Inside Mutual Funds
We look at how mutual funds work and why you might consider them as part of your your investment portfolio.
We describe the differences between unit trusts and Open Ended Investment Companies (OEICs) and consider the benefits of a professionally managed portfolio that is instantly diverse in terms of the asset types and sectors it invests in.
Mutual funds can deliver income or capital growth and the large number of products available mean that you should be able to find the market exposure you want with an exposure to risk you are comfortable with.
DIY Investor suggests some of the key factors that may inform your choice and a wide range of investment managers share the vision they have for their fund and why you might consider investing in it.
What are Mutual Funds?
Mutual funds are collective investments that pool investors’ money to buy and sell shares or other assets to maximise profits and reduce risks.
Different types of fund are Unit Trusts, Open Ended Investment Companies (OEICs) and Investment Trusts and they may concentrate on a particular market, asset class or sector.
Mutual funds deliver an instantly diversified investment with decisions made by a professional fund manager.
There are over 2,000 different unit trusts and OEICs available to investors in the UK, split between asset class (equities, fixed income and property), geography (UK Equity, North America and Emerging Markets), and sector (agriculture, energy and technology).
An investor can choose between funds that seek to deliver income and those that reinvest to deliver capital growth.
Since the 2012 Retail Distribution Review the cost of ownership of funds – now known as the ongoing charge figure, or OCF – has reduced by up to 50%.
What is a Unit Trust?
Unit Trusts are collective investments, actively managed by an investment professional who seeks to deliver market-beating performance based upon the quality of their investment decisions; they can be used by the DIY investor to cost effectively build a diversiﬁed portfolio of investments.
A fund may have investments in 50 or even 100 different companies in its portfolio, allowing you to obtain exposure to multiple stocks or bonds more simply than investing directly in the market yourself.
Unit trusts also provide access to asset classes that may otherwise be difficult to invest in, such as property, as well as in built diversification.
Unit trusts invest in a wide range of geographic markets, different asset classes in a range of industry sectors and can be bought and sold via most investment platforms.
Funds invest in one or more of the main asset classes – shares, bonds, property, cash and derivatives with differing weighting applied to each, and deliver a ready made investment portfolio.
What is an OEIC?
An Open Ended Investment Company (OEIC) is broadly similar to a unit trust in that it is an open ended collective investment that expands and contracts the number of units in circulation according to demand.
Unlike a unit trust, each OEIC operates as a limited liability company, quoted on the London Stock Exchange and unlike the ‘unit holders’ that invest in unit trusts, those that invest in an OEIC are ‘shareholders’ in that investment company; because of this structure, OEICs are governed by company law rather than trust law.
Most new funds that are launched are established as OEICs and over time it is believed that many unit trusts will adopt the company structure.
Selecting a Mutual Fund
An important first step for the DIY investor is to construct a financial plan.
Before you start selecting funds, that means deciding just what your investment goals are, deciding on your investment horizon, and perhaps most importantly making a judgment on the level of risk are you able to accept.
As rule of thumb, the further away your objective, the more risk you can accept in your portfolio, but it’s important you can sleep at night – never take on more risk than you are comfortable with.
By building a diversified portfolio you can protect against market volatility and ensure you benefit from growth stories wherever they occur.
Consequently, a well constructed portfolio will offer exposure to different shares, bonds, markets and sectors.
That can sometimes be difficult for investors to achieve – especially when they are starting out and beginning to build that portfolio; fortunately funds offer a solution since each one delivers a readymade diversified portfolio.
If you decide that investment funds are going to form at least part of your portfolio construction, there’s a wide choice available that can help you to achieve your goals.
Funds – the Facts
A fact sheet is a key document that allows investors to understand a fund’s objectives, major holdings, investment strategy, costs and historical performance; to some it may suggest the future potential of the fund.
Fact sheets are available on issuers’ websites, they can be found on fund supermarkets and investment platforms and the DIY investor could do well to spend some time getting to grips with these important documents so that they are able to objectively research and compare and contrast funds they are considering.
Investing in Funds
Many of those new to DIY investing start by assembling a portfolio of funds and investment trusts achieving instantly diversified investments at a reasonable and transparent cost.
Some prefer to let the experts take the strain and buy an actively managed fund while others will seek to track a certain index – some follow popular markets such as the FTSE100 whereas others will look for more esoteric global opportunities.
Investing in a tax-efficient ISA wrapper is rarely a bad idea as it is one of the few opportunities the DIY investor has to make money whilst paying very little tax, and those advantages are explored elsewhere on this site.