Funds

Short word, big subject

Take any collection of assets – shares, bonds, anything, mix of all – you’ve got a fund. There’s no legal restriction on the word. If you invest in something called a fund, make sure it is what you think it is.

The important distinctions between different types of funds are:

  • Announced investment strategy – what type of assets, selection process, disposal process
  • Pricing mechanism – how the price at which investors buy or sell into the fund is set
  • Legal structure – the rules that bind the assets together and determine the rights of investor

Most funds fall into three categories: 'Open-ended funds', Closed-ended funds', and 'ETFs' 

 

Open-ended funds

These used to be exclusively called 'Unit Trusts' in the UK (‘Mutual Funds’ in the US). In the last few years they have been increasingly replaced by ‘Open–Ended Investment Companies‘ (OIECs, pronounced ‘oiks’) in the UK and ‘Undertakings for Collective Investment in Transferable Communities’ (UCITs, pronounced 'you-sits') if sourced in Europe. Legally there are tiny differences between unit trusts and OEICs/UCITs which are immaterial to the simple investor.

‘Open-ended funds’ match the demands of investors to invest or divest with equivalent increases or decreases in the funds under management. That is to say if there is a net inflow of funds the managers buy more assets. If there is a net outflow of funds (i.e. a net demand from investors to sell) the managers sell enough assets to realise the cash to pay them. That's why it's called 'open-ended'.

The fund is divided into a number of units and the units are valued at the end of each day by reference to the market prices of the individual assets in the fund. Units are cancelled, or more units are issued, to match the net funds withdrawn, or invested.

 

Closed-ended Funds

Another way to package assets is to structure them as a company, have access to cash (i.e. add a borrowing facility), issue shares and arrange for the shares to be traded on a stock market. Investors buy and sell the shares through their broker in the same way as shares in Tesco. The price is set by the market, just like shares in Tesco e.g. Funds like this are called ‘Investment Trusts’ in the UK, and generically are described as ‘closed-ended’.

 

ETFs

And finally we have a modern hybrid – Exchange Traded Funds (ETFs). ETFs are structured to track an index – or engage in some other formulaic use of investors’ money. ETFs are closed-ended in the sense that the shares are traded on the market. But they are backed by a mechanism that allows major market participants to buy or sell a basket of underlying assets to match any net sales or purchases of ETF shares. This ensures the share price closely tracks the value of the underlying assets.

 

Are you surprised that we end up just calling all these things ‘Funds’?