Funds: What You Need To Know

What are funds? 

Funds are investment vehicles that pool money collected from multiple investors to invest in diverse securities, like stocks, bonds, and other assets such as derivatives. The funds are usually actively managed by professional portfolio managers. 

The typical fund holds dozens, or even hundreds, of instruments as this structure allows investors to spread their risk in a consistent and managed way. 

A fund roughly works like an investment company, in which individual investors hold shares. The fund is governed by a set of rules- called a mandate - that dictates which investments the fund manager can make.  

This mandate can be based on geography, asset classes or instruments, sectors, currencies, or any combination of strategies. 

Once defined, the fund manager invests the fund’s money in assets that adhere to the criteria of the mandate.  

Imagine this:  

Ten investors with GBP 10,000 each want to invest in emerging markets. Individually, the investors would have to perform their own analyses, identify the potential projects, and then negotiate the entry level requirements to GBP 10,000. 

By pooling their money, the investors negotiate with ten times the leverage, and one professional fund manager undertakes the analysis and selection process on their behalf to ensure alignment of interests.  

When investors join forces, the collective amount of investable funds allows for a much more diversified and balanced portfolio of holdings.  

Are “mutual funds” the same as “funds”?  

Many countries refer to the term “funds” differently, and we know it can get confusing for investors. So, to keep things clear, here’s a list of what it is called in several well-known locations: 

USA: Mutual funds 
Hong Kong: Mutual funds, Unit Trusts 
Switzerland: Mutual funds 
UK: Funds 
France: OPCVM (Undertakings for Collective Investment in Transferable Securities) (UCITS) 
UAE: Mutual funds and Funds 
India: Mutual funds 

What to look for when choosing funds

When investing in funds (or mutual funds), there are so many options, it can be difficult to know what to look for when choosing a fund to help you meet your investing goals.  

Here are a few things we think you should consider: 

The mandate  

When you begin considering which fund to invest in, take a look at the rules that define which investments the manager of a fund is allowed to make. The rules, called a mandate, can be based on a variety of different factors such as which instruments, and how much of the fund, can be allocated to certain areas. For example, a Global Equity Fund would be required to invest in stocks, not bonds, from all over the world. 

Asset classes  

Another thing to consider is asset classes. Is it a stocks-only fund? Or does it contain bonds, cash or alternative investments as well? Alternative assets can be anything from windfarms to forests and infrastructure, such as roads and other investments, that are not traded on a traditional exchange.  

Geography  

Another consideration when choosing funds is geography. Funds often have a geographical target such as regions, i.e., South-East Asia, North America, Europe, or countries such as India, China or the United Kingdom, or even specific stock indices such as the S&P 500 and NASDAQ100 in the United States, or FTSE 100 in the UK. This allows investors to invest in areas that would normally require a tremendous amount of research.  

Trends 

Finally, you can look for trends and themes. Want to invest in biotechnology or artificial intelligence? Companies with a strong, ethical profile? No matter if you are looking to invest in real estate or robotics, you will be able to find a fund that matches your interests and/or personal values.  

What is the difference between a fund and an ETF? 

Exchange-traded funds, also referred to as ETFs, are similar to funds, as both instruments bundle together securities to offer investors diversified portfolios. Yet, the two investment types have significant differences. 

ETFs trade throughout the trading day, like a normal stock, while funds trade only at the end of the day, at the net asset value (NAV) price. 

Most ETFs track a particular index and therefore typically have lower operating expenses than actively invested funds. 

The tax treatment of funds and ETFs may also differ. For more details, please refer to your personal tax advisor. 

How are funds traded?  

The nature of funds, where groups of investors pool their money and invest together, means that they are not traded like regular stocks.  

The fund usually holds several assets, which can be individual stocks, bonds, cash positions, and other investments. At a set time each day, the value of all individual holdings in the fund is calculated. This means that the face value of each individual investor’s holding in the fund does not change throughout the day, as it is updated once every day.  

When investing in a fund, the investor pledges a sum of money, which is then invested the next time the value of the fund is calculated. The value of the fund is the collective value of all the underlying investments, i.e., stocks, bonds, cash. 

Let’s say the value of the entire investment in a fund is GBP 10,000,000. The investor wants to invest GBP 5,000. The GBP 5,000 goes to the fund, and the retail investor then holds 0.5% of the fund, now valued at GBP 10,005,000, including the new investment.  

In some cases, the new investor simply takes over the shares from another investor, who is about to exit the fund.  

Either way, this means that you own a fraction of the entire portfolio, making sure that the risk is spread through a much higher level of diversification than the original amount of money would be able to obtain.  

If you want to sell your part of the fund, the inverse is true: you simply put in a “sell” order and your share in the fund is liquidated by the end of the day. The money is then wired back into your account.  

Trading funds means you get a wide and diversified portfolio without needing to spend your valuable time looking at charts throughout each day. 

What are the advantages of trading funds? 

