Investment Funds

Saving through Investment Funds

Banking , Investment funds , Making a complaint , Money , Risk

What is the idea and history of Investment Funds?

Investment funds can invest in many different kinds of financial instruments and there are many categories of funds of different types, with different levels of risk. 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 a set of regulations and rules 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.

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 prospectus containing required disclosures about the fund, its assets and managers.

What types of Investment Funds are there?

Open-Ended Funds

Open-ended funds sell their own new units to investors, stand ready to buy back their old units, and are sometimes listed on a stock exchange. Open-ended funds are so called because their capitalisation is not fixed, they issue more shares depending on how much investors want to invest in the fund. In Malta the words SICAV p.l.c which follows a name of a collective investment scheme denote that the fund is open-ended.

Close-Ended Funds

Shares in close-ended funds are not readily transferable on the market especially if they are not listed on a securities exchange. Shares issued by such funds are bought and sold similar to ordinary shares. The capitalisation of these companies remains the same unless action is taken to increase the issued capital.

UCITS

’Undertakings for Collective Investment in Transferable Securities’ (or UCITS) are a set of European Union Directives that aim to allow collective investment schemes to operate freely throughout the EU on the basis of a single authorisation from one Member State.

Hedge Funds

A Hedge fund, is usually used by wealthy individuals and institutions, which is allowed to use aggressive strategies that are unavailable to mutual funds, including selling short, leverage, program trading, swaps, arbitrage, and derivatives. Hedge funds are exempt from many of the rules and regulations governing other mutual funds, which allows them to accomplish aggressive investing goals. Hedge funds are also referred to as Professional Investor Funds.

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 highest 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:
  • low risk treasury or municipal (community) bonds,
  • high risk corporate bonds (with higher potential profit but also higher risk).

• 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 high profit (and 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.

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?

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 resort to the financial services ombudsmand or consumer complaints manager of the country in which the fund is registered.

However, there is also an alternative of 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. In Malta, this scheme is referred to as the Investor Compensation Schem and it is a rescue fund for customers of failed investment firms which are licensed by the Malta Financial Services Authority. The Scheme is intended to promote confidence not only in licenced institutions but more importantly, in the financial system as a whole. Both the Deposit Compensation Scheme and the Investor Compensation Scheme are in fact finance by the banks and investment firms respectively. This means that the consumer will not be asked to contribute to these scheme. The Schemes can only pay compensation if a licenced investment firm is unable or likely to be unable to pay claims against it. In general this is when the licensed firm stops trading or becomes insolvent. The Scheme is based on the EU Directive 97/9 on investor compensation schemes.

Glossary:

Assets - Being in debt - Bonds – Capital Gain - Capital Loss - Closed Ended Funds - Collective Investment Schemes - Convertible Bond - Debt - Derivatives - Dividend - Fixed Account - Growth - Inflation - Investor Compensation Scheme - Investing - Liquidity - Making a profit - Maturity Date - Open Ended Funds - Ordinary Shares - Preference Shares - Professional Investor - Prospectus - Protected Fund - Retail Investor - Risk - Saving(s) - Savings Account - Security(ies) - Shares – Stock index – Stock Exchange - Yield

Further reading:

• Investment Funds - Fact Sheet

Web links to relevant texts and sites:

• Malta Financial Services Authority - Website of the Consumer Complaints Manager

- FIN-NET

• Internal Market Website : Securities:

Links to Module 2:

• Stock Market Investments

Cross references to other Factsheets in Module 7:

Banking | Making a complaint | Money | Risk