Your coffee break investment plan - Day 7: Finding your way around funds
Funds are simply pooled investments, which allow individuals to invest their cash in a diversified range of stocks across a wide range of industries. But given there are thousands on offer, choosing one can feel like tiptoeing through a financial minefield. We look at the basics of what are available.
Passive vs active
In the broadest sense there are just two styles of to choose from - passive and active.
Passive funds, sometimes referred to as index trackers, are computer run portfolios that simply mirror or ‘track’ a particular stock market index, such as the FTSE 100 index of the UK’s biggest companies.
Their performance is dependent upon the fortunes of the market they are tracking. If it rises, the fund and the value of an investor’s stake will follow but equally the opposite happens if the market falls.
The bottom line is that investment returns from passive funds will echo, less costs, what the index has achieved. But they offer long-term investors cheap access to markets, as you can pay less than 0.1% in annual charges. They are growing in popularity too with sales hitting £5.4bn in 2015.
The more adventurous investor interested in the passive route may like to look at exchange-traded funds (ETFs). Again these are baskets of shares, and they robotically track a particular index. ETFs also offer a cheap way of accessing the market but they are listed on the stock exchange and are traded like stocks, so you have the flexibility of buying and selling them in real time.
Active investing on the other hand carries higher annual charges, typically nearer to 1% a year but with the heavier price tag comes added service. An active portfolio has a fund manager in the driving seat, buying and selling stocks on your behalf and what they want to achieve are market-beating returns.
The main advantage of the active route is if a manager believes a particular sector or stock is about to fall, they can sell out and buy into something more attractive enabling them to protect their investors from potential losses.
Open vs closed-ended
It is worth bearing in mind fund structures too. Open-ended funds are sometimes referred to in City speak as unit trusts or open-ended investment companies (OEICs), in that when you buy units, the portfolio provider simply issues a new batch. Open-ended funds can be active or passive.
Closed-ended funds, also known as investment trusts, are a slightly different beast though their end-goal, to deliver market-beating returns, is the same. They are closed ended, because they issue a limited number of shares, are structured as a limited company and listed on the stock exchange.
As investment trusts are traded as stocks, their price can fluctuate, depending on investor demand. If a trust is popular its shares can move up to trade at a premium. In other words, they can exchange hands for a greater cost than their actual net worth or net asset value (NAV).
However, if the trust drops out of fashion shares can fall in value and can start trading at a discount to their NAV. This means for example, if a trust is trading at a 10% discount, you can snap-up £100 worth of assets, for £90.
If you missed them, make sure you read the first articles in this series.
Also watch Moneywise editor Moira O’Neill interview Andy Parsons from The Share Centre about why you should start investing.
The term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.
Open-ended investment companies are hybrid investment funds that have some of the features of an investment trust and some of a unit trust. Like an investment trust, an Oeic issues shares but, unlike an investment trust which has a fixed number of shares in issue, like a unit trust, the fund manager of an Oeic can create and redeem (buy back and cancel) shares subject to demand, so new shares are created for investors who want to buy and the Oeic buys back shares from investors who want to sell. Also, Oeic pricing is easier to understand than unit trusts as Oeics only have one price to buy or sell (unit trusts have one price to buy the unit and another lower price when selling it back to the fund).
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
Net asset value
A company’s net asset value (NAV) is the total value of its assets minus the total value of its liabilities. NAV is most closely associated with investment trusts and is useful for valuing shares in investment trust companies where the value of the company comes from the assets it holds rather than the profit stream generated by the business. Frequently, the NAV is divided by the number of shares in issue to give the net asset value per share.