Investment funds explained
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Investment funds: "Equal opportunities for all in all markets"
The benefits of investment funds, where individuals from all walks of life pool their savings together, can be summed up as offering everybody - from professional or institutional investors to people with limited time, or limited investment skills or modest means - access to investment returns otherwise only available to more sophisticated investors, who are able to buy their own professional portfolio management advice. Investment funds generally entail less risk than direct holdings of securities, and offer economies of scale.
Information on the product you, as an investor, are contemplating buying is crucial.
Normally, all important information must be included in an investment fund’s prospectus. However, prospectuses have become increasingly complex and difficult to understand, thus discouraging investors from reading them. In addition and despite decades of European market integration, Member States still have different requirements concerning information to be given to investors. As a result, fund managers operating throughout different countries of the EU have to provide different information depending on the country into which they are marketing their product.
EFAMA strongly believes that the solution to these problems can be found in the form of a short and simplified prospectus. As it stands today, this simplified prospectus may become reality by the end of the year…
In anticipation of the formal introduction of this simplified
prospectus EFAMA wishes to help you better understand, in general
terms, what investment funds are and how you can use them best in
managing your savings.
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What are Investment Funds?
An investment fund or collective investment scheme is a financial investment vehicle, which is aimed at private investors – little or large – or institutional investors – insurance companies, banks – and offers the following five key advantages over direct investment in shares, bonds, and property:
- Risk is spread and therefore reduced;
- Funds allow you to tap into professional, expert and full time investment management expertise;
- Funds are cost effective;
- Funds offer access to markets that may otherwise be closed or too technical for retail/individual investors;
- Funds benefit from institutional safety, which means they are heavily regulated and supervised.
Investment funds are not an invention of the financial engineers of the late 20th Century. The first investment fund was set up in 1849 in Switzerland and was called: “Société civile Genèvoise d’emploi de fonds”. In 1868 the British followed suit with the “Foreign & Colonial Government Trust”, which for the first time defined what investment funds stood for: “…vehicles, which provide the investor of moderate means with the same advantage as large capitalists in diminishing risk in foreign and colonial stock by spreading the investment over a number of stocks.” The first US fund, the “Boston Personal Property Trust” was set up in 1894 and the Germans followed in 1923 with the “Zickert’sche Kapitalverein”. All these early funds were of the closed-ended type, in other words funds with a fixed number of shares that were quoted on an exchange.
The first open-ended fund “The Massachusetts Investment Trust” was set up in 1924 in Boston (US).
The pan-European investment fund history, on the other hand, is considerably younger. Starting point was the so-called UCITS directive of 1985, which defined investment funds as: “vehicles the sole objective of which is the collective investment in transferable securities of capital raised from the public and which operate on the principle of risk spreading”. The European directive entered into force on 1 October 1985 and has been implemented into national law by all Member States of the EU and the European Economic Area (EEA). “UCITS” is an abbreviation for “Undertaking for a Collective Investment in Transferable Securities” and describes an investment fund that complies with the UCITS directive and is freely marketable within the EEA.
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The European Investment Fund Regulation
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- To approximate the competitive conditions among UCITS at the European level, and
- To ensure an effective and uniform protection of investors, who are attracted by the promoters’ offers.
As ancillary aims, the directive was also designed to simplify cross-border marketing and to help to bring about a European capital market.
UCITS are by definition only open-ended investment funds that are marketed to the public and can adopt the contractual or the corporate guise. Outside the UCITS directive, Member States may allow other types of investment funds in their jurisdiction, which do not benefit from the European passport. Among these so-called “non-harmonised” investment funds (non-UCITS) are, in particular, closed-ended funds, real estate funds and special funds for institutional investors as well as special funds for retirement provision.
The UCITS directive is a product-directive (rather than an institution-directive as the other financial services directives) based on three key principles:
- Minimal harmonisation of national legislation;
- Mutual recognition of authorisation;
- Home-country control (except for cross-border marketing and advertising).
