How does it work?
Investment Funds are regulated legal entities that collect money from multiple investors and invest it on their behalf. Investors receive shares in the fund according to the size of their investment.
Depending on the fund’s strategy, investments can include all kinds of assets such as stocks, bonds, precious metals, or other investment funds. In any case, the fund is operated by a professional manager who allocates the money collected, takes care of the administration, and charges a fee in return for this service.
Historically, traditional mutual funds have dominated the landscape, but Exchange Traded Funds (ETFs) have gained more and more market share in recent years. ETFs are traded on an exchange and can be bought and sold throughout the day, while shares in mutual funds are valued once per day and bought directly from the manager. Traditionally, ETFs pursued relatively simple strategies such as systematically buying the largest companies in a market (often referred to as passive strategies). However, a growing number of ETFs also use sophisticated, active strategies previously only pursued by Mutual Funds or even Hedge Funds.
How do they make money?
The aggregate value of the assets held by the investment fund is its Net Asset Value (NAV). When the assets the fund bought appreciate, so does the NAV. Therefore, the return on an investment in an investment fund depends on the return on the investments pursued by this fund, minus the cost associated with it (management fees, trading cost, etc.). For example, an equity fund benefits from the appreciation in value and dividend payments of the stocks it buys, while a Fixed Income fund profits from the interest paid by the bonds held. Some funds are highly active and pursue complex strategies to cash in on market inefficiencies and short-term opportunities. Others, especially most ETFs, bet on long-term economic growth and interest income. On top of this, they may generate additional returns by lending securities to other market participants against collateral and a fee.
How risky is this asset class?
It depends a lot on the fund. For example, an investment fund that buys only stocks is much riskier than a fund that invests only in government bonds. In addition, funds distributed to non-professional investors generally need to be approved by the respective national supervisory authority to comply with many strict regulatory requirements. For instance, they are not allowed to run overly concentrated portfolios or take leverage which guarantees a certain level of risk limitation. Beyond this, investors can obtain information on a fund’s strategy and riskiness from data providers such as Morningstar that classify investment funds on a scale from 1 to 5.
Why is it important for my portfolio?
Investment funds come with a range of advantages. They allow unsophisticated investors to benefit from the know-how of the professional manager and pursue even complex strategies. They also make it possible to acquire a well-diversified portfolio with very a very small amount of money. Some investment funds don’t even require a minimum investment anymore. This means that an investor can invest in a large basket of stocks such as the biggest 500 American companies (S&P 500) with as little as one dollar. Pursuing the same strategy by directly purchasing all stocks in the basket would require thousands of dollars. On top of that, the growth of the ETF industry has resulted in a rapid decline of management fees, and ETFs tracking broad markets such as the largest US corporations are offered more or less for free. Due to their scale, investment funds can also benefit from lower trading fees, tax advantages, and extra income from securities lending.
How do you approach investing in Mutual Funds and ETFs?
Due to their many advantages, Mutual Funds and ETFs form the backbone of our Wealth Management solutions. But, unfortunately, the investment fund universe is large and highly diverse, giving investors the agony of choice. Moreover, due to the industry’s sophisticated marketing machine, it is also easy for investors to get trapped in poorly managed or overly expensive solutions. We, therefore, screen extensive databases and constantly monitor the market to find the best products for our clients. We consider various criteria, including the client’s tax situation and special requirements such as a preference for certain investment styles.
We usually construct a core consisting of broadly diversified, low-cost ETFs on major Equity and Fixed Income markets and selectively add positions in attractive, more sophisticated strategies.
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