A fund is an investment vehicle that allows a large number of people to pool their money together in order to invest in a range of different securities such as stocks and bonds.
When you buy shares in a fund, you're buying an ownership stake in a range of investments that are managed by a fund manager. The fund manager combines your money with that of other investors and uses the money to buy and sell investments, with the goal of increasing the value of the fund.
The investments held in a fund are called the fund's assets. The fund manager invests the fund's assets, typically by buying stocks, bonds, or a combination of the two. Some funds buy more complicated securities such as property and commodities and almost all funds have a ‘buffer’ of a cash allocation.
The investments within a fund are often referred to as a fund's holdings, and all of a fund's holdings together are its portfolio.
The price for a share in an open-end fund is calculated by taking the total value of the securities owned by the fund and dividing that number by the number of fund shares outstanding. So if a fund has US$1 million in assets, and there are one million shares outstanding, each share would cost US$1. This per-share value is called the net asset value (NAV).
When you invest in a fund, you are getting exposure to every investment within that fund. For example, as of 30 November 2014, the best performing China equity fund over the last ten years was the First State China Growth fund.
As of 31 August 2014, the First State fund’s three largest holdings were China Oilfield Services, making up 6.45% of the fund, ENN Energy at 5.26% and Baidu at 4.97%.
If you chose to invest in this fund, a US$1,000 investment would mean that you owned a US$64.50 stake in China Oilfield Services, a US$52.60 stake in ENN Energy and a US$49.70 stake in Baidu. You would also have owned smaller stakes in 48 other companies, since the fund owned shares in 51 companies as of 31 August, 2014.
Investing in this fund would allow you to be diversified over a broad range of assets, which is desirable since you avoid putting “all your eggs in one basket” and instead spread your risk across 51 different investments. Your risk is spread, so your investment does not depend too heavily on the fortunes of just a few individual companies.
Funds differ based on their investment strategies and investment holdings. Some funds focus on buying and holding shares in a single-country such as China while other funds may focus on investing in bonds issued by companies in emerging markets. A fund's investment strategy will affect a fund’s risk profile and performance.
The Benefits of Fund Investing
Funds offer some notable benefits to investors:
1. They Require a Small Initial Investment
If you had just US$1,000 to invest it would be difficult for you to assemble a varied, diversified investment portfolio on your own. But by buying a fund offers this – and gives you the clout of the asset manager.
2. They're Easy to Trade
Whether you’re buying funds online by yourself or hiring a broker or financial adviser to do it for you, funds are easy to buy. Once you have set up the financial transaction, it often takes just a phone call or mouse click to buy or sell shares in a fund.
Unlike many other security types, such as individual stocks, you don’t need to find a buyer when it's time to unload your open-end fund shares. Instead, the vast majority of funds offer daily redemptions, meaning that the fund company will give you cash whenever you are ready to sell.
3. They're Regulated
Fund managers are regulated. For example, fund managers in Hong Kong are regulated by the Securities and Futures Commission (SFC). But the fact that funds are regulated does not mean you cannot lose cash. The value of a fund can go down as well as up and past performance is no guarantee of future returns. If the underlying holdings lose value, so will the fund.
4. They're Professionally Managed
If you plan to buy individual stocks, you will probably want to do in-depth research to ensure you’re making a good investment. That may involve reading a company's cash-flow statement or assessing the company’s debt obligations. Such in-depth financial knowledge is not required to invest in a fund. While fund investors should have a basic understanding of markets and do research before buying into a fund to assess its suitability, in the end, there is much less investment research required.
You are putting money into a fund and then the fund manager will select individual securities on your behalf. They do the investment research for you and you can take advantage of the fund manager's specialist investment knowledge.
Not all funds deliver their aim however, some funds charge expensive fees and some funds can perform poorly. But overall, funds are good investments for those who don’t have the money, time, or interest necessary to compile a collection of securities on their own.