Mutual funds: Articles

There are now more mutual funds and unit trusts available to investors than ever before. Despite the poor performance of many of these funds, they are still being actively sold to the public via financial advisers and retail banks.

Funds come in a range of different guises depending on where you live. In the UK they are frequently described as unit trusts, in the USA as mutual funds, in France and Luxembourg SICAV (Société d'Investissement À Capital Variable) is often used.

You may sometimes hear funds referred to as UCITS (Undertaking for Collective Investment in Transferable Securities). These are funds authorised, theoretically, for sale in European Union countries. Under the EU's UCITS directive, a fund complying with UCITS requirements should be authorised in all EU states. In reality, this is rarely the case. Each local regulator will attach further conditions to the sale of the fund.

Our coverage of the funds market

Fintactica focuses on the best funds available in the market, regardless of who manages them or where they are registered. More often than not, they will be managed by smaller businesses without the marketing resources to sell them to clients on the other side of the world. Some successful smaller managers will try to avoid too much attention from private investors, because they do not have the resources to manage hundreds of client relationships, but will be prepared to consider investments from small numbers of wealthy individuals.

We keep you the investor informed of the best-performing funds available in the international universe. We also maintain the Fintactica 50, a list of some of the best-performing investment funds in the offshore universe, covering all the main asset classes, which we update on a quarterly basis. In addition, we provide coverage of some of the better portfolio management services available, although most of this coverage will be made available in our private banking section. We also suggest subscribers view the Fintactica Portfolios to see our recommended asset allocation weightings for fund portfolios.

Offshore funds

This site focuses its attention on 'offshore' funds. By this, we mean funds being sold in more than one jurisdiction, not necessarily funds domiciled in an offshore jurisdiction like the Channel Islands or Cayman Islands. Traditionally, funds reserved for sale in countries outside the home country of a fund management group would be set up in an offshore centre, but these days it is becoming increasingly common, certainly amongst European groups, for fund managers to simply register funds for sale in second or third countries without using the offshore route. You will sometimes find a fund launched locally that is simply a duplicate of a fund being managed in another country, with perhaps a few tweaks in its investment mandate to conform to local regulations. You may even find your usual financial services provider has 'branded' the fund as its own product, but in reality has 'outsourced' the fund to another manager in another country.

As a resident of a given country, you will generally only be approached by vendors with funds authorised for sale in that country. This is certainly true of North America, Europe, and other developed countries, although there are still many nations in the world today that have yet to develop legislation concerning the sale of funds to private individuals. This does not mean you cannot invest in funds that are not authorised for sale in that country, just that a fund manager cannot be seen to be actively marketing that fund. Be aware that your local tax authority may require you to declare you investments in offshore funds, and that some fund managers may refuse to accept certain nationalities as clients for tax reasons (US nationals are particularly handicapped in this respect due to the stance taken by their regulators).

As an expatriate or high net worth investor, you will sometimes be consulted on which individual funds you would like to invest in, although these choices will often be skirted over in favour of the actual product or portfolio management service that an adviser or bank is trying to sell you. Your provider should be able to justify the presence of each fund in your portfolio.

Funds of funds

Funds of funds (funds that invest in other funds), or fund portfolio services, are becoming increasingly accessible to private investors. They were once reserved only for the wealthiest clients of private banks, but due to client demands, are becoming more readily available from retail banks. Once again, in such cases your attention will be focused on the performance of the overall portfolio, not the underlying funds. Banks believe that, as a busy individual, you do not want to be bombarded by reams of information on what the individual funds in your portfolio are doing.

Generally-speaking, funds of funds are good investment vehicles for private investors, as they help to spread the risk you take by investing in funds by spreading the money over a number of different asset classes. A portfolio will generally be given a risk rating (usually high, medium, or low) that reflects the amount of risk you are taking by investing in this product.

The best funds of funds on the market will be those in which the manager has no restrictions as to which funds he can buy. This is usually not the case, unless you are a particularly wealthy client, as such portfolios are more expensive to manage. The worst kind of fund of fund to be invested in will only use the funds managed by the bank or fund manager selling the portfolio to you: in other words, there may be better-performing funds available on the market, but you will not be able to have them in your portfolio, at least not via this bank.

You may still be able to get a decent return from such a fund, but no bank or fund manager can claim to have the best-performing fund for every asset category there is, and frequently you will find component funds in your portfolio are underperforming their peers.

In short, we believe that private investors are still not being given a broad enough selection of funds to choose from. As with many other financial services businesses, institutional investors are given preferential access to this market by dint of the fact that they simply have more money to invest. But well-informed private individuals with larger sums of money to invest (in excess of US$100,000) will find they can subscribe to funds generally not available to the ordinary retail investor.

Fees

Funds make money from you by charging you a fee. There are usually two types of fees you will pay: a sales charge, and a management charge. Fees will vary from company to company, and fund to fund. Generally speaking, equity funds (investing in stocks and shares) will charge you more than bond funds. The usual sales charge, or 'front-end fee', for an equity fund, will be 5% of the value of the investment. If you are investing via an intermediary or private bank, you may be able to recoup some of this, as it is from this money that the fund manager pays introducers their commission. Many brokers now pay some of this commission back to their clients.

Some funds will be described as 'no load' funds. These will not charge an entry fee, but may recoup this by charging a slightly higher management fee. In some ways, this is a fairer system, as the fund manager only makes more money if his clients stay in the fund for longer, and are therefore happy with his performance. The other fee is the management charge, typically between 1.0% to 1.5%. This is levied every year regardless.

The vast majority of funds still pass on other costs, in addition to the fees above, to the client. These are not large, but can still be substantial, especially if you have a lot of money invested. These 'hidden' charges are often only mentioned in the sales literature, in small print, and are ostensibly levied to pay for various marketing and administration costs.

London-based research firm Fitzrovia International has developed a formula for measuring what it calls the 'total expense ratio' or TER. This is the annual percentage reduction in investor returns that would result from largely fixed operating costs if markets were to remain flat, and the fund's portfolio were to be held and not traded during a period. A fund's TER is a statutory requirement in the USA where the American financial services regulator (SEC) has warned that funds' costs can have "an enormous impact on returns." TERs are not widely published outside the US, but it is always worth assessing these costs against the historical performance of a fund you plan to invest in.

Asset classes

Funds are divided into a vast array of different asset classes (e.g. equities, bonds, commodities, etc.) Apart from the standard equity funds investing in mainstream stock-markets, you can find a long menu of bond and money market funds, as well as emerging market funds (investing in the developing world), sector funds (investing in a specific industry, often on a global basis), and commodity funds. There is also a growing range of 'thematic' funds that pursue an investment strategy built around a fund manager's theory that certain companies will benefit from a new macroeconomic trend (e.g. growing demand from consumer goods in the developing world). Index-tracker funds also have their place in a portfolio: they seek to track an established investment index, like the FTSE, Dow Jones, or Nikkei, by buying companies within that index in roughly equivalent weightings. By this means the fund will perform as closely as possibly to the original index. Such tracker funds are popular because they tend to charge lower fees, and generally outpeform 80% of the 'actively' managed funds on the market. They are most popular during bull market phases, when equities are rising.

Investing across a broad range of asset classes will help you the investor to reduce your risk. If one market happens to perform badly, the theory is that another will perform well, and help to offset your losses. Getting this balance right, and making a decent profit, is something that occupies thousands of the world's best investment brains on a daily basis.