Intro - Investing in funds
Different ways to invest
Investors can invest directly in financial markets, or they may do it through investment funds. If they invest directly, the investor decides what to buy and how much to buy. While if they invest through a fund, it is up to the asset manager to choose and weight the securities. For that service, the investor usually pays a fee. The asset manager will be responsible for trading and managing the investors’ assets, as well as reporting on its performance. Investment decisions and operational burdens are effectively moved from the investor to the asset manager.
A quick overview of funds
Funds are usually pooled vehicles, meaning that multiple investors may participate in the same fund. They are also regulated, which gives the asset manager certain fiduciary responsibilities. These responsibilities may vary depending on the jurisdiction or domicile of the fund, but their goal is to ensure all investors are treated fairly and that they are well informed about the fund’s investment strategy and its potential risks.
Those investing through a fund may be seeking diversification. Diversification is a key concept in investing and was once described by Harry Markowitz1 as “the only free lunch” available to investors. In practice, it means attempting to reduce risk by spreading money across different investments.
In addition to participating in pooled vehicles, larger institutional investor may also be able to contract an asset manager to manage a portfolio just for them. In these segregated mandates, institutional investors can direct the asset manager to tailor the investment to their needs.
Let’s walk through the main types of pooled investment funds that are available to investors.
Mutual funds - Investing in funds
When investors are talking about mutual funds, they are usually referring to a specific type of open-ended fund. Open-ended means that it was not created with a limited number of investors in mind but that it will grow with an increase in investor demand. Each investor, in exchange for their capital, will be issued units or shares representing a proportion of the securities held in the fund. When an investor wants to sell, the asset manager will cancel those shares or units.
While investors get shares or units, mutual funds are not quoted in exchanges, and they will usually only calculate the value of a share or unit once a day. So, while an investor can make an investment at any time during the day, it will not go through until the next dealing point.
Mutual funds are the oldest type of investment funds, and there are now over 138,000 mutual funds worldwide representing almost $55 trillion2 in assets.
Below are the four types of mutual funds. They can follow a passive or an active investment strategy.
Cover specific regions or countries (World, USA, etc.), size segments (large, mid and/or small caps) and investment styles and strategies (ESG, climate, factors, thematics)
Cover specific regions or countries (World, USA, etc.), bond types (government bonds, corporate bonds) and credit ratings (investment grade, high yield)
A subset of fixed income funds which targets shorter-term fixed income securities from governments, banks and companies that are highly liquid and have a high credit rating. These funds aim to provide a slightly higher return than bank deposits
Cover both equities and fixed income securities, with the goal to balance or reduce risk
To invest - Investing in funds
To invest in a mutual fund, an investor may be asked for a minimum investment. Investors may also need to pay fees related to the fund (annual fund manager charge) and possibly other fees related to how the investor is accessing that fund (for example platform fees and transaction fees).
close-end etfs - investing in funds
As opposed to open-ended funds, closed-end funds are created with a fixed number of shares at the start, which represent the investment of an initial set of investors. If new investors want to participate, they will need to find someone who wants to sell their shares. As investments mature, dividends will be paid to investors, either as cash or to be reinvested (meaning that they will purchase new shares in the fund).
Closed-end funds are typically listed on exchanges, which means that investors can trade shares throughout the day at the current market price.
Globally, assets have reached $3.7tr for more than 24,000 closed-end funds3. The funds tend to be managed by private capital firms investing in private markets and who prefer to have a stable pool of capital to pursue specific opportunities which may be more limited in numbers. For example, while the global public equity market has reached almost $102tr4, the private equity market is estimated to around $7.6tr in size5.
ETFs stand for Exchange Traded Funds, and it refers to a specific type of fund that can be bought or sold on an exchange, just like shares. It is a relatively recent innovation and has gathered a lot of traction. There are now over 8,000 ETFs worldwide with more than $10tr in assets6.
This type of fund usually follows a passive investment strategy, seeking to replicate the performance and composition of an index. Just as mutual funds, investors in ETFs may access a wide range of markets across equities and fixed income.
As they tend to focus on passive strategies, ETF fees have historically been lower than mutual fund fees. While in the US the average fee for an equity mutual fund was 0.44% in 2022, the average fee for an equity ETF was 0.16%7.
All of this , has led to an increase in ETF popularity with investors. This in turn has led to more ETF launches globally, but especially in the US, where in 2022 70% of new fund launches were ETFs versus 30% being mutual funds8.
Many ETFs are required to disclose their holdings daily, while mutual funds may only disclose their holdings quarterly.
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Footnotes - Investing in funds
1 Harry Markowitz, American Economist (1927-2023), Nobel Prize winner
2 As of June 2023. ICI, Release: Worldwide Regulated Open-End Fund Assets and Flows, Second Quarter 2023 | Investment Company Institute (ici.org), including supplementary tables.
3 As of December 2021. IOSCO “IOSCO Investment Funds Statistics Report, January 2023”
4 As of December 2022, SIFMA “SIFMA Capital Markets Fact Book 2022”
5 As of June 2022, McKinsey “McKinsey Global Private Markets Review 2023”
6 As of June 2023. ICI, Release: Worldwide Regulated Open-End Fund Assets and Flows, Second Quarter 2023 | Investment Company Institute (ici.org), including supplementary tables.
7 Expense ratios, asset-weighted averages. ICI Research Perspective “Trends in the Expenses and Fees of Funds, 2022”
8 Oliver Wyman “The Renaissance of ETFs”