There are some excellent benefits for investors when they invest in funds. Here are our top five: 

Diversification  

Investing in funds can be a convenient way to increase your so-called risk-adjusted return. When you invest in funds, you get instant diversification because funds are usually comprised of a variety of instruments such as stocks and bonds, across industries and regions. A diversified portfolio is generally considered less risky than owning individual stocks since you spread your risk. 

Lower fees 

Investing in funds gives you access to many instruments for an often relatively low price. Funds typically have lower fees and transaction costs compared to the costs associated with frequently buying and selling individual stocks, which can impact returns significantly over time. Nevertheless, fund costs vary, so pay attention to each fund’s costs. 

Professional Management 

Investing in funds helps you ensure constant, professional care of your portfolio. Fund managers have the expertise and resources to evaluate companies and markets to make informed investment decisions. They monitor holdings and make adjustments to optimize performance and risk. 

Saves time 

Investing in funds can be an efficient way to save time. Building a healthy and diversified portfolio takes expertise and time. Extensive experience and skills are required to research companies, monitor a portfolio, and manage risk. 

More choices

 Investing in funds allows you to invest in a vast number of investment opportunities. This enables retail investors to access more niche asset classes that would otherwise be unavailable to them. These niche asset classes have distinctive sources of potential return, risk, and performance drivers. This provides better diversification throughout the economic cycle and the opportunity to tailor a portfolio by aligning it with investors’ preferences and needs. 

In addition to these advantages, funds can be chosen based on third-party providers' ratings such as Morningstar. Such ratings help investors assess a fund's past track record (risk-adjusted return) relative to its peers. 

What are the disadvantages of trading funds? 

While funds have great advantages- compared to investing in individual stocks- there are also a few challenges that you may want to consider before investing in them. 

Lack of control  

If you invest in funds, you give up control and leave the decision to select, buy and sell specific stocks to the fund manager, which may not always match with what you prefer. No matter how you feel about some of the holdings, you have no say in what this fund is invested in. 

Lack of transparency  

Funds do not disclose their holdings and trading activity in real time. Generally, they report holdings on a delayed basis upwards of 60-90 days (sometimes even more!), so you won’t be able to see exactly how your money is being invested at any given time. 

Underperformance

While funds aim to optimise returns and risk, it is no guarantee they will outperform the overall market or match the returns of a well-selected portfolio of individual stocks. Fund managers, like any market participant, can make poor choices or miss opportunities at times. Make sure to do your homework before selecting the fund you want to invest in. 

Order execution 

For most markets, funds trade once a day after the close of the market. This limits the possibility for swift reaction when big market movements occur. 
 
Funds have distinct advantages compared to stocks; however, this doesn’t mean that an investor cannot add both to their portfolio. Funds and individual stocks are not mutually exclusive; it's more a matter of personal preferences, considering how much experience and time you have, and your personal investment goals. 

Are there risks with trading funds? 

At Saxo we always want to be transparent with you about any possible risks when you invest. Funds are usually considered an investment opportunity that helps you lower market risk with diversification, but here is a list of risks you may want to consider:   

Funds Risk List 

Market risk 

There is a risk that a fund's value will decrease due to broader market fluctuations. Any potential gains and losses in the market will also be reflected in the value of the fund through an increase or decrease in the value of the underlying securities. 

Liquidity risk 

Imagine you want to sell your old car, but there are not many buyers in the market. You may have to lower your price or wait for a long time to find a buyer. This is an example of liquidity risk, which means that some assets are hard to sell quickly without losing value. Liquidity risk also affects some funds that invest in such assets. For example, a fund that owns exotic investments may have to sell them at a discount or wait until the buyers want to pay the given price. The difference between the price you can buy and sell an asset is called the spread, and it is usually larger for illiquid assets than for liquid ones. 

Potential costs/charges related to instruments 

Funds have a few different costs that are embedded into price valuation on a daily basis, depending on the cost the performance over time may be impacted more or less. Typically the cost only makes up a smaller portion of performance day to day, given the overall cost relative to market movement or performance.  

Maximum loss in trading funds 

The maximum loss a client can face when trading funds is dependent on the amount invested and the performance of the fund. If all the underlying investments go to 0, it is possible to lose the entire invested amount. Most funds are quite diversified and typically have the purpose of ensuring that significant losses are mitigated through the management of the fund. This means that an erosion of assets by more than 50% would be highly unusual and, if this did happen, it would challenge the mandate and purpose of the fund.   

Other risks: 

Depending on the specific type of fund, there may be additional risks such as currency risk, interest rate risk, credit risk, or geopolitical risk. 

Why invest in funds? 

When you invest in a fund, your money is managed by professional portfolio managers who make informed decisions about where to allocate your investment. Having this kind of advanced portfolio management can be a significant advantage for those who may not have the time or expertise to manage their own investments. 

