AMFIE ACADEMY - Investing in Traditional Investment Funds
Investing in Traditional Investment Funds
For many investors managing a portfolio can seem both daunting and time-consuming. Placing part of your savings in an investment fund, which can provide professional monitoring of your portfolio through an investment vehicle, can help you to earn more from your money and keep up with inflation.
Within the vast pool of existing investment funds, traditional investment funds offer some clear advantages. Traditional investment funds are those with UCITS (Undertakings for the Collective Investment in Transferable Securities) status. As such, they are subject to European legislation and are regulated under the ‘UCITS Directive’. Most funds with UCITS status are either Mutual funds or Open-ended investment companies.
Traditional investment funds offer investors increased protection. They follow rules concerning transparency, liquidity, diversification and risk management, as well as supervision and information given to investors. They are also assigned a risk category from 1 to 7, which can help you assess the level of risk to which the investment would expose you.
While traditional investment funds offer increased protection, choosing one or more funds may still seem challenging. A clear understanding of your objectives, risk tolerance and time horizon, together with knowledge of the different characteristics of funds can make the task easier.
There are many different types of traditional investment funds. Some focus on a single asset category, such as equities or bonds. Others hold a combination of different types of assets (e.g.: asset allocation funds). There are also traditional investment funds focusing on specific countries, regions, sectors and market segments.
Traditional investment funds can be either actively or passively managed. With actively managed funds, portfolio managers decide which securities and assets will be included in the fund. Fees are generally higher.
Alternatively, index funds, which are passively managed, track and aim to duplicate the performance of a benchmark index. Passive funds only conduct trades when the composition of the index changes. Low turnover means lower costs and fees are generally low.
In addition, you can also choose to invest in either distribution shares, which pay dividends or accumulation shares, which reinvest the income from dividends and interest back into the fund.
It is essential to understand the different types of charges that come with an investment before you purchase it. Fees consistently have a strong impact on performance because traditional investment funds are valued by subtracting fees and commissions from net asset value.
Many funds charge a type of sales fee called a ‘load’, either at the time of purchase (front-end load) or upon the sale of the investment (back-end load). Front and back-end loads typically average between 3-6% of the total amount invested or distributed.
In addition, it is important to look at the management expense ratio which indicates the total percentage of fund assets charged to cover fund expenses. The higher the ratio, the lower your potential return on the investment at the end of the year.
Finally, one must not forget that traditional investment funds carry a number of risks, including:
- Management risk: If the fund is actively managed, performance will depend on the portfolio manager’s decisions.
- Market risk: Traditional investment funds depend on changes in the prices of the securities they hold. The more concentrated they are in a single sector, country or asset category, the more their performance is likely to fluctuate in response to developments in the markets.
- Liquidity risk: Traditional investment funds are valued at least twice per month. While most can be traded daily, liquidity will also depend on the liquidity of the assets held within the fund.
- Currency risk: Currency risk does not just depend on the currency in which the fund is denominated, but on the currency exposure of all the underlying investments.
This article is provided for educational purpose only and on the basis that you make your own investment decisions and do not rely upon it. AMFIE is not soliciting any action based on it and it does not constitute a personal recommendation or investment advice.
As part of AMFIE's cash management - Off Balance, the Association excludes all speculative products (Commodities, precious metals, options, convertible bonds). The categories of financial products in which AMFIE may invest are listed in Article 4 of the discretionary management mandate.