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Investment funds are one of the most common form of investing. Making an investment in a fund means that the customer buys units in a fund from the fund management company. The company managing the fund pools the assets invested by the customers and invests them in various objects, together constituting the investment fund. An investment fund is divided into fund units of equal size. The customer buys a specific number of such units. The price of the fund units is determined on the basis of the respective value of the investment objects. In practice, the investment fund is a securities portfolio where you can make an investment by buying units in it.
With the help of the funds, it is possible for the customer to spread the investment with even a small capital, more extensively than would be possible with direct investments in stock. Moreover, the customer need not necessarily follow the share prices as intensively when investing in the stock market through a fund since the fund management company exercises an active investment operation.
The investment fund has a portfolio manager who is responsible for the purchases and sales of the fund, in line with the rules of the fund. The portfolio manager can be one person or a team. The portfolio manager actively follows the market, assisted by company and sectorial analyses made by investment analysts. Some portfolio managers are also personally involved in the running and management of companies where the fund assets are invested.
Return and risk
Even when investing in investment funds, it is important to remember to risk involved. The value of the investment may increase or decrease, and the past history of a fund is no guarantee for its future performance. Before investing, it is advisable to read the fund prospectuses and rules and learn about its investment policy, risks and cost structure.
The expected returns and risks of different funds vary. Return and risk always go hand in hand. The larger the return aimed at, the bigger the risk one must be able to take. The risks of investment funds are based on the risk of their investment objects. The investment fund must diversify the risks by investing in several different objects so that successful investments compensate for potential losses. Risk-taking is regulated through many rules, with the purpose of preventing overly large investment in one single object, for example.
Investment fund expenses
The investment fund fees vary greatly from fund to fund. The expenses are incurred for unit subscriptions, redemption and potential custody of the unit in the fund. Many investment first provide custody for their own funds free of charge. All funds charge a management fee which is not separately charged but it weighs on the return of the fund. Moreover, the securities broker fees for the sales and purchases of securities and other investment objects are paid out of the investment fund assets.
Various types of investment funds
Money market funds (short term bond funds) are investment objects with a low risk level, with a fairly stable performance.
The long-term funds have generally had an annual return of 2-3 percent. Due to slight value fluctuation, in other words risk, the investment performance may be somewhat negative in certain years, but then again, the return may be 4-5 percent or even higher than that.
As concerns fixed income funds, it is wort remembering that when market interest rates increase, the value of the fund may go down, at least momentarily.
In equity funds, the return expectation is high but at least in the short term, the fluctuation in unit value may be significant. The value of an investment can easily increase or decrease even 30% during a year. The longer the equity fund investment, the smaller the risk due to share price variation. On the long term, the return on equity funds levels off and is approximately 9–10 % per annum.
In mixed funds, the fund manager decides, on behalf of the investor and in line with the fund rules, on the shares of investments in the equity and fixed-income markets. The risks of these investments are somewhere between the fixed-income and equity funds. The returns expected from and risks associated with a mixed fund are largely determined on the share of the assets allocated by the fund in equity.
Special mutual funds (non-UCITS funds) have the permission by Government to deviate from the restrictions imposed by the Investment Fund Act. Normally, these funds focus on one sector only or concentrate their investments in a smaller number of object. The risk level of the special funds depends on their investment policy.
Alternative investment funds (AIF) refer to corporations or other mutual investment mechanisms where assets are sought from various investors and invested in line with a defined investment policy. Alternative investment funds must have a manager, with a licence in line with the Act on alternative investment funds, or a respective registration. Managing an alternative investment funds includes both the portfolio management and risk management. Managing the AIFs may also include fund marketing operations.
Protection of assets invested in investment funds
Investment funds do not enjoy the protection of the investors’ compensation fund. However, the fund management companies must keep the fund assets separate from their own assets by depositing the fund assets in a separate custodial corporation. Therefore, the fund assets cannot be used to cover the fund management company’s liabilities. Unit owner are not personally liable for the fund’s obligations.
Investment in shares (equity investment) means direct investing in a limited liability company. A public limited liability company (plc) listed in the stock exchange has issued shares which can become the object of trading in various trading systems. The value of stock, i.e., shares depends on the demand for the particular share in the securities market, while the demand, in turn, depends on the performance of the company. For this reason, the investor in shares should learn about the company in detail, including its sector of operation and the information published by the company on its operations.
The fluctuation in share prices may significant, and the investor may lose the invested capital. By diversifying the investments in companies of various sectors and also areas, the investor can set off the impact of stock prices or sectoral cyclical fluctuations on their investments. In equity or stock investing, it is worth noticing that the investment firm providing trading services for investors normally also charges for its services.
Bonds are loans issued by banks, companies, governments or other corporations. Bonds and their expected returns, risks and investment periods may vary considerably. Traditionally, the bonds – for example government bonds – are based on the investor receiving the restitution of their invested nominal capital on the maturity day. The capital can also be repaid to the investor in annual instalments. The restitution of the capital depends on the solvency of the bond issuer on the bond maturity date.
Although the bond terms promise for the full restitution of the bond capital on a specific maturity date, the insolvency of the bond issuer may lead to a situation where the capital is not returned to the investor. The risk related to the issuer’s insolvency is called issuer risk. Depending on the terms of the bond, the capital is necessarily not returnable before the maturity date so that the money invested in tied until the said due date. The capital invested in bonds can provide returns which may depend on the trend in the underlying security or index, or it may be a fixed percentage.
The above is a non-detailed description of investment products. The investor should always familiarise themselves with the individual features and risks of the chosen investment object. In addition to the above investment objects, there are several other investment instruments offered on the market. The investment products can come with a very complex mechanisms of return and risk formation. Investing in a product without understanding its risks or other features may be a true gamble. Therefore, the investor should always get thoroughly informed before making the decision to invest.
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