CEEAAM - Investment Funds

Investment Funds

Investment Funds

Determining the appropriate financial solution for a client is based on financial background and degree of uncertainty that they can handle in regard to a negative change in the value of their portfolios. Investment funds pool the money from many investors and manage their wealth in a professional way. Their simplicity and flexibility make them ideal for investors with limited financial knowledge, time and resources. Asset managers invest in a wide variety of securities, and in that way diversify their clients’ portfolios. Investors buy investment fund units, as they are provided with the immediate benefit of instant diversification and asset allocation without the large amounts of cash needed to create individual portfolios. Asset managers are able to take advantage of their buying and selling size, and thereby reduce transaction costs for investors. Another advantage of mutual funds is the ability to increase and decrease exposure with relative ease.

In general, investment funds are considered the most cost efficient investment vehicles for smaller amounts. Additionally, investors with large capital find investment funds an attractive means of parking liquidity on a temporary basis. Tactical investors, who are waiting to re-enter the equity markets but are disappointed with the interest rates paid on bank savings deposits, often find money-market funds to be an attractive cash-parking vehicle. These funds aim to give returns that are potentially higher than the fixed deposit rates.

Actively managed funds

In the case of actively managed funds, asset managers keep a close eye on the macro and micro economic environment and trade actively with the goal of exploiting market inefficiencies by purchasing securities that are undervalued, or by selling securities that are overvalued. Their aim is to outperform an investment benchmark index and create excess returns for the investors. The performance of an actively-managed investment portfolio depends on the professional skills of the manager who is attempting to boost returns with a combination of stock picking, market timing and asset allocation decisions. Active managers may hold superior stocks or other securities that perform better than average, and may time the market moving in and out at the right moment, riding the upswings and missing the falls.

Investors who do not believe in the efficient-market hypothesis and are keen on attaining higher- than-average returns on their investments select actively managed funds.

Passively managed funds

Passively managed funds most often track some kind of global or sector indices. The portfolio manager of the fund is replicating the index, rather than trading securities based on his or her view of the potential risk/reward characteristics of various securities. Typically, passively managed funds have lower expense ratios and lower capital gains distributions. Passive investing is a popular strategy among ETF investors. Exchange traded funds are available in hundreds of varieties, tracking a huge number of indices. They offer all of the benefits associated with index mutual funds, including low turnover, low cost and broad diversification.

contrast to actively managed traditional funds whose daily value (NAV) is determined once a day and where the investor gets to know the price that he/she traded on only a few days later, passively managed ETFs are traded actively intraday as well. Their price is constantly changing along with the index tracked. The investor may even determine a limit price for the order. Reports note that passive portfolios diversified in international asset classes generate more stable returns, particularly if they are regularly rebalanced.

In developed markets, passively managed index funds tend to outperform the majority of actively managed funds in the long run. However, in emerging markets, where the markets are less efficient, skillful active managers can more easily beat the index consistently over a series of years. Yet the end-investor still has the problem of discerning how much of the outperformance was due to skill rather than luck, and which managers will do well in the future.

Hedge funds

The main difference between hedge funds and traditional funds is that hedge funds are primarily characterized as absolute return funds. Absolute return differs from relative return because it is concerned with the return of a particular asset and it is not compared to any other measure or benchmark. As an investment vehicle, a hedge fund seeks to make positive returns by employing investment management techniques that differ from traditional mutual funds. These investment techniques include using short selling, futures, options, derivatives, leverage and unconventional assets. Hedge funds are also an unusually powerful source of diversification. Diversification is not simply a function of number of securities in the portfolio, but the degree to which each security or strategy has a unique risk “personality”.

Hedge funds are especially valuable in this context because, when implemented with care, their risk personality differs substantially from equity market risk.

The role of hedge funds is becoming increasingly important in the 21st century with the enormous size of the investments they manage.

In most jurisdictions, hedge funds are open only to a limited range of wealthy investors who meet certain criteria set by regulators and in exchange, hedge funds are exempt from many regulations that apply to ordinary investment funds.

There exist two types of Investment funds depending on the ownership structure: open- and closed-end. Open-end funds sell an unlimited number of shares to fund shareholders directly or through a brokerage firm. The shares of an open-end fund are sold at its net asset value, plus any brokerage commissions and other fees.

In comparison, closed-end funds sell a limited number of shares one time. Investors trade shares of closed-end funds in the secondary market on the stock exchange. Since shareholders do not redeem shares of a closed-end fund, the fund is able to invest a greater share of its assets in securities that are less liquid than those invested in through open-end funds.

Fee structure

Funds charge fees to operate and manage the fund. Management fees are paid the fund companies to manage the funds. Investors are usually also charged an upfront sales charge at the first purchase, while other funds charge a back-end load upon sale of fund shares. There are also funds that have no sales charge and these are known as “no-load funds.” Typically, hedge fund managers also charge success fees or performance fees that are calculated as a percentage of the fund's profits, usually counting both the realized and unrealized profits. Some hedge funds also use high water marks so that managers who have made money for an investor and then lose part of that capital cannot take a performance allocation (or fee) until the loss has been recovered. Others also specify a hurdle rate, signifying that they will not charge a performance fee until the fund's annualized performance exceeds a benchmark rate, such as T-bill yield, LIBOR or a fixed percentage.