Funds typically invest in a wide range of securities. This diversification can help to mitigate risk, as the poor performance of some investments can potentially be offset by the strong performance of others. Reduced portfolio risk is achieved with diversification, as most funds will invest in anywhere from a few to several hundred different securities—depending on their focus. 

Funds are easy to buy and are offered by many different issuers, so clients can access a variety of funds potentially operating with similar mandates. This accessibility also increases the competition in the industry which may also be to the benefit of investors.  

Funds are typically priced once a day, at the end of the trading day. This means that all investors who buy shares on a given day get the same price. Also note that most funds have low minimum investment requirements, making them an affordable and accessible investment option for people with varying levels of wealth.  

Dividend reinvestment is another reason many investors prefer to invest in funds. As dividends and other interest income sources are declared for the fund, they can be used to purchase additional shares in the fund, therefore helping your investment grow.  

How much do funds cost? 

You may be wondering about fees and potential added costs that can be associated with funds.  

While funds charge different costs, the main cost to consider is the ongoing cost, which represents the annual fee for managing the fund. This covers operational costs, administrative expenses, and management fees. The ongoing cost is deducted from the fund’s assets and is reflected in its net asset value. 

Fund prices can be influenced by several factors, such as market conditions (changes in overall market performance, economic indicators, or investor sentiment), and asset performance (the value of the underlying securities, alternatives or derivatives held by the fund). 

The issuer of the fund typically calculates a price (NAV, or net asset value) which represents the value of all underlying instruments divided by the number of units in circulation. These are usually calculated daily, but certain instruments may be calculated less frequently, for example on a weekly or monthly basis.  

What are the different types of funds?

There are several types of funds, including: 

Money market funds: These funds invest in short-term, low-risk, high-quality bonds. 
Bond funds: These have a higher risk than money market funds and make long-term investments into bonds specified in the fund’s investment objective. 
Stock funds: These funds invest directly in corporate stocks. 
Balanced or mix funds: These funds invest in a combination of assets – stocks, bonds and other funds. 
Alternative investment funds: These funds invest in non-traditional assets like direct-infrastructure, derivatives, private equity, non-listed products, etc. 

A helpful way to determine what kind of fund you want to choose is by looking at a fund’s KID (Key Information Document). The KID holds basic information about the instrument, such as its investment objective, fund, cost and charges, historical performances, and other key characteristics. 

What is the difference between actively managed funds and index funds? 

Index funds 

Index funds were created to track- as opposed to simply ‘beat’- a specific index, like the S&P 500. Index funds are typically a low-cost way to invest, and this is why index funds may also be considered a low-risk way to invest. 

Actively managed funds 

Unlike index funds, actively managed funds were created to actually try to beat the market. They are managed by experienced portfolio managers who choose instruments that they feel will outperform benchmarks. This is one of the reasons actively managed funds are usually a higher-cost way to invest, and therefore can be seen as higher risk.  

How do dividends work with funds? 

Dividends are the investor’s portion of a company’s profits. Funds that own dividend-paying or interest-bearing securities indirectly pass those cash flows on to investors in the fund. The company approves the amount based on its financial results. Any such distributions from the underlying securities essentially just adds the cash to the total net assets of the fund. 

Dividends also represent a portion of a company’s profits. Companies that are thriving financially often transfer a portion of their profits to shareholders in the form of dividends. Each shareholder gets a set amount for each share held.  

In a high-dividend-yield fund, this income can actually be a major percentage of its total return. The fund also sets the frequency of dividend payouts, so the dividends paid out to investors may not correspond 1:1 with what the fund receives. 

Funds can also be issued both in accumulating versions (non-dividend paying) where any sort of income derived from the underlying securities are essentially reinvested into the strategy of the fund.  

Alternatively, a fund may also be INC or DIST, which are terms associated with a fund paying dividends to the investor. This income may be a pass-through of the underlying value of the fund, but, through a sell-off portion of the gains, it could also be a portion of the actual return that is paid out to investors. 

As the money is received, it is held as cash or in highly liquid low-risk debt instruments (sometimes called cash equivalents). Because of this extra cash, the AUM goes up, and you will also see an impact on NAV (it goes up) due to these dividends coming in.  

Typically, the dividend of e.g., stocks, is equal to the drop in price. Therefore, the receival of dividends has no impact on the fund's value. Then, as the fund manager finds the right opportunity, he takes these dividend payouts to invest so that this money grows too. 

Why you should trade Funds with Saxo  

We’ve won multiple awards for our products and platforms. But the real reason investors choose us is that we’ve built a secure and transparent offering that provides maximum investing flexibility. We can offer you: 

-Ultra-competitive prices on funds 
-Funds with zero commission 
-Access to 3600+ funds from the world’s top money managers 
-Award-winning investment platforms, tailored to your experience level 
-Powerful tools and natively designed apps 
-24-hour service  

Start investing in funds today:  https://www.home.saxo/en-gb/products/mutual-funds