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ABC of investment funds

Oct 15 2012 10:24
TRYING to understand the different types of investment funds available on the market can be a daunting prospect.

Investment funds may well offer the best customised solution for investors, but many of us scratch our heads when it comes to the wheres, whens and hows.

An experienced financial adviser will be able to explain what each fund type does, the risks and returns associated with them and how charges work, and then recommend which are suitable for your needs and best fit your specific risk profile.

The Discovery Invest FUNDmentals provide insight into the different types of investment funds.

What are investment funds?

Investment funds offer you, the investor, the capability to achieve diversification across a range of investments by simply investing into one fund.

The fund you choose and invest in will pool money together from many investors to invest in either cash, shares, bonds, properties or a combination of these and other types of assets to create a diversified investment.

A fund or asset manager will oversee your fund to ensure that it meets its objectives. As with all investments of this nature, the most important thing to remember is that investment funds should be viewed as long-term investments, meaning at least five years but preferably longer.

Six types of investment funds

 - Equity funds (equity is also known as shares)

Shares are issued by a company to raise money to develop the business. Fund managers buy these shares, which are traded on the stock market.

Depending on the investment strategy, some may only invest in large companies, or only in medium to small companies. There are funds that will invest in particular sectors, such as financials and resources, offering the investor a diversified investment into a particular industry.

 - Bond funds

Bond funds invest in a diversified portfolio of fixed interest securities and the securities within the fund will give investors an income from the coupons, or interest, that is paid out.

Examples are government and corporate bonds. Funds that invest in government bonds are generally considered less risky than those that invest in corporate bonds. However, high return rates are not guaranteed.

 - Balanced funds

The advantage of balanced funds is that they invest in a combination of cash, bonds, property and equity. However, this mix varies depending on the fund’s objective.

It is important for investors to be aware of the split between equities, property, bonds and cash to have a full understanding of the risks and rewards within a particular fund. 

- Specialist funds

Specialist funds invest in a specific sector of the economy, such as in healthcare, telecommunications, IT, technology, green energy, property, and natural resources.

No matter which sector or industry investors show an interest in investing in, chances are there is a fund that invests in that sector.

 - Global funds

A truly diverse portfolio should take advantage of global diversification opportunities, which allow investors to invest anywhere in the world.

Global funds offer a convenient solution to achieve a geographically diverse portfolio. If investors do not favour any specific country, global funds are the easiest way to go global.

 - Emerging market funds

Investors wanting to invest in emerging countries with potential for high economic growth can invest in these countries through emerging market funds.

The Bric countries (Brazil, Russia, India and China), Malaysia and Taiwan are good examples of emerging countries with potential for very high economic growth.

Their high growth potential may be due to a number of factors, such as political and structural changes including privatisation, liberalisation of trade or better access to capital.

The main risks, however, are political instability and higher reliance on external capital. The financial markets can experience dramatic fluctuation at any given time. 

What are the risks and returns?

Investors must bear in mind that no investment is risk-free. There is a degree of risk with investment funds, just as there is with any other type of investment.

The returns which investment funds give can be high or low, depending on the markets. It is important that you, as an investor, are comfortable with your investment fund’s risk profile and susceptibility for short-term volatility.
How can performance be measured?

You can track and measure the performance of your investment fund by looking at the performance figures in the financial press and on the internet.

These figures show the cumulative performance for one year, three years, five years or even up to 10 years. Your fund's performance is often compared to a benchmark index, or the sector average performance.

This sector average performance indicates the average performance of all funds within that particular sector.

The performance and subsequent sector rank of a fund is an indicator of how good it is in comparison to funds with similar investment objectives.

However, it is critical for investors to bear in mind that the past performance of an investment fund is not a guide to its future performance, as past high returns do not guarantee high returns in the future.

Investing in funds is a long-term investment, so it is more important to look for investment funds and fund or asset managers that consistently outperform the sector average performance indicator over a sustained period of time.

You need to remember that while a fund may outperform its sector, if the sector average performance for that fund is negative, then the actual return on that fund could be negative.

Charges on investments funds

Investors usually pay an annual management fee of between 0.5% and 2%. There could also be additional fees, such as performance-based fees.

When combined, these charges represent the total expense ratio which is taken from your fund’s performance.

Knowing and understanding what investment funds are and leveraging your financial adviser’s expertise and guidance will help you to make the most of your investments.

- Fin24

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