Investment Funds

Definition of an investment fund: An undertaking the objective of which is the collective investment of capital provided by investors. Such undertakings are typically companies, unit trusts and limited partnerships and may be open or closed - ended.

Source: Irish Stock Exchance www.ise.ie

Understanding Investment Funds

Introduction to Investment Funds?

Investment funds can be invested in many different kinds of financial instruments. There are many categories of funds with different levels of risk attached to each. Most of a fund’s investment portfolio is constantly adjusted under the supervision of professional managers, who forecast the future performance of investments appropriate to the fund and choose those which most closely match the fund’s investment objectives. Most funds are administered through a “parent” company, which may hire or fire fund managers.

Investment funds are subject to rules and regulations and, unlike other businesses, they are not taxed on their income as long as they distribute it to their shareholders. Also the level of taxation may depend on the type of investment (in some countries incomes from treasury bonds are tax-free).

The first investment fund was founded in 1924 in the United States shortly before the stock market crash in 1929 (which started a period of Great Depression). After that in 1930’s the first laws regulating the activity of investment funds were passed. These laws require that each fund has to be registered and provide investors with a prospectus containing required disclosures about the fund, its assets and managers.

Types of Investment Funds

The Financial Regulator on its website itsyourmoney.ie has useful user friendly information and savings and investments.

The most common classification of investment funds is based on the type of assets they invest in and includes:

Equity funds – investing in stocks, which can be further divided into:
- growth funds – investing in companies that have a potential for large capital gains,
- income funds – investing in companies with potential profits,
- index funds – investing in companies that are part of major stock indices,
- sector funds – investing in companies from selected sectors of the economy.
Bond funds – investing in long-term or short-term bonds of different levels of risk (and profitability) including:
- treasury or municipal (community) bonds, typically government guaranteed
- corporate bonds (with higher potential returns but also higher risk rated).
Money market funds – usually investing in short-term debt obligations being a substitute of bank deposits (with lowest risk but also the lowest profitability). The biggest risk for an investor is the risk of inflation, which may outpace the profits.
Funds of funds – investing in other investment funds are designed for investors who cannot choose the right type of fund for themselves or want to diversify their investment (according to their age and risk preferences).
Umbrella funds – containing several sub-funds investing in different markets or different countries, which makes it cheaper for an investor to switch from one sub-fund to another.
Hedge funds – investing in potentially high profit (and mostly high risk) advanced financial instruments.
Guaranteed funds – with an underlying guarantee that the invested capital will be returned in full in certain period of time plus the minimum profit.
Property investment funds – investing in properties like: land, houses, apartments etc.

The characteristics of a specific fund may only be suited to larger investors where minimum investment amounts apply.

What should you know before joining an Investment Fund?

Investment funds offer several advantages over other types of investment including:

lower transaction costs (which are divided among all the shareholders),
lower risk compared to individual (direct) investment (due to higher diversification of assets),
professional management keeping track of the market changes.

Many investment funds offer several classes of shares (usually depending on the amount invested) with different range of services, level of fees or expenses and usually different performance results. Such funds enable investors to select a fee and expense structure most appropriate for their investment goals (including the amount and length of investment) as well as individual attitude towards risk.

But investment funds are not risk free and the future investors should ask themselves the following questions before investing in the fund:

How much risk am I willing to take?
What am I saving for (retirement, education, “rainy days” etc.)?
What is the time horizon of my investment (short or long)?
Would I need the invested money quickly in case of an emergency?
What type of fund am I interested in?
What are the fund’s objectives and investment policy?
How long do I intend to keep my shares?
How often will I be informed about the fund’s progress?
When and how are dividends on units or shares of the fund distributed?
What is the fund’s capital and past performance?
What are the fees involved, besides entry and exit commissions?
What is the history and origin of the investment fund?
Quality of the fund manager based on past performance, although this is not an indicator of future performance.

What you should know about cross-border activity and protection

You can invest not only through a mutual investment fund which is operating in your home country but also through a fund operating and registered in another country. In that case if you have complaints concerning any wrongdoings (like unauthorised or wrongly executed orders, lost records etc.) and it cannot be solved by your investment fund (i.e. its customer service department) you have to go to an appropriate court in the country in which the fund is registered.

There is an alternative to settling it out of court with the help of FIN-NET which is the co-operation network between national out-of-court dispute settlement bodies for financial services within the European Economic Area (EU countries plus Iceland, Liechtenstein and Norway). Out-of-court procedures are usually quicker and cheaper then court disputes, but being a voluntary alternative may not be fully satisfactory and comparable to court rulings.

You should remember that your investment may be protected in a similar way as your bank deposits by the deposit insurance system. However, it is a protection against a fraud, negligence, wrongdoing or bankruptcy of an investment fund but not against any looses caused by market fluctuations (like falling prices of stocks your fund has invested in). There is also a maximum limit of protection which may differ from country to country, so you should check that before choosing an investment fund and an amount you want to invest.