IN the last few articles I’ve been talking a great deal about ‘funds’, so I thought it would be worth delving into these in a bit more detail.
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 that 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 investment.
What do funds invest in?
A fund’s investment portfolio 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 reduce 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) or sector concentration (a commodities fund may predominantly hold mining stocks).
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 higher gains.
Do funds pay an income?
Funds can pay an income, or they can reinvest income with an aim to grow the capital you’ve invested.
It depends on the fund, the share class you hold, and the objective of the fund.
Some funds aim for capital growth, and do not pay a significant income because they invest in companies which do not pay dividends – instead reinvesting their profits into the business with a view to growing the enterprise.
Other funds invest in more mature businesses, which do pay a dividend, so these funds are more likely to provide an income.
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. It is expressed as a percentage.
What is a passive fund?
Passive investing is the opposite of 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 portfolio will allow them to outperform an index. The answer is usually to hold a mix of both in your portfolio.