Investment Funds are formed from contributions pooled together by a number of different investors to buy a range of assets, such as stocks and shares. This fund is professionally managed so to achieve the objectives agreed at the outset.
Combining the contributions of a number of investors allows increased diversification than an investor would achieve alone; therefore reducing the risk of the investment.
There are a number of different funds available to invest in, each with their own end objectives, charges and rules. Listed in more detail below are four types of investment fund you are most likely to come across.
Unit trusts.
Unit trusts refer to a collection of investments which are pooled together into a fund for which you can purchase units. The level of risk associated with this fund is reduced as it contains a range of shares.
Each unit trust adopts an investment strategy so you can invest according to your attitude to risk. A high risk fund may be those invested in emerging markets as apposed to the lower risk of investing in well established UK companies.
The value of each unit is determined by the overall value of the fund which moves in line with the share prices of the investments within the fund. The level of growth you hope to achieve will depend on the level of risk you adopt; more risk provides greater opportunity for growth.
If however the investments perform badly the underlying share value will fall and consequently the value of the unit trusts. The higher the level of risk you take the more susceptible you are to a drop in the value of the underlying shares.
OEICs.
Open ended investment companies, also known as OEICs for short allow investors to pool their money together with thousands of other people. The net amount is then invested into the world stock markets by a fund manager. The fund will be invested according to the level of risk adopted by investors. Typically you can expect an initial charge of around 6% along with an annual management charge.
Some OEICs may have an umbrella fund structure producing sub funds each with different investment objectives. This enables investors to invest in the same fund for both growth and income with the capacity to move money from one sub fund to another as your circumstances change. As with unit trusts the level of risk taken is determined by the investor and subsequently the funds which they invest in. The value of your investment is not guaranteed and with higher risk your investment is more susceptible to the volatility of the market.
Investment trusts.
Investment funds look to produce medium to long term capital growth, an income or with some funds, an amalgamation of the two. As with unit trusts, you purchase units from the investment fund. The main difference however is that investment trusts are companies in which you buy shares, so you invest directly rather than indirectly.
The share prices within investment trusts are affected to a certain degree by supply and demand and their value fluctuates accordingly. The price of an investment is not always a true reflection of the value it holds. If the underlying value of the shares goes up, but its popularity does not; the value of the investment trust is not guaranteed to increase in value to the same extent.
There is a range of funds to invest in; including UK and overseas shares, fixed interest securities and property amongst others. Investment trusts invest in shares of different companies allowing the risk to be spread and thus reduced. Risk cannot be removed completely but investing in a number of different shares helps spread the loss should one or more of them fall.
Similarly to unit trusts, investment trusts adopt different strategies depending on their desired outcome. The primary objective for some may be capital growth whereas others may strive for a steady income with some chance for capital growth.
Exchange Traded Funds.
Exchange traded funds (ETF) are listed on an exchange such as the London Stock Exchange, and often endeavour to replicate an index by investing in equivalent assets and proportions. The objective of replicating an index in this manner is so it should perform equally to the index that it replicates. An example of such an index may be the FTSE 100. If a fund is mirroring the FTSE 100 which rises by 10% in a year, then the ETF should also rise by 10% less any fees you have to pay to the manager of the fund.
There is a wide range of indexes that are replicated by ETFs; including metals, energy, commodities and currencies. As they require no active management, being passive investments, they tend to be low cost investments although there are always exceptions.
There are some ETFs, typically known as synthetic ETFs that exist to replicate the performance of indices by using derivatives instead of shares.
A derivative being a financial contract valued to the expected future price movements the asset is linked to, in this case the index. Investors are exposed to the risk of the index performance and the event that the party supplying the derivative becomes insolvent. Some derivatives may ‘short’ the index that is replicated, in other words the fund generates a profit if the index falls instead of rises but consequently loses money it should rise.
