INVESTMENT FUNDS EXPLAINED

Understanding Investment Funds

Investment funds are collective vehicles that pool money from multiple investors to purchase a diversified mix of financial instruments such as stocks, bonds, real estate, or other assets. These funds provide retail and institutional investors with an accessible route to diversified portfolios managed by professionals. Rather than selecting individual securities, investors acquire shares or units in the fund, gaining exposure to a broad selection of assets.

The Role of Pooling

Pooling is at the heart of investment funds’ structure. Individual investor contributions are aggregated into a single fund. This pool facilitates:

• Diversification: Enables investment in a variety of asset classes and sectors.
• Economies of scale: Reduces transaction costs and offers lower investment thresholds.
• Professional management: Fund managers make informed investment decisions on behalf of all investors.

Understanding NAV: Net Asset Value

The value of each share in an investment fund is typically determined by its Net Asset Value (NAV). NAV is calculated by taking the total value of a fund’s assets, subtracting its liabilities, and dividing the remainder by the number of outstanding shares. It is updated daily to reflect market movements in the underlying assets.

The Role of Fund Managers

Investment fund managers play a critical role in operating the fund. They are responsible for:

• Constructing and maintaining a suitable investment portfolio based on the fund's objectives.
• Conducting in-depth market analysis to identify growth or income opportunities.
• Managing risk through asset allocation and hedging techniques.
• Ensuring compliance with regulatory and ethical standards.

Managers may work independently or as part of financial institutions such as banks, insurance companies, or dedicated asset management firms.

Investment Strategies

Investment funds employ a range of strategies depending on their goals, which are clearly outlined in each fund’s prospectus. Common strategies include:

• Growth investing: Focuses on capital appreciation by investing in companies with high growth potential.
• Value investing: Targets undervalued assets believed to yield strong returns in the long term.
• Income investing: Seeks steady income through bonds, dividend-paying stocks, or real estate.
• Balanced: Combines growth and income by investing across equities and fixed income.
• Index tracking: A passive approach aiming to replicate the returns of a specific index.

Some specialised funds may only invest in certain sectors (tech, energy), geographies (Asia-Pacific), or asset classes (commodities, infrastructure).

Liquidity and Accessibility

Most open-ended funds allow investors to redeem shares at NAV on any business day, offering high liquidity. Some funds, like hedge funds or private equity funds, may impose lock-in periods or limited redemption windows due to their illiquid asset holdings.

Benefits and Risks

Benefits:

• Professional management and expertise.
• Diversification across sectors and asset classes.
• Regulatory oversight promoting transparency and investor protection.
• Affordability through pooled costs.

Risks:

• Market risk affecting portfolio value.
• Managerial risk based on fund performance decisions.
• Liquidity risk for those in less accessible funds.

Main Categories of Investment Funds

The universe of investment funds is broad, but most fall into a few major categories. Each is structured differently, has distinct objectives, and serves varying investor needs. Understanding these differences is critical to aligning a fund with your financial goals.

1. Mutual Funds

Mutual funds, also known as open-ended investment companies (OEICs) in the UK, allow investors to buy or sell shares at the fund’s NAV at the close of each trading day. These funds are typically actively managed, meaning fund managers choose specific securities in an attempt to outperform the market or benchmark indices.

Types include:

• Equity funds: Invest primarily in stocks for growth.
• Bond funds: Provide consistent income by focusing on governmental or corporate debt.
• Balanced funds: A mix of equities and fixed income for moderate risk-return profiles.
• Money market funds: Invest in short-term instruments and are considered low risk.

2. Exchange-Traded Funds (ETFs)

ETFs are similar to mutual funds in terms of pooled investment strategies but are traded on stock exchanges like individual shares. Most ETFs track an index (e.g., FTSE 100, S&P 500), offering passive investment at lower costs. They provide real-time pricing and typically high liquidity which appeals to retail investors seeking transparent and flexible solutions.

3. Hedge Funds

Hedge funds are private investment vehicles that cater to high-net-worth individuals and institutional investors. They employ a variety of complex, high-risk strategies including:

• Leverage (borrowing to amplify returns)
• Short selling (betting against depreciating assets)
• Derivatives (swaps, options) for hedging or speculative purposes

Hedge funds are lightly regulated compared to mutual funds and often have lock-in periods and high minimum investment thresholds.

4. Private Equity Funds

These funds invest directly in private companies through equity ownership or takeovers, usually aiming for long-term gains through business restructuring or scaling. Investments are highly illiquid and capital is typically committed for a period of 7–10 years; suitable only for investors seeking high returns with a high risk tolerance.

5. Real Estate Investment Trusts (REITs)

REITs invest in income-generating real estate properties such as commercial buildings, housing complexes, or warehouses. Publicly traded REITs offer investors access to real estate assets without property ownership responsibilities. They typically distribute most of their earnings as dividends, making them attractive to income-focused investors.

6. Fund of Funds (FoFs)

FoFs hold a portfolio composed of other investment funds, thereby achieving further diversification. While they offer a simplified approach for investors, they may incur additional layers of fees.

7. Index Funds

Index funds closely track a market index. Instead of active stock-picking, they replicate index holdings, making them cost-efficient and lower risk relative to actively managed funds. They appeal greatly to passive investors and long-term savers.

Suitability Considerations

When selecting a type of investment fund, investors should consider:

• Their risk appetite and return expectations
• Investment horizon and liquidity needs
• Tax efficiency and cost structure
• Managerial style: active vs passive

Each fund category addresses diverse investor profiles and market conditions, making them powerful tools for wealth accumulation when chosen wisely.

Active vs Passive Investment Management

At the heart of fund investing lies the decision between active and passive management. Each approach represents a philosophy around market behaviour and how best to achieve long-term returns.

What is Active Management?

Active funds are run by portfolio managers or investment teams continuously researching, selecting, and reallocating assets with the aim of outperforming a benchmark index or specific performance target.

Benefits of Active Funds:

• Flexibility to exploit short-term market opportunities
• Ability to adapt to changing economic or geopolitical events
• Potential to outperform the benchmark in inefficient markets

Challenges:

• Higher management fees due to research and trading activity
• Risk of underperformance if manager misjudges the market
• Potential lower transparency in decision-making

What is Passive Management?

Passive funds, such as index funds and most ETFs, aim to match—not beat—the performance of a specific market index. Fund managers buy the constituent assets of that index in proportion to their market weight and make minimal adjustments over time.

Benefits of Passive Funds:

• Lower fees due to reduced transaction activity
• Broad market exposure with high transparency
• Suitable for long-term investors using a ‘buy and hold’ strategy

Challenges:

• No chance to outperform the index
• Will experience full market downturns as holdings mirror the index
• Lack of tactical adjustment in response to major economic shifts

Performance Comparison

Empirical studies show that consistently outperforming the market is challenging—even for experienced active managers. While some funds do beat their benchmarks over short periods, many fail to do so net of fees in the long term.

Consequently, investors choosing between active and passive strategies must weigh costs, performance consistency, and their personal outlook on market efficiency.

Which Strategy is Right for You?

Neither strategy is universally superior. Many investors opt for a blended portfolio that includes both approaches. For example, they may hold passive funds for core market exposure and complement them with specialist active funds targeting niche sectors or regions.

The key lies in aligning your chosen style with your investment objectives, time horizon, and risk preferences.