5.3.6 Investment funds
Buying shares in a single company or even holding shares in, say, three companies, is generally a risky form of investment. This is because the fortunes of a company, on which its dividends and share price depend, are subject to all sorts of risk. These risks can be broad economic risks, such as recession or an increase in the cost of oil, or risks specific to each company, such as the loss of a major contract or increased competition.
To spread these risks, investors typically invest in shares – and other assets, such as bonds – through investment funds. An investment fund pools the money of lots of investors and uses it to hold a wide range of shares, bonds and other assets. Even relatively small amounts of money placed into such funds can be spread across a wide variety of shares or other assets.
With different compositions of investments the returns from different unit trusts vary substantially.
Table 6 The best unit trusts of the decade
|1||BlackRock Gold and General||684%|
|2||JPMorgan Natural Resources||579%|
|3||Threadneedle Latin America||360%|
|4||Scottish Widows Latin America||343%|
|5||Jupiter Financial Opportunities||336%|
Table 7 The worst unit trusts of the decade
|767||Inv Perp Japanese Smaller Companies||-66%|
|768||Legg Mason Japan Equity||-68%|
|770||New Star Technology||-70%|
|771||AXA Framlington Global Technology||-72%|
The investments in these investment funds may be selected by managers, based on their research, which aims to assess the prospects for shares and other bonds (called ‘actively managed’ funds). Investors pay fees for the services of the fund managers and are provided with periodic reports on their investments. Other funds (called ‘passively managed’ or ‘tracker’ funds) simply hold investments designed to move in line with a specified share index, and typically have lower charges.
Investment funds come in many forms, including:
- Unit trusts: this is an arrangement whereby trustees hold shares and/or other assets on behalf of investors and a management company makes decisions about what and when to buy and sell. Investors hold units in the unit trust and the value of the units directly reflects the value of the underlying assets in the fund.
- Open-ended investment companies (OEICs): this is very similar to a unit trust, but is structured as a company rather than a trust. This structure is more familiar and acceptable to investors in other countries of the European Union and so enables managers to trade more easily across borders. Investors buy shares in the OEIC and the value of the shares directly reflects the value of the assets in the underlying fund.
- Investment trusts: these are companies that are quoted and traded on the stock market. But, unlike trading companies, the purpose of an investment trust company is to run an investment fund. Investors buy shares in the company. The price of the shares partly reflects both the value of the assets in the underlying fund (called the ‘net asset value’ or NAV). But the price is also affected by the balance between investors buying and selling the shares on the stock market. As a result, the shares could trade at less than the NAV (called trading at a discount) or at more than the NAV (trading at a premium). Like any other company, investment trusts can borrow money, which enables them to boost the amount they can invest. Borrowing to invest increases the inherent risk of the fund.
- Exchange-traded funds (ETFs): these are also companies traded on the stock market but, in this case, the share price is directly linked to the value of the underlying investments. Traditionally, ETFs are tracker funds. This could be, for example, the FTSE 100 Index or a more unusual index tracking, say, the price of commodities or works of art. But, increasingly, new types of ETF are being developed that follow different investment strategies.
- Life insurance funds: some types of life insurance can be used as investments. The investor pays in regular premiums or a single lump sum premium and the policy builds up a cash value that may be drawn out either as a lump sum or as a stream of income payments, depending on the particular type of policy. Often policies are unit-linked, which means that the premiums are invested in the policyholder’s choice of one or more funds, similar to unit trusts. The cash-in value of the policy depends on the performance of these funds.
- Pension funds: in a similar way to life insurance, contributions to a pension scheme may be invested in one or more underlying funds. The value of the pension scheme depends on the performance of those funds. You will look at pension schemes in detail in Week 7.
Investment funds can be bought direct from fund managers, through stockbrokers or through websites (often called ‘platforms’).
An additional consideration for many people is a desire to invest their money in a socially responsible way. There are different aspects to what constitutes socially responsible investment, including both positive and negative criteria.
Positive criteria include investing in companies that treat workers fairly or are engaged in environmental protection. Examples of negative criteria include avoiding funds that invest in companies involved with animal experiments, arms, violating human rights or pornography.
One difficulty for an investor is that ethical or social responsibility is a relatively subjective term so you need to examine where the fund invests your money. One way of checking whether a fund that claims to be ethical or socially responsible shares your own views, is to check the main companies the fund invests in.