The directive only covers those products (investment funds), which are:
- Domiciled in a Member State (of EU & EEA);
- Publicly offered;
- Repurchased or redeemed at net asset value at the unitholder’s request;
- Investing in transferable securities;
- Operated on the principle of risk-spreading;
- And which entrust their assets to a depositary.
Investment funds that fulfil these requirements can under the European passport be freely marketed across borders in 18 EEA countries without further authorisation, they only need to be registered in the country of destination (host country). However, once inside the country of destination they must comply with the laws, regulations and administrative provisions in force concerning marketing and advertising as well as taxation. They must also take the measures necessary to ensure that facilities are available for:
- Payments to unit holders;
- Re-purchasing or redeeming units;
- Information of investors.
During its short existence, the UCITS directive has already become a globally recognised model for fund regulation that provides for a high level of investor protection. It is this investor protection that has helped the strongly growing European investment funds industry preserve its integrity and has engendered such confidence among investors.
The five cornerstones on which the investor protection of the UCITS directive is based, are:
- Comprehensive information for investors;
- Effective supervision of the fund;
- Meaningful diversification in …
- … tradable and liquid instruments; and a
- Separation of management and safekeeping of assets.
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Suitability, financial goals of an investor
No matter how old you are and however much you have to invest,
there is likely to be a fund to suit you. There are cautious
funds, funds for the adventurous and many more in the middle. You
have to decide what is right for you.
You may be planning ahead for your retirement, or just want to invest some money for ‘a rainy day’. Whatever your reason for saving, it makes sense to spread your investments over a wide range of assets. But there is no such thing as a risk-free investment; life always has risks attached. The question is how much risk are you prepared to take and for how much of your portfolio?
For more detailed information about the risks and suitability of investment funds, click on the questions below.
A.Who should buy an investment fund?
B.How can investment funds help investors meet their financial objectives?
C.How long should investors keep their money in investment funds?
A. Who should buy an investment fund?
Investment funds are suitable for anyone who:
- Is looking to invest in the capital markets but does not want the risks or costs associated with direct investment in equities or bonds;
- Already has enough money to cover their everyday spending needs and has some spare cash;
- Can accept possible temporary falls in the value of their investment.
B. How can investment funds help investors meet their financial objectives?
Whether you are looking to supplement your income or make your savings grow, invstment funds can help. Depending on what your objectives are, you can find a fund with aims to provide strong capital growth or one that provides more protected returns. Likewise, there are funds that can provide an immediate income, and funds to provide a growing income.
You can invest small sums of money into an investment fund each month or make larger, lump sum payments. Unlike some other products, you are not locked in to an investment fund; you can withdraw your money at any time.
C. How long should investors keep their money in investment funds?
Investment funds must be considered as a long term savings product. Investments should be held for at least three to seven years, preferably longer. In fact, the longer the time-scale, the greater the potential to make money grow.
Less than 3 years to invest: Cash or money market funds are a useful way to save money that is surplus to your normal spending requirements over the short term.
3 to 7 years to invest: Bond funds are designed to provide a good level of income and, on occasion, some capital growth in a low to medium risk environment.
Over 7 years to invest: Investing in equity funds over longer periods of five years or more have, on average, outpaced all other traditional forms of saving.
Over time your investment objective and goals will change, when you start a family or are coming up to retirement, for example. As an investor, your main worry is that your investments do not fall short of your financial goals. As such, you should make regular checks to ensure that your portfolio is still compatible with your financial needs. It might be necessary to change the asset allocation.
D. What are the risks associated with investment funds?
There is no right or wrong level of risk. What is appropriate for one person depends on their unique financial circumstances and objectives. A retired person is unlikely to take the same risks as a young person with no dependants. Some people are prepared to accept a greater degree of risk in the short term, as there may be significantly better rewards in the longer term.
Concentration of investments in a single type of asset can greatly increase your exposure to different types of risk. You can reduce these risks by spreading your savings among a mix of funds invested in different types of assets. Risk can be further managed by choosing funds that match your financial goals and by staying invested through periods of wide price swings.
