Investment Funds
- A form of collective investment.
- Investors with similar objective combine their money into a large central pool.
- Investment company channels the funds into a diversified portfolio of financial instruments such as stocks and bonds.
- Can be classified according to asset class such as stock funds, bond funds, money market funds, venture capital funds etc.
- Can also be termed, according to their investment objective, such as aggressive growth funds, growth funds, income funds, balanced funds etc.
- Some are set up for industry specific such as Technology funds, Bio-tech funds etc.
- Some of them invest according to geographic areas such as global funds, European funds, China funds etc.
- Investment funds have become the third largest financial intermediary after commercial banks and life insurance companies.
- Highly regulated in most countries.
- Companies and individuals are licensed by the local regulator to provide advice on a specific range of products dependent upon the nature of their business and qualifications achieved.
Mutual Fund and Unit Trust
Investment funds are commonly known as mutual fund or unit trust.
Mutual Fund
- The investment company is set up with the objective of investing in shares of other companies.
- It is owned by the stock holders for whom it makes the investment.
- A mutual fund company has a board of directors elected by its stockholders.
- The board hires professional money manager, the management company to manage company’s assets.
- Management company may be independent firm, investment advisor, firms associated with brokers, or insurance company.
- A management company may manage a number of mutual funds, each of which is a separate organization with its own board of directors.
Unit Trust
- Trust is an old concept under English Common Law, which are recognized in countries such as the UK, Australia, Canada, Hong Kong etc. In Japan, France Taiwan, US, mutual fund is adopted.
- A unit trust is an investment vehicle set up under a trust. To form a trust, an investment company purchases a specific set of securities and deposits them with a trustee.
- A number of units known as redeemable trust certificates are sold to the public. These certificates represent proportional interest in the securities deposited with the trustee.
- Units of the unit trust can usually be sold back to the trust, at a price calculated on the basis of bid prices for the underlying assets in the portfolio. (market value of the securities in the portfolio).That is, the Net Asset Value (NAV) per unit.
- Have determined the price, the trustee may sell one or more securities to raise the money required for the repurchase.
Net Asset Value (NAV)
NAV = ( total assets – total liabilities ) / number of units outstanding
Open-end Funds
- Variable capitalization
- On a hand it stands ready to purchase existing shares/unit at a price on or near the NAV
- On the other hand, it continuously offers new shares to the public.
- This means the fund gets bigger and more shares are created as more people invest.
- It can also shrink and shares are cancelled as people withdraw their investment.
- Share/unit price is based on the value of the investments the company has invested in.
Closed-end Funds
- A closed-end fund is a publicly traded investment company whose line of business is investing in other financial assets or companies
It issues a set number of shares initially to capitalize the fund. - After IPO, rarely issue new shares or repurchase shares.
- Investors can trade these shares in the secondary market i.e. Stock Exchange
- Closed–end funds commonly trades on organized exchange such as NYSE, Hong Kong Stock Exchange.
- Because of its nature, price of the fund does not necessary equal to NAV, instead it is determined by the market.
- More people want to sell, price tends to fall and lower than the NAV, more buyers than sellers, price tends to rise.
- Studies in the US indicated that US closed-end funds usually traded at a discount to the NAV between 5 to 20%
Charges and Fees of Investment Funds
Usually there are two types of fees incurred in investing mutual funds:
Sales or load fee
For the operation and distribution costs of the fund.
Management fee
Annual fee paid to the fund management company for their services
Sales Fee/Load
When funds are sold through a sale force, a commission based on the shares it sells is paid, this is known as a load charge.
Common types of load are – No load, Front-end load, Back end load, Level load.
No-load fund means there is no initial sales fee so share price equals to NAV. However, redemption fee or penalty will be charged if shares are sold back to the fund within certain time limit.
Front-end load means up-front fee is charged once as a percentage of the initial purchase price. Commonly known as Class A shares and is an attractive choice for long-term investors.
Back end load means fee will be paid when the shares are sold. However, a distribution fee of up to 1% is applicable annually. There is also a contingent deferred sales charge. This charge is usually at 5% within the first year and decline by 1% each year, reaching zero after the fifth year. Commonly known as class B share. More attractive for medium term investors of at least 5 year. May also have the option to convert to class A share after a number of years and annual distribution fee will be avoided thereafter.
Level load requires investors to pay a small front-end charge on initial purchase and possibly back-end charge if sold within one year. Higher distribution fee is applicable to cover ongoing fund expenses. Commonly known as class C shares and is more attractive for short-term investors.
Management Fees
- All funds charge annual management fees for the providing investment and advisory services. Fee is set at a percentage of the average NAV of the fund. e.g. 1.25% per annum
- By law, all charges and fees have to be disclosed properly and clearly stated.
- If there is performance fee, the fee can only be payable:
- No more frequently than annually; and
- If the NAV exceeds the NAV on which the performance fee was last paid.
Other fees
Other fees which may be charged include administration fee, trustee fee and custodian fee etc.
Advantages & Disadvantages of Investment Funds
| Advantages | Disdvantages |
Diversification Professional management Growth potential Convenience Access to Global markets Flexibility Liquidity Affordability Cost efficiency Administration Protection Up to date investment position Automatic reinvestment of gains Exchange privilege ( into other funds ) |
Management fees Lack of choice Lack of owner’s rights
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