An investment fund or mutual fund is an investment vehicle, which brings together the money of several investors to invest it together. That is why they are also known as collective investment institution (IIC).
Mutual funds accumulate the money of many investors to invest in other financial assets, such as stocks or bonds. The value of the mutual fund depends on the value of the assets that are contained within the fund. Therefore, the performance of the fund will depend on the performance of the assets it contains.
By contributing several investors to a common fund, mutual funds allow small investors to access professionally managed investment portfolios, in addition to diversifying their investment.
Each investor in the fund, known as a participant, contributes money by purchasing shares in the mutual fund. This money is accumulated in a common fund. The investment fund is managed by a management company. With the money accumulated, the fund buys financial assets on the stock market. The assets you have purchased are deposited with a depository entity.
Each share represents a small proportion of the entire investment in that pool. To calculate the value of a unit, the value of all the assets of the investment fund is divided by the number of units. This price is known as the net asset value.
Investment funds are intended for any type of investor. However, there is a very wide range of investment funds for different investor profiles. Not all mutual funds are suitable for all investors.
There are many agencies that try to rate each of the funds to help us know which fund to invest in. The most famous fund analysis company is Morningstar, and its stars have become a staple of investment fund analysis.
How does an investment fund work?
We are going to explain how an investment fund works in a very simplified way. Let’s imagine that we managed to convince 10 friends to invest together.
The first question that would arise is who of the 10 knows something about finances. Let us assume that nobody has this knowledge. The solution would be to hire a specialized investment company to manage the money that we have put in common, we are going to call this “management company”.
The second point that would be debated is who is going to keep all those assets or money, as human beings are distrustful by nature, the solution will be to put them in a "depository entity". Its only purpose will be to safeguard the money of the 10 friends.
All the people who come together under the umbrella of the fund are called participants and the investor’s performance is established based on the collective results.
Advantages of investment funds
Mutual funds generally offer a number of advantages to fund participants.
The main advantages of an investment fund are:
- Diversify investment: Investment funds allow us to broaden the spectrum in which we are investing, since by accumulating money from many investors they can access more markets.
- Access to almost any market: Through the different types of funds you have access to markets that in many cases would not be within your reach if you invest individually.
- Professional management: To invest in the stock market it is necessary to have financial knowledge. Investment fund management is carried out by financial professionals.
- Efficiency: By investing collectively, mutual funds take advantage of economies of scale. They incur lower costs when operating in the markets.
- Tax advantages: Investing through mutual funds tends to have tax advantages for taxpayers in almost all countries.
- Wide range of possibilities: Currently there is an extraordinarily varied type of fund that allows finding suitable products for any investor profile.
- Regulation: The funds cannot do what they want with their money, they have to follow the rules established within their regulations.
Types of investment funds
There are a wide variety of types of mutual funds. They can be classified in many different ways. According to your investment vocation, risk, type of return or geographical area, among other parameters.
The most used and popular is the classification by investment vocation. Thus, we can highlight the following types of investment funds:
- Monetary investment fund.
- Fixed income investment funds.
- Equity investment funds.
- Mixed investment funds.
- Global investment funds.
- Guaranteed funds.
- Hedge Funds, alternative management funds or hedge fund.
- Funds of funds.
- Index funds or index funds.
What is the minimum capital to invest in an investment fund?
The funds generally have no entry limit by law, the more we are the better for all. However, most investment funds of large fund managers do require you to enter with a minimum contribution.
Classes of an investment fund
The investment funds of large management companies usually have several different classes of the same fund. These classes of the same investment fund are usually done for one of three reasons:
- Have accumulation class or distribution class: The distribution class distributes dividends, while the accumulation class saves the dividends or coupons received for the assets it contains and reinvests them. This is a tax advantage in most countries and also allows for compound interest, simply by holding the fund.
- Have the fund accessible in different currencies : For example a class in dollars, another class in euros and another class in pounds. Classes in different currencies may not be hedged (the fund simply transfers the initial investment to the other currency and gives a net asset value in the other currency) or hedged (the fund uses hedging instruments to eliminate currency risk from the fund, for example if the fund initially invests in dollars but I invest in the hedged euro class, the return should be the same, minus the cost of the hedge).
- Have different classes that differentiate the types of investors : To separate small investors from large investors and institutional investors.
An example of the distribution by classes according to the type of investor could be:
- Class A for private investors: Minimum investment of 100 euros and management cost 1%.
- Class B for private bank investors: Minimum investment of 1 million dollars and management cost 0.75%.
- Class C for institutional investors: Minimum investment of 10 million dollars and management cost 0.30%. In order to invest in institutional classes, there may also be a series of requirements.
What and who forms an investment fund?
An investment fund is made up of four main components:
Participants or investors are those people who invest their money. Their capital goes to the common equity of the fund and in return they receive shares of the fund in proportion to what they invest.
The funds are flexible, you can enter at the time of creation or later. In the same way, you can withdraw totally or partially at the time you want.
The shares are the equal parts into which the assets of an investment fund are divided, this number of shares is not fixed, it depends on the purchase of shares (subscription) or sale (redemption).
Consequently, the value of the shares also varies. The value on a specific day is called the net asset value of the investment fund (NAV). That is why the shares are negotiable securities, but they are not usually traded on any market. In this sense, it is the management company itself that sells or repurchases the shares.
The management company is the one who administers and manages the fund, determines the investment policy to be followed. That is, where the assets of the fund formed by the contributions of the participants will be invested.
Each investment fund has a single management company, although this can manage different funds. The management companies charge subscription and reimbursement commissions (which can reach 5%) in addition to commissions for the result, management commission, the control of the depository company, accounting and for the preparation of periodic reports for the CNMV.
It can be a bank, savings bank or securities company. Its function is to safeguard the fund’s assets, which can be assets or cash, and it also performs control functions over the manager, for the benefit of investors.
To learn more about investment funds, read the types of investment funds and learn what are the advantages of investing in an investment fund.