Collective investments pool capital from different investors to create a larger and more diversified portfolio of assets.
By doing this, individual investors can diversify their portfolio and have it managed in a much more efficient way than by selecting assets individually.
There a number of different types of such schemes, as follows;
Mutual funds – units trusts – OEICS
A mutual fund is the most commonly used type of pooled or collective investment scheme. It is an investment fund that enables investors to pool their money together into one professionally managed investment. Mutual funds typically invest in stocks, bonds, cash or a combination of these assets. The underlying securities or holdings, are combined to form a mutual fund, often also called a portfolio.
The advantages of investing via a mutual fund include:
- Economies of scale: the fund manages large transactions, the costs and commissions are more competitive, which reduce the overall cost per individual
- Liquidity: normally there are no penalties for early encashment
- Diversification(spread of risk): when merging capital, the fund can invest in a wider range of instruments, even when an individual investor only contributes with a relatively small amount of money directly
- Access to specialist investment expertise and know-how: professionals within the financial industry have access to information and research that private investors do not have
- Reduced administrative burdens
- Most funds are highly regulated and have a high degree of liquidity, which can be a big comfort to some investors
- The investor may gain access to markets with restricted access to institutional investors
For all the reasons described above, mutual funds may be suitable for you if:
- You want to develop a highly diversified investment portfolio
- You value professional expertise to manage your investments
- You don’t have the time to regularly monitor the performance of your investment portfolio
Open-ended and closed-ended collective investment funds
An open-ended fund is one where the fund creates new shares (described as units) when you invest in the fund, and cancels shares when you withdraw your investment. A closed-ended fund is one whose shares (or units) are offered to investors for a limited period only, to raise a fixed amount of capital. Price is determined by supply and demand and the selling price is expressed as either a premium or discount to the net asset value (NAV).
Exchange-traded funds (ETFs)
Exchange Traded Funds are securities which are traded on a stock market index in the same ways as an individual share or bond. An ETF most often represents a basket of assets, such as the constituents of a major stock market index like the FTSE 100, or the S&P500. As with stocks and shares, ETFs are priced and traded throughout the business day. ETF’s can be actively managed or can be passive index trackers, although the vast majority of those currently available are passive index trackers. This usually means they are lower cost than a managed fund, since there is no active management to be undertaken.
Structured products
A structured product, often called a structured note, is a type of closed-ended fund. It is generally a pre- packaged investment, which is based on derivatives, a single security, a basket of securities, options, indices (including multiple indices), commodities, debt issuances and/or foreign currencies.
Generally speaking, structured products offer the following features:
- Income or growth but generally not both
- Defined returns and defined risks
- Returns associated with an indicator such as FTSE 100 Index, gold prices, etc
- A defined term, often in the region of five to seven years
- Underwritten by a counterparty such as a bank
Structured notes are often complex investments, to be held as part of a suitably diversified portfolio for certain clients, depending on the risk profile of each investor.
Hedge funds
A hedge fund is a type of alternative investment which seeks to generate higher returns by investing in a pool of underlying securities. Hedge funds implement a range of different strategies, including taking long and short positions to leverage investment risk and capitalize on potential investment opportunities.
The hedging aspect works by taking a position in one stock and an opposite position in another similar stock, (hedging their bets) and hoping that the call pays off. By taking a long position, the hedge fund is buying stocks it hopes will go up in price, whereas by opening a short position, the hedge fund is borrowing the underlying asset, selling the stocks to buy them later at a lower price. In other words, it needs the prices to drop in value in order to make a gain.
Although it is possible to offset the risk in such an operation to some degree, none the less hedge funds often offer a greater degree of volatility than equivalent traditional long only funds.
In order to optimize the hedge fund’s investment freedom, hedge funds may impose lock-in periods, sometimes of as much as 12 months or more.
Many hedge funds have high initial investment sizes, so access is effectively limited to wealthy individuals and institutions.
They typically charge an annual management fee and performance-related fees.
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