What are Funds?
Funds are pools of capital collected from multiple investors to invest in various assets, such as stocks, bonds, real estate and other securities. They provide investors with an opportunity to diversify their investments and, crucially, access professional management.
Definition of Funds
The broadest definition of ‘Funds’ is that Funds are investment vehicles that can be structured in various ways, including mutual funds, hedge funds, private equity funds and exchange-traded funds (ETFs). On UMushroom the definition is a bit narrower, limiting itself mainly to mutual funds, ie the pooling of investor money into a tightly controlled common investment strategy resulting in ‘highly regulated mutual benefits and risks’
ETFs enjoy their own category on UMushroom (for reasons explained below) while more specialized funds such as hedge funds and private equity funds tend to require large initial investments (for reasons also explained below) and do not feature extensively on UMushroom.
Discover the wide range of funds available on UMushroom to help you grow your investment portfolio.
How Do Funds Work?
Funds operate by pooling money from investors to create a larger capital base for investing. The fund manager or management team subsequently makes investment decisions based on the fund’s clearly defined objectives. This second aspect is the key differentiator between funds and ETFs: funds are usually actively managed while ETFs tend to be ‘passive investments’, meaning the ETF manager does not make investment decisions. A review of the ETF lexicon will help to clarify this point further.
Funds are not bought and sold on an exchange. Instead, an investor places what is commonly referred as a subscription with the fund manager who will process that subscription by issuing units in the fund, in exchange for the cash invested. The reverse of this process is referred to as a redemption. For the investor the exact mechanism is not very important with the broker taking care of the process and on UMushroom subscribing to a fund uses the same process as buying an equity or an ETF or a crypto currency. But beware, the order will take longer to execute and be converted into a portfolio position!
The manager of the fund is expected to apply his or her expertise in and knowledge of the global capital markets to generate a return on investment which is superior to what might be available by investing in an ETF. An example would be to compare an ETF tracking the S&P500 and a fund manager who has expertise in US equities and commits to delivering an investment return which is (much) better than the equivalent ETF. And this is the key: the investor gets access to the manager’s expertise which is/can be positive but which also comes at a (higher) annual cost. Consequently, the fund fees displayed on UMushroom are an essential input to any investment decision.
A mutual fund tends to be highly regulated by the regulator of the country in which the fund is operating. The purpose of such regulation is to protect all types of investors including those which have relatively small amounts of savings to invest and who may not have the extensive financial training to assess all the risks presented by the global financial markets.
Funds which are much less tightly regulated include hedge funds and private equity or private debt funds. These types of funds have almost unlimited freedom in making investment decisions and can therefore generate large investment return but also present a total loss on capital invested. To ensure investors with limited life savings do not take uninformed risks, the minimum initial investment in such funds tends to be well in excess of a million dollars or equivalent, the assumption being that individuals with such amounts of money to invest can also afford to lose large amounts of money. These funds do not appear under the Funds category on UMushroom.
Why Are Funds Important?
To answer this question it is important to have a clear understanding of what in finance is referred to as ‘alpha’ and ‘beta’. These are concepts deserving of their own lexicon but a brief introduction is required here too.
Oddly enough, beta comes first and is the investment result an investor can obtain purely by following/tracking the market. To generate beta the best investment vehicle by far is the ETF. An ETF tracking the S&P500 for example will generate investment returns which are identical to the performance of the S&P500 minus fairly insignificant fees.
Alpha is the result of applying investment expertise to generate an investment return which is better than the market. This would be called positive alpha. Conversely, if the fund manager is not able to deliver on the promise of ‘beating the market’ and underperforms the market, the result might be called negative alpha.
Mutual funds almost always try and generate positive alpha (performance in excess of the underlying market) in addition to beta (the actual performance of the underlying market). Some mutual funds try and generate only alpha and an absolute return fund would be such a fund.
As mentioned, beta comes first because any aspiring investor with no current investments would be best placed to invest into low cost ETFs, thereby ‘generating beta’. It is a market tracking investment strategy and is, over a sufficiently long horizon, almost unbeatable. See also the ETF lexicon for more information on this topic. Furthermore, a Google search on what Warren Buffet has said over his multi decade investment career would further underwrite this starting proposition.
Of course, investing for many investors is more than just following the markets and receiving beta year after year. This may mean actively investing in equities and/or researching what crypto currencies can offer and/or investing in mutual funds which will have specific investment goals not available elsewhere. All of these strategies have as main aim to generate alpha.
Investing in funds is therefore an important part of the investment focus of any investor. A simple example would be a fund manager who has a very good understanding of the US equity markets and is able to generate, for example, 2% more in investment returns than an ETF tracking the S&P500. Such a fund would carry higher fund fees than the ETF but this is a cost easily justified by the expertise of the manager. Other funds may give exposure to investment opportunities not available elsewhere, such as a fund committing to invest only in, for example, companies with a very good ESG (Environment, Social & Governance) score. Such a fund may not (or indeed it may!) beat the underlying market but the ‘feel good’ aspect of making such an investment will have sufficient value for an investor to justify the higher fees and potential market underperformance.
The ’Compare’ functionality on UMushroom is the ideal place to go to to compare how fund managers have performed over the last years in comparison to the markets they are trying to beat (hint: select the fund you are interested in and compare with an ETF which tracks the market which the fund manager is trying to outperform).
UMushroom presents all the mutual funds which are available for sale (or more precisely, subscription) in the jurisdiction where you as user of the UMushroom platform are located. There are some other considerations which are relevant to mutual funds such as ‘Suitability’ (take note of the red, amber and green flag alongside each fund!) which are described in the Fund Suitability lexicon elsewhere.
Common Misconceptions About Funds
- "All Funds Are the Same": Different funds have different strategies, fees, and risk profiles, making it essential to understand each fund's characteristics.
- "Investing in Funds is Low Risk": They can be. And they can be very high risk. While funds can offer diversification, they still carry risks associated with market volatility and investment choices. A fund closely linked to cash and related money market investments tends to have a very low risk of negative investment returns while a fund which, for example, tracks a basket of crypto currencies can be high risk. The Risk Level entry for each fund is a good indicator.
- Mutual Fund: A type of fund that pools money from investors to purchase a diversified portfolio of stocks or bonds.
- ETF: An investment fund traded on stock exchanges, holding assets like stocks and bonds.
- Private Equity Fund: A fund that invests directly in private companies or engages in buyouts of public companies.
FAQs About Funds
Q: What is the minimum investment required for funds?
A: Minimum investments vary by fund but can range from a few hundred to several thousand dollars.
Q: Are funds regulated?
A: Yes, funds are typically regulated by financial authorities to ensure transparency and protect investors.
Q: How do I choose the right fund?
A: Consider factors like your investment goals, risk tolerance, and the fund's performance history and fees.
Related Terms
- Mutual Fund: A type of fund that pools money from investors to purchase a diversified portfolio of stocks or bonds.
- ETF: An investment fund traded on stock exchanges, holding assets like stocks and bonds.
- Private Equity Fund: A fund that invests directly in private companies or engages in buyouts of public companies.