There is always a risk of losing money if when you want to cash in your holding at the same time as capital market prices are falling. This reinforces the importance of regular portfolio reviews to make sure it still meets your financial requirements.
On balance, however, no matter what your risk profile and investment objectives may be, it is likely that with the appropriate advice a corresponding fund can be found to accommodate your personal investment goals and circumstances.
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Investment Objectives
Investment funds can be classified according to their investment objectives. The following definitions give a description of the four main categories of investment funds, which can each have their specific investment objectives:
Money Market Funds
Money market funds invest a sizeable portion of the fund’s portfolio in short term bonds and/or money market instruments (such as certificates of deposit, commercial paper, treasury bills, ...) and/or cash (cash accounts, saving accounts, term deposits, ..). The fund’s average maturity usually does not exceed one year and therefore a money market fund is less vulnerable to interest rate fluctuations, whilst credit risk is expected to be negligible.
Within this category a further distinction can be made following the currency exposure of the fund: funds invested in US$-denominated instruments, invested in €-denominated instruments, … In principle investment funds are available for all major currencies.
Bond Funds
Bond funds invest in fixed interest rate securities as a sizeable portion of the fund’s portfolio. An important distinction is that individual bonds have final maturity dates, whereas bond funds do not (short-, medium-, and long-term funds), nor is the income bond funds pay out fixed like with individual bonds. Please note that when interest rates rise, the value of your bond fund generally drops.
Bond funds generally have a global average maturity of more than one year and its investments can consist of different instruments with very different quality ratings. As a result some bond funds can experience higher volatility and credit risk can vary widely, depending on whether you choose gilt-edge government bonds (high grade quality rating) or high-yield corporate bonds (e.g. one minute dot.coms). Currency risk enters the equation in the event of a multi-bond fund.
Within this category a further distinction can be made according to the currency or credit exposure, such as single or multiple currency funds as well as bonds with a different credit exposure.
Equity Funds
Equity funds invest in the stock market at a significant portion of the fund’s portfolio. Equity funds are frequently also called stock funds. They always reflect the characteristics of the market (i.e. market risk).
Within this category a further distinction can be made following the chosen exposure:
- Global,
- Regional (e.g. Eurozone, …),
- Country,
- Sector (e.g. pharmaceutical, telecoms, …), or
- Theme (e.g. ethical fund, ecological fund, emerging markets, …).
Balanced Funds
Balanced funds (also called Asset Allocation Funds or Mixed Funds) spread their portfolio over the three main asset classes described above (money market instruments, bonds and equities).
Within balanced funds a further distinction can be made following the percentage they allocate to each of these 3 different asset classes. The more these funds invest in money market instruments and fixed income instruments (bonds), the less risk they bear, the more equity exposure they have, the higher the risk profile of the fund becomes.
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Main Characteristics of Investment Funds
Use of income
Investors can choose a fund with a policy on the use of income that matches their financial goals. Funds can either accumulate or distribute the income earned and/or capital gains to all or only to part of the unitholders.
- Accumulation units imply an automatic reinvestment of all income earned and/or capital gains realised by the funds; whereas
- Distribution units imply the income earned and/or capital gains are distributed to the unitholders.
In many cases, an investment fund issues both types of units.
Fund orientation
Investment funds can be found in a wide variety of legal forms in the countries of the EU. First and foremost, a distinction must be made regarding the orientation of a fund: closed-ended or open-ended.
- A closed end fund has a fixed number of shares or units in issues that are publicly traded. The price of a closed-end fund share depends on the supply of and demand for the fund, and may thus be higher or lower than the value of the assets in which it invests.
- An open-ended fund, on the other hand, has an unlimited number of shares or units in circulation; and the investment company may issue new shares or units at any time. This facility for investors at any moment of their choice to sell their units based on the value of its investments (the net asset value) is a key feature of open-ended funds. Investors thus have the facility to receive back from the fund the current value of their units in cash.
UCITS are by definition open-ended and form the main category of investment funds that cater to the public, which EFAMA represents.
Legal forms
Within the category of open-ended funds, two distinct categories of legal forms can be found:
- Contractual funds (common funds or unit trusts) are constituted under either the law of contract or under trust law (cf. below) and thus do not have legal personality. Contractual funds issue units and investors are called unitholders. The fund – which is effectively a pool of money – is run by a management company, which may or may not delegate to third parties certain investment and/or administration tasks. The management company is responsible for all matters regarding the fund. As with all investment fund forms, the depositary is charged with the safekeeping of the fund’s assets and with the monitoring of management activities, which must always be taken in the sole interests of the investor.
- A unit trust is a type of contractual investment fund in the UK and Ireland based on trust law, whereby an independent person - a trustee - holds the assets of the investment fund for the benefit of the underlying investors. The trustee is placed under fiduciary responsibility to ensure that the fund is managed in accordance with its investment policy and objectives. Broadly speaking, the trustee performs the role that the depositary has on the European continent.
- Corporate funds do have a legal personality, issue shares and are structured like a company. These corporate funds are also described as investment companies. In French speaking countries they are constituted as SICAVs (Société d’investissement à capital variable), whereas in the UK they are OIECs (Open-ended investment companies). With corporate funds the investors simultaneously are the shareholders (Please note that all mention of units in this document includes shares in SICAVs ). The investment company usually delegates the investment and administration tasks to others and typically has no staff of its own other than a Board of Directors (or an Authorised Corporate Director in the case of OEICs), which carries the overall responsibility for all matters regarding the fund. As with all investment fund forms, the depositary is charged with the safekeeping of the fund’s assets and with the monitoring of management activities, which must always be taken in the sole interests of the investor.
Overview of legal forms in Europe
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Corporate forms |
Contractual forms |
Trust form | |
| Austria |
Not permitted |
Kapitalanlagefonds Spezialfonds |
Not permitted |
| Belgium |
Société d’Investissement à Capital Variable / Fixe (Sicav/Sicaf) |
Fonds Commun de Placement (FCP) |
Not permitted |
| Czech Republic | Not Permitted |
Otevrený podílový fond (OPF) | Not permitted |
| Denmark | Investeringsforening (UCITS) / Specialforening (Non-UCITS) |
Not permitted |
Not permitted |
| Finland | Not Permitted |
Sijoitusrahasto UCITS-Rahasto Erikoissijoitusrahasto | Not Permitted |
| France |
Société d’Investissement à Capital Variable / Fixe (Sicav/Sicaf) |
Fonds Commun de Placement(FCP) |
Not permitted |
| Germany |
Investmentaktiengesellschaft |
Spezialfonds |
Not permitted |
| Greece |
Portfolio Investment Companies |
Investment (Mutual) Fund |
Not permitted |
| Hungary | |
||
| Ireland |
Open Ended Investment Companies – Oeics |
Not permitted |
Unit Trusts |
| Italy |
Società d’Investimento a Capitale Variabile (Sicav) |
Fondi Comuni di Investimento |
Not permitted |
| Luxembourg |
Société d’Investissement à Capital Variable / Fixe (Sicav/Sicaf) |
Fonds Commun de Placement – FCP |
Not permitted |
| Netherlands |
Beleggingsmaatschappij |
Not permitted |
Fonds voor gemene rekening |
| Norway | Not permitted |
Verdipapirfond | Not permitted |
| Poland | Towarzystwa Funduszy Inwestycyjnych - Spólka Akcyjna |
Stowarzyszenie Towarzystw Funduszy Inwestycyjnych w Polsce - STFIwP | Not permitted |
| Portugal |
Not permitted |
Fundos de Investimento Mobiliário |
Not permitted |
| Spain |
Sociedades de Inversión Mobiliarias de Capital Variable/Fijo (Simcav/Simcaf) |
Fondo de Inversión Mobiliaria (FIM) |
Not permitted |
| Sweden | Not Permitted |
Värdepapoersfonder | Not Permitted |
| Switzerland |
Not permitted |
Effektenfonds (FCP) |
Not permitted |
| United Kingdom |
Open Ended Investment Companies – Oeics |
Not permitted |
Unit Trusts |
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Basic Guidance to Understanding Performance
One of the most frequently used criteria for choosing an investment fund is performance.
