Benefits of using funds
If you feel you do not have the time, knowledge or inclination to manage your own portfolio of investments, you can delegate responsibility for managing your money to a professional fund manager. When you buy a fund or collective investment, you pool your capital with other savers and pay professional money managers to make investment choices on your behalf. You pick the asset class, geography or theme and then the fund managers invest the money for you.
One of the major advantages of funds is that they enable you to build a diversified portfolio. By investing even just a few hundred pounds in a fund, you can usually obtain exposure to far more stocks or bonds than you can by investing directly in the market yourself. In addition, funds enable you to gain access to an array of geographical markets around the world, a variety of specialist asset classes and a range of industry sectors.
Investing in funds will usually involve taking on a certain degree of risk.
here is also a tax benefit of funds. In the UK, switches between shares within funds are free of capital gains tax (CGT) for the saver. This is not the case if you manage a portfolio of shares unless these are held in tax efficient wrappers such as Individual Savings Accounts (ISAs). We suggest you consult a professional adviser about the tax implications of your investments.
There are two main structures of funds – open ended and closed ended. The former are split between unit trusts and open ended investment companies (OEICS) while the latter comprise investment trusts.
Open-ended funds: You can invest in or redeem cash from open ended funds at any time. Fund managers create shares or units for new investors and cancel them when they are redeemed. This means that the size of the fund can increase and decrease depending on investor demand – they are open to subscriptions and redemptions. The price an investor pays is based upon the actual value of the underlying assets (called the net asset value or NAV).
Closed-ended funds: The closed-ended funds, also known as investment trusts, are structured as listed companies and trade like any other equity on the stock market. They are “closed” in the sense that, once created, they are typically not open to subscriptions and redemptions. They have a limited amount of shares available and any buying and selling has to be carried out in the open market. This means these funds’ prices can differ from the NAV. The price of the fund is determined by investor demand as well as gains or losses in the underlying assets. The price you can pay for a share, therefore, can either be more or less than what it is actually worth (known as trading at a premium or a discount to NAV). For a fund manager, a closed-ended fund has the benefit of stabilising the amount of money with which they invest and can make this structure a better fit for slower moving, less liquid asset classes such as property.
Active and passive funds
Funds can either be actively managed or passive, with positives and negatives for both. The days of an either/or call on active versus passive look to have passed, however, with most investors blending the two as part of a diversified portfolio.
Active: When you invest in active funds, you are paying a fund manager to pick investments on your behalf. The manager is making “active” decisions in an attempt to beat similar funds and so-called benchmark indices. The FTSE 100, for example, measures the performance of the 100 largest companies listed on the London Stock Exchange and can be seen as representing the UK equity market. While the aim of an active fund is to outperform, decisions can go wrong and some funds will lag their peers and the wider stock market.
Passive: A passive fund, on the other hand, attempts to replicate the return of a specific index as closely as possible rather than trying to outperform it. A FTSE 100 tracker, for example, holds the 100 companies that comprise the index, with no attempt to choose between them. This removes the human element from investing, taking out “active manager” risk. By investing in a passive fund, you are accepting that your investment is unlikely to perform better than its benchmark. It will generally be cheaper than an actively managed fund, however, for which you are paying for a manager’s expertise.
You may decide you do not have the time or the inclination to build and monitor a portfolio of funds yourself. One way of outsourcing the management of funds is to invest in Multi-Asset portfolios or funds. These are portfolios and funds managed by one asset manager and which invest in a number of underlying funds and asset classes on your behalf.
One of the key advantages of Multi-Asset managers is that they can provide diversification across funds, managers, sectors, markets and asset classes through just one portfolio or fund. This is advantageous because no single investment manager is usually the best performer across one asset class, let alone all asset classes. Diversification across both asset classes and investment managers can reduce risk and enhance returns. Multi-Asset managers can react quickly to investment opportunities and changes in the market environment, which can be particularly valuable in volatile markets. The buying and selling of the underlying funds can be carried out in bulk, which can potentially reduce costs.
Benefits of using funds