Managing my financial journey
Managing my financial journey

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Managing my financial journey

3.2 Investment funds

In the next video, Professor Janette Rutterford talks to Martin about the different types of investment funds, including hedge funds and the factors that investors should bear in mind when choosing funds to invest in.

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MARTIN UPTON
As a small private investor how do you go about choosing the right fund for you?
JANETTE RUTTERFORD
Well you can look at what they invest in and you can look at who manages them and you can look at track records and people do. You can look at the one year performance, three year historical performance, five year historical performance and so on. But there's no guarantee that that's going to do well in the future. What you might be able to identify by looking at performances are ones that are consistently doing badly and avoid those.
The other thing to look at is what they're investing in and they normally give you a pie chart of where they're investing in, what sectors, what countries and so on and that's got to tie in with what you think you should be investing in and I would recommend a sort of global strategy so you have a bit of UK, a bit of US and so on. And so you spread. And these people do it for you. If you don't have very much money to invest they will do you the global diversification that you need.
MARTIN UPTON
Do you think that funds encourage like investment inertia amongst people in that you give the money to a fund manager and say "well okay they're looking after it. I don't need to worry. I don't need to be proactive in terms of my investment. My fund manager's going to look after me".
JANETTE RUTTERFORD
Well in principle your fund manager should be looking after you. They should have an investment objective, which is clear in the documentation. So for example a capital growth European fund or an income UK fund and it's sort of in the small print here "this is what I'm gonna do", and so you rely on the fund manager getting rid of dud companies, finding new good companies and generally looking after your money.
MARTIN UPTON
Okay. And you get regular investment reports from your fund manager and you should be reading those carefully. You shouldn't just be throwing them in the bin or filing them in the cupboard?
JANETTE RUTTERFORD
No. I mean you can probably do it online as well now. But the thing that they're a bit coy about is first of all transaction costs, which are normally not very explicit. But the other thing is they're not very good at performance measurement so they don't often give you the performance relative to a benchmark. They will often say you know "you've made X thousand pounds or X hundred pounds or you've lost X thousand pounds", but they won't say "if you'd invested in a general index in this sector you'd have done better or worse". And that's quite useful to look at what you would have got if you'd bought an index or a passive alternative.
MARTIN UPTON
One particular category of investment funds, which has attracted a lot of interest and indeed criticism in recent decades are hedge funds. How are these different to investment funds?
JANETTE RUTTERFORD
Well they're probably more specialist. So first of all they're not about hedging. They're not about reducing risk. They're normally about taking on some kind of investment strategy which you hope to out perform some kind of benchmark or do relatively well or some of them promise what's called 'absolute return' so you they might say "you'll get the interest rate plus three per cent". So if the interest rate is one per cent you'll get four per cent return. They promise you. Now you have to believe that they're going to out perform. That they've got this investment strategy sewn up, as it were, which is obviously not always the case. And they tend to have very high fees so you have to make very high returns to compensate for the fees that you're going to pay.
In my experience people haven't done very well because they've often been buying short term but these things are done very poorly in the short term because if they're risky they can go down as well as up. The other problem is that they - some of them leverage up and you have to be aware that the risks that they are taking on is greater because they are taking on debt to try and make higher returns. So you're in the very risky end of the spectrum typically with hedge funds.
MARTIN UPTON
So they're not really for the new investor and even if you're an experienced investor you would say you only invest in these for the longer term and with other types of investments within your overall portfolio. Is that what you're saying?
JANETTE RUTTERFORD
That's what I'm saying. I wouldn't say they were right for the small investor. For example in the crash of 2008 a lot of them were invested in securities which they couldn't get out of so they're what's called illiquid and so although they promise like the unit trusts to be available every day to give you your security some of them actually only promise to give you your money back once a year for example which is not very handy. But even then some of them reneged on that and gave you different types of shares, which you might eventually be able to get some money from. So it's actually a very risky end of the market.
MARTIN UPTON
So the riskiness - is it attracting greater regulation? I mean are hedge funds operating under a different set of rules when it comes to regulation on conventional investment fund?
JANETTE RUTTERFORD
Well I think they do because they tend to be off shore so they tend to not be regulated in the same way as unit trusts and investment trusts are much more heavily regulated.
MARTIN UPTON
Okay. So if you had one last tip to give to an investor that's currently not in investment funds at all but is thinking of investing in a fund for the first time, or a number of funds, what would be your tip?
JANETTE RUTTERFORD
My tip would be to go to for investment trusts rather than unit trusts. Unit trusts as I said are the ones that are marketed heavily to individuals but investment trusts, like Foreign and Colonial, which is still going since 19 - 1868 rather ...
MARTIN UPTON
Still going?
JANETTE RUTTERFORD
... It's still going - are global investment trusts. So there are these big investment trusts which have lower management fees and lower transaction costs when you buy them so and they offer the same sort of diversification that unit trusts do.
MARTIN UPTON
Janette, thank you very much indeed.
JANETTE RUTTERFORD
Thank you.
End transcript
 
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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.

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.

Described image
Figure 8 With different compositions of investments the returns from different unit trusts vary substantially.
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