The comparison of performances, in an increasingly open and competitive market, is an essential element to sound investment decisions. EFAMA has therefore developed a set of principles of good conduct to improve the quality of information disclosure to the public to enable investors to understand better the performance record of each investment fund.
Measurements of Performance
The most favoured method by EFAMA is the calculation of the result of an investment on the basis of the net asset value (NAV).
In order to give a fair comparison of the results of fund management styles, neither front-end charges nor redemption fees are included. Fees being deducted directly from the fund (e.g. management fees) are taken into account by using the NAV only for computing the performance.
Any distribution made by the fund is calculated as re-invested on the ex-dividend-day. Therefore distributed money is understood as re-invested and taking part in the future performance of the fund in question. Re-invested dividends cause an interest on interest effect within the fund.
The European investment funds industry has agreed on promoting a bar chart that illustrates the performance figures for a particular fund:
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Average Annual Total ReturnPast 5 years 27%Past 10 years 14% |
Performance is always backward looking
Performance measurement can only tell you what happened in the past, and an investment fund’s past returns are no indicators for future performance. The value of an investment and the income from it can go up as well as down and you may not get back the amount invested.
Time does matter
Short term performance may not tell the whole story. One should take a look at fund performance over a longer period of time, such as five or ten years. Especially with equity funds - usually held over a longer period of time - checking out only last year’s performance may lead to unrealistic expectations.
Be careful with what you compare
Performance seems to be a good tool to find the best fund, but it is important to compare with each other only those funds that follow similar investment strategies. It does not make sense to compare money market funds with equity funds, as they have completely different investment objectives and risk/return profiles.
But even within the same category of funds, differences of performance may be explained by differing investment strategies. For example, a category „Equities World Wide“ might include funds investing in blue chips on the one hand and funds investing in dot.com-companies all over the world on the other hand.
For more detailed explanations on performance, please turn to the “FEFSI Code of Good Conduct on the presentation of performance records and the classification of investment funds”.
Tax issues
The taxation aspects of investment funds will depend on the structure of the fund, the fiscal form of the fund and the domicile of the fund. In addition, the investment fund itself may be taxable.
In principle, three levels of tax impact can be identified:
- At the level of the investment itself;
- At the level of the fund itself;
- At the level of the investor.
Ultimately the tax impact will depend on the jurisdiction and structure of the fund as well as the jurisdiction of the investor.
Fund fees and expenses
Investment funds provide a variety of investment-related services and benefits that help make saving and investing simple, accessible and affordable. These benefits and services, however, have a cost. The fees and expenses paid cover the costs of managing a fund.
For as long as the investor has an investment in the fund, fees and ongoing expenses have to be paid. Some funds also require the investor to pay a sales commission when he/she buys, sells or exchanges the fund.
Fees and expenses can essentially be divided into two categories:
Unitholder transaction fees
Unitholder transaction or redemption fees are all related to the purchase or sale of investment funds (covering all types of funds, e.g. common funds, SICAVs, etc…). Part of this charge may come in the form of a commission to be paid to brokers when units are bought or sold. In the prospectus, these fees, commonly known as the initial charge "loads," are included in "unitholder fees".
- Sales charges on purchase
Initial charges are for what the investor pays when buying units in a fund. This fee, or part of it, usually compensates an investment professional for his/her services, especially for the advice he/she provides in selecting a fund to meet the investor’s investment goals.
- Sales charge on redemption
A disposal or redemption fee is another kind of sales fee, which may be charged by some funds when the investor sells their units and forms an alternative way to compensate financial professionals for their services. A common type of disposal or redemption fee is calculated typically as a percentage of assets and applies only for the first few years that you own your fund. The fee often decreases over time in stages until it disappears altogether.
In some cases, both acquisition and disposal fees are used (also known as dual pricing), securing that remaining unitholders do not have their returns impaired by frequent purchases or withdrawals. In other cases, only a front-load is used (single pricing). In some countries, the disposal fee can be reduced according to holding period.
In some cases distributors will add commissions over and above the sales fees and the disposal fees of the fund management company.
Unitholder sales fees may also come in the form of stamp duty or other public levies on purchases/sales of units.
It should be noted that the totality of fees and expenses for funds must be clearly set out in the fund’s prospectus.
Fund operating expenses
The fund operating expenses are borne by all unitholders of the fund and serve to pay the ongoing costs of running a fund and other services. They are usually shown in a fund's prospectus, and consist of one or more of the following expenses (different countries have different rules about how these are charged and presented):
- A management fee to the management company or in cases where the fund employs its own professional management the costs incurred hereby;
- Distribution expenses, i.e. costs incurred for advertising, printing and regular fees to distributors based on outstanding units (as opposed to fees paid directly by unitholders as acquisition fees) etc;
- Custody fees;
The largest component of a fund's total operating expense usually is the management fee, which is the ongoing fee an investment fund pays to its investment adviser or manager for supervising its portfolio and administering its operations.
Institutional safety aspects
Authorised investment funds are overseen by a variety of different parties and investors are well protected by the authorities.
The Role of the Supervisory Authority
The supervisory authority generally ensures the compliance and respect of the rules of establishment and functioning of an investment fund. As such it does not have a prudential quality and does not appraise the quality of the investment choices and operations made by investment funds.
The issuance of an authorisation and the integration into the listing of officially authorised investment funds by the supervisory authority, therefore only signifies that the fund has complied with all rules for its constitution and operation.
For further information on the contact details of the Supervisory Authority in all the EU countries, please consult the web page “Investment Funds worldwide – Europe”.
The Role of the Depositary
An investment fund’s assets must be placed with a depositary for safekeeping. The depositary is responsible for the physical safekeeping of the assets and the everyday administration of these assets. The depositary holds the assets on behalf of the fund and not for its own benefit.
Its duties do not end with safekeeping and include an important monitoring role, whereby it must:
- Ensure that the sale, issue, repurchase and cancellation of units in the fund is carried out in accordance with the regulations and the fund documentation.
- Ensure that the value of units is calculated in accordance with the provisions of the fund, scheme particulars and relevant regulations on a periodic basis to inspect the procedures and controls employed by the transfer agent;
- Carry out the instructions of the management company unless they conflict with the regulations or the fund documentation;
- Ensure that in transactions involving a fund’s assets, payment is made by / to the fund within acceptable time limits in the market place;
- Ensure that a fund’s income is applied in accordance with the regulations and the fund documentation;
- Scrutinise the conduct of the management company in each accounting period and report thereon to the unitholders; and
- Ensure that the terms and conditions of any delegation agreement entered into by a fund for the purposes of efficient portfolio management are observed.
In all of the above functions, the depositary acts in the sole interests of the unitholders. In case of shortcomings investors can turn directly to the depositary for compensation.
The Role of the Auditor
In the corporate form of a fund, e.g. SICAV or OEIC, the independent auditor is appointed by the investment company, whereas in the context of a contractual form the auditor is appointed by the fund management company to provide an outside and independent appraisal on the fund’s management.
The Role of the Management Company
It is the responsibility of the investment fund manager to manage the assets held in accordance with the provisions of the fund, scheme particulars and relevant regulations. The manager makes a charge for this, known as the annual management fee.
In addition, the investment fund’s management company:
- Deals in units with the public or their agents;
- Promotes and advertises the units;
- Deals with day-to-day administrative matters;
- Prepares and issues the scheme particulars and prospectus;
- Issues bi-annual reports and accounts to unitholders.
Depending on national legislation on the matter, investment funds can delegate or subcontract the above administrative functions to a specialist third party.
In most countries, the management company is allowed to delegate parts of its functions, however, the management company of a contractual type fund or the Board of Directors of a corporate type fund can never delegate their overall responsibility.
