares that are traded on the stock market.

If an investor wants to buy into a trust, someone must first sell their shares unless new shares are issued by the company.

An investment trust can also be traded at a ‘premium’ or ‘discount’ to the actual value of its holdings, depending on the popularity of the fund.

Basic laws of supply and demand apply: if more people are selling the fund than buying, the fund will trade at a discount, meaning an investor can buy into the trust for less than its holdings are worth.

If there is a heightened demand to buy the trust, but few shares are available, its price will spike.


Active vs passive

Passive investment is the opposite to its active counterpart in that funds will ‘track’ a relative index, the FTSE 100 for example, rather than aiming to outperform it through a series of strategic asset allocations and stock choices.

A passive fund works on the assumption that the market will be more efficient than subjective choices made by an individual or team of managers.

The advantage of passive funds is that they tend to be cheaper than actively managed vehicles. Passive funds can either be trackers, which are bought and sold in the same way as active funds, or exchange traded funds (ETFs) that function as shares.

There is an ongoing debate over whether active or passive funds can consistently deliver targeted returns. Active managers will argue that their expertise and focused attention on the makeup of the portfolio will outweigh a fund that simply follows the makeup of the index.