Introduction to Investment Funds – Definitions of Common Terminology
It is often difficult for the novice investor to work out the most effective investment strategy. This is because a lot of the terminology associated with investment activity is complