A mutual fund is an investment vehicle that works by pooling the cash deposits of different individuals or companies and investing them in different securities. The pooling of the capital of different persons allows access to different investments on favourable terms in order to obtain a return for the participants.
What are mutual funds and how do they work?
When investing in a mutual fund, the money is managed by a management company specialised in the management of different investment portfolios, which can be composed of different securities such as equities, corporate and government bonds, real estate, international securities, other investment funds, mortgage bonds, etc. The composition of the portfolio is defined in the investment fund contract, whereby the investor can choose to participate according to his or her preferences.
What are mutual funds?
Mutual funds are based on a pool of investments (they become a diversified alternative) consisting of equities, debt securities or also so-called fixed income instruments (bonds, bills, time deposits, etc.), or it can be a combination of both (equities + fixed income).
In addition, they have no maturity and do not require rollover, which makes them a very convenient alternative and allows money to be readily available (liquidity). Investment funds are managed by a company regulated by the Securities and Insurance Authority (SIA), which is presented as the “Administrator”.
How to choose a Mutual Fund?
Regulation of Mutual Funds
Mutual funds and the administrators who manage them are subject to the rules laid down by the legal authority regulating these investment vehicles, there must also be rules governing the operation of the investment fund and specific regulations issued by the Securities and Insurance Authority. Therefore, the supervisory authority is entitled to unlimited supervision of all books, portfolios and documents of investment fund management companies.
Each fund defines its own investment policy, which is contained in the internal rules of the investment fund and approved by the Securities and Insurance Authority. On the basis of this information, the investor can make an investment decision in the fund that best suits his or her needs.
Performance of investment funds
Performance depends on the performance of the underlying asset to which the investment fund is linked. In general, the higher the investment risk, the higher the return. A common misconception is that fixed income securities are always profitable. This is not always the case, as it depends on the market price of the debt, the development of interest rates and the fund manager’s management skills. An investment in mutual funds does not guarantee future returns (except in the case of guaranteed mutual funds), its performance is mainly determined by 2 factors:
Capital gain or loss: is the change in the value of the assets that make up the investment fund (generating gains or losses). Dividend and interest income: refers to interest earnings or dividends paid on instruments held in the investment fund.
Diversification of investments
The main feature of an investment fund is the diversification of the financial securities in which it invests. On the other hand, the pooling of participants’ money gives retail investors access to products that were previously unavailable to them. It is a product with no maturity and high liquidity.
Investment fund shares
When a person joins an investment fund, his or her contributions are expressed in units. When an investor contributes to an investment fund, he receives shares in that fund.
The quota is calculated on a daily basis, through which we can judge the performance of the fund, when a contribution is made to the fund, it is calculated in quotas that have a value. The calculation is as follows: if we make a contribution of 10,000 USD on a day when the quota is 100 USD, we get 10,000 USD/100 USD = 100 quotas worth 100 USD. After some time we want to withdraw our money, at which point the fund has reached a return of 8%, which is reflected in the value of the contribution, which will be 108 USD. When we withdraw our money, we get 100 shares * 108 USD= 10,800 USD.
In this way, you can always find out how much money you have accumulated in an investment fund by simply multiplying the number of shares you own by the value of the corresponding share.
Advantages of mutual funds
These are the advantages of investment funds:
- You can invest from very low amounts
- Simplicity: they are easy to reverse
- Security. Investment funds are issued by banks and entities supervised by the Securities and Insurance Authority, which provides investors with management security.
- Liquidity. With the daily instalment calculation, an investor can redeem his capital at any time, which is different from a fixed deposit.
- Globalisation, access to any market.
- Multiple investment alternatives that adapt to the risk profile of each individual. Availability. With a small investment, an investor can access various instruments that would not be available to him/her as an individual investor due to their value or high transaction costs.
- Professional management. Through management companies with investment professionals who maximise objective returns.
- The investor does not have to participate in the buying and selling of assets as he would if he were managing his investments directly.
- They allow access to diversified investments, build portfolios according to the level of risk that suits you, and integrate fixed income and equity instruments that are difficult for private individuals to access.
- Partial or full repayments can be made as often as desired, there are no fixed duration or maturity conditions.
- They do not expire and do not require renewal.
- If your investment needs or objectives change, you can switch some or all of your investment to other funds that better suit your new needs.
- Only the actual gain you receive when you redeem your investment fund shares is taxable, i.e. until you redeem your investments, they do not constitute income for tax purposes.
What are the types of mutual funds?
In general, mutual funds have different investment portfolios, so we can find funds that invest only in equity (capitalisation), others that invest in debt securities, and mutual funds that invest in both types.
Investment funds typically invest in such instruments:
Short-term debt instruments: publicly offered securities representing debt with maturity of less than 365 days at the fund’s valuation date.
- Investment funds investing in shares or units.
- National or international funds.
- Funds denominated in local or other currencies.
The objective of mutual funds is to diversify their investments, which is achieved by selecting different assets from both the same asset class and assets with different types of risk; countries, industries and investment conditions. Mutual funds can also be identified by the market in which they invest: domestic, international or emerging, developed countries or multinationals, in derivatives contracts, both listed and over-the-counter, and others.
As described above, investment funds can be divided into 8 types:
- Investment funds investing in short-term debt instruments with a duration of 90 days or less.
- Investment funds investing in short-term debt instruments with a duration of up to 365 days.
- Mutual funds investing in medium and long-term debt instruments.
- Mixed mutual funds.
- Open-ended mutual funds.
- Mutual funds in equity instruments.
- Structured Guaranteed Mutual Funds
- Mutual funds for qualified investors.
Time to return on investment in mutual funds
At any time, you may request the redemption of your investment in investment funds, adjusted to the performance achieved or a portion thereof, to be paid out within a period not exceeding that specified in the fund’s articles of association. At the time you decide to withdraw, the value of the contribution will be calculated for the calculation of your capital.
The payment period is approximately 3 to 5 days. It is also important that you are aware of the exit fees for each fund.
Questions to ask yourself before investing in mutual funds Some of the questions you should ask yourself before investing in mutual funds are
- Do you know why you invest in mutual funds: will it be a short-term or a long-term investment?
- Do you want to increase your pension when you stop working?
- Know your risk tolerance: take on more risk for higher returns, or sacrifice profitability for peace of mind?
- In addition, it should be considered whether the investment is an important part of the savings or whether it will be possible to bear a loss on the investment made.
We hope this article has cleared up your doubts about what investment funds are, what their characteristics are and what to look out for when investing in them. If you want to continue learning more about investment funds, I recommend: Guide to investment funds so that you can start investing in investment funds from scratch. If you have any questions or additional information, please do not hesitate to contact me.