Collective Investment Schemes

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These are financial products where money from a number of different investors is pooled and then invested by a fund manager according to specific criteria. The scheme or fund is divided into segments called ‘units’, which are to some degree similar to shares. Investors take a stake in the fund by buying these units – they will therefore become unitholders. The price of a unit is based on the value of the investments the fund has invested in. Collective investment schemes may have different fee structures – make sure you understand how you will be charged before you invest as charges may have a major impact on the performance of your investment.

Collective investment schemes can invest in shares, bonds, deposits and other investments. Usually, fund managers select the investments they think will do best and switch from one to another as market conditions change. However, fund managers are obliged to follow prescribed investment criteria which are set out in the prospectus which is approved by the regulator

There is a wide variety of funds
:

  • Money market – They invest in deposits and short-term securities. These are low risk but cannot be expected to give high returns over the long-run.

  • Bond Funds – invest in corporate bonds, government bonds and/or similar securities. They are medium to low risk and usually aimed at providing income rather than growth. Because there are many different types of bonds, bond funds can vary dramatically in their risks and rewards.

  • Equity Funds – generally involve more risk than money market or bond funds, but can also offer the highest returns. A fund’s value (Net Asset Value) can rise and fall quickly over the short term, but historically shares have performed better over the long term than other type of investments. Not all equity funds are the same. For example, growth funds focus on stocks that may not pay a regular dividend but have the potential for large capital gains.

  • Balanced Funds – invest in a combination of shares and bonds, ensuring diversification. They are suitable if you want a medium-risk investment. They can be aimed at providing income, growth or both.

  • Tracker – unlike the other funds listed here, there is no fund manager actively choosing and switching securities. Instead, the investments are chosen to move in line with a selected stock index– such as the FTSE 100, an index of the share prices of the 100 largest companies (by market capitalisation) in the UK which is updated throughout the trading day. As there is no active management, charges are usually lower.

  • Specialist – invest in particular sectors, such as Japan, or particular types of shares, such as small companies. Suitable only if you are comfortable with relatively higher risk.

  • Sector – invests in a specific sector such as Retail or Telecommunication Services.

You can earn money from your investment in three ways:

  1. A fund may receive income in the form of dividends and interest on the securities it owns. A fund will pay its unit holders nearly all the income it has earned in the form of dividends. Usually, these funds are called “Distribution Funds”.

  2. The price of the securities a fund owns may increase. When a fund sells a security that has increased in price, the fund has a capital gain. At the end of the year, most funds may choose to distribute these capital gains (minus capital losses) to investors.
  3. If a fund does not sell but holds on to securities that have increased in price, the fund’s value (Net Asset Value) increases. The higher net asset value reflects the higher value of your investment. If you sell your units, you make a profit (this also is a capital gain).

Usually funds will give you a choice: it can send you payments for distributions and dividends (such funds are called “Distributor” funds), or you can have them reinvested in the fund to buy more units (called “Accumulator” funds).

You cannot open a newspaper or read a magazine without seeing adverts promoting the performance of collective investment schemes. But past performance is not as important as you might think, especially the short-term performance of relatively new or small schemes. As with any investment, a fund’s past performance is no guarantee of its future success. That said, however, volatility of past returns is a good indicator of a fund’s future volatility. Over the long-term, the success (or failure) of your investment in a fund will depend on a number of other factors.

Check total return

You will find the fund’s total return in the financial highlights, usually in the front of the prospectus or the annual financial statements published by the fund. Total return measures increases and decreases in the value of your investment over time, after subtracting costs (you will usually find it written as “Net Return”). When expressed as a percentage, net return for an indicated period is calculated by dividing the change in a fund’s Net Asset Value, assuming reinvestment of all income and capital gains distributions, by the initial price.

See how the net return has varied over the years. The Financial Highlights show yearly total return for the most recent five or ten year period. Looking at year-to-year changes in total return is a good way to see how stable the fund’s returns have been.

Scrutinise the fund’s fees and expenses

Funds charge investors fees and expenses – which can lower your returns. For example, if on an investment of €5000, you have to pay a front-end fee of 2% (€100), the actual amount invested would be €4900. This means that if you wish to realise an adequate return, the fund would need to achieve a return which would at least get back the fee that you paid initially. Find the section in the fund’s prospectus where the costs are laid out. You can use the information in this section to compare the costs of different funds.

Usually, fees fall under two main categories:

  1. sales load and transaction fees (paid when you buy, sell, or exchange your units), and
  2. ongoing expenses (paid while you remain invested in the fund).

Sales Loads

  • No-load funds do not charge sales loads.

  • Front-end load: A front-end load is a sales charge you pay when you buy units. This type of load reduces the amount of your investment in the fund.

  • Back-end load: A back-end load is a sales charge you pay when you sell your units. It usually starts out at a specified amount for the first year and gets smaller each year after that until it reaches zero (say, in year four of your investment).

Ongoing expenses

The section about fees tells you also the kind of ongoing expenses you will pay while you remain invested in the fund. The relevant section shows expenses as a percentage of the fund’s assets, generally for the most recent fiscal year. Here, the section will tell you the management fee (which pays for managing the fund’s portfolio), along with any other fees and expenses.

Some funds also charge a performance fee. This annual fee – which is usually paid to the adviser of the fund – is applied by applying a percentage to the difference in the performance of the fund during the year compared to the performance with the previous year. The calculation of the fee may not be very straight forward and you will need the assistance of your intermediary if you want to know more about how this fee is calculated. In essence, this fee gives an incentive to the adviser of the fund to select the best securities on the market in which to invest. A better performance will mean that the adviser gets a larger share of the profits which the fund has generated.

A difference in expenses that may look small to you can make a big difference in the value of your investment over time.

Many funds allow you to switch your units for units of another sub-fund within the same collective investment scheme. The fee section will tell you if there are any switching fees.

Read the sections of the prospectus that discuss the risks, investment goals, and investment policies of any fund that you are considering. Funds of the same type can have significantly different risks, objectives and policies.

You can get a clearer picture of a fund’s investment objectives and policies by reading its annual and semi-annual reports. You should be receiving these reports at least annually – if not, please contact your investment firm or the fund manager to send you these reports.

You can also research funds at most reliable Internet sites and investor magazines.

One final hint: Generally the success of your investments over time will depend largely on how much money you have invested in each of the major asset classes – shares, bonds and cash – rather than on the particular securities you hold. When choosing a collective investment scheme, you should consider how your interest in that fund affects the overall diversification of your investment portfolio. Maintaining a diversified and balanced portfolio is key to maintaining an acceptable level of risk.

 



Last updated: Sep 07, 2016