In the large investment fund industry there are thousands of funds, with over 30 Investment Management Association (IMA) sectors attempting to organise all of these options into categories.
Of the sectors, the most popular in 2010 were: Strategic Bonds, Global Bonds, Absolute Return, Cautious Managed and Global Growth. The sectors are defined by certain criteria; for example, in the Global Growth sector funds must invest at least 80 per cent of their assets in global equities, diversified over geographic regions.
More broadly investment funds can be divided into two main groups of assets: bonds (government and corporate debt) and equities (shares). Again in broad terms, bonds carry less risk than equities but equities are generally associated with the potential for higher returns.
The other broad differences between investments funds are those that are actively managed and passively managed, and between those aiming to provide a level of income and funds designed to deliver long term growth.
See The Passive vs Active Investment Debate for more information on the differences between passive and active funds.
Also managed by investment managers are investment trusts, an investment vehicle that is close-ended and issues a set number of shares. They are also known as investment companies because they are structured like a company and individually listed on a stock exchange.
Head of investments at Fair Investment Company, Nick Scarrett said: “The main considerations for an investor when investing in a fund are to take into account the levels of risk involved with a particular fund and the investment objective, for example whether you are making an investment to provide long term growth or looking to invest in funds in a way that has the potential to return a level of income at points in the year.”
A fund’s factsheet will contain a large amount of the information you need to help make a decision on whether to invest, including what the charges of a particular fund are. However, for a full explanation of how a fund’s charges operate you should read the Key Features document or brochure
Generally, funds will have an initial charge for investing, an annual management charge and also a total expense ratio (TER). The TER is the total amount a fund charges in a year for the annual management charge (AMC) and costs of running a fund, such as accountant and auditor costs.
Some funds may have slightly different charging structures, which may include a performance charge if a fund has a return over a certain level, and in some cases a withdrawal fee if funds are taken out before a minimum amount of time has elapsed.
Also, passive fund charges may operate slightly differently. In some cases, such as Vanguard funds, the AMC represents the total expense ratio, including the administration costs of the fund, but on Vanguard funds a ‘preset dilution levy’ or a purchase fee may be charged on investing.
This is like an initial charge and is a relatively low percentage that covers the costs to the fund when a new customer invests. The Vanguard Emerging Markets Index fund also charges a small redemption fee for withdrawing from the fund.
Investing through fund supermarkets or services like the Fair Investment ISA and Investment Account you can receive a 100 per cent discount on initial charges funds may carry, as well discounts on annual charges.
Do your sums
Charges are represented as a percentage. For example, a fund may have an annual TER of 1.66 per cent which may be deducted from overall capital or from the income the fund generates.
For example, the M&G Global Basics Fund has a total expense ratio of 1.68 per cent, 1.5 per cent is the annual management charge, with 0.0175 and 0.15 custodian and administration charges. The total annualised percentage of 1.68 is taken from the income (or return) the fund generates.
A fund will either take the annual charges and expenses from the return of the fund or the fund’s capital value.
Benchmarks and indices
Fund performance is measured against a number of different benchmarks or indices. A common benchmark is to use the average performance of funds in the relevant IMA sector, with individual funds then ranked in four groups, known as quartiles. First quartile funds are the best performing funds in that sector.
The other main performance measure is the most relevant index for a particular fund. For UK equity funds this could be the FTSE100 or FTSE All Share Index of company equity.
Researchers and ratings
There are various organisations that gather data on fund portfolios and performance and rate them along certain criteria. Fair Investment Company works with Rayner Spencer Mills who simply rate a fund with a single approval stamp. Rayner Spencer Mills rated funds are in the Fair Investment Select 100.
Other organisations include Morningstar, Lipper, OBSR (Old Broad Street Research), Citywire and Standard & Poor’s (the credit rating agency). Fund factsheets will often contain the rating the fund has obtained from a particular research group.
Ratings may be presented alphabetically, e.g. the highest S&P rating is AAA, or by star ratings, used by Morningstar.
Equity funds will often carry greater risk than bond funds, while equity funds investing in emerging markets may carry higher risk than funds investing in more established markets, like the UK or USA.
Risks may include the fund encountering difficulties when buying and selling investments, political uncertainty and the fact that investments may not have the same protection as in more established markets.
For example, the index company FTSE classifies Egypt as a secondary emerging market, a high profile emerging market economy recently affected by political turmoil. Factsheets will normally provide a breakdown of where a fund invests.
Stocks and shares ISAs
Nick Scarrett discusses some of the basics when investing your ISA allowance in stocks and shares. Read here »
No news, feature article or comment should be seen as a personal recommendation to invest.
The value of investments and income from them can fall as well as rise and you may not get back the full amount invested. Different types of investment carry different levels of risk and may not be suitable for all investors.
Prior to making any decision to invest, you should ensure that you are familiar with the risks associated with a particular investment. If you are in any doubt as to the suitability of a particular investment, both in respect of its objectives and its risk profile, you should seek independent financial advice.
© Fair Investment Company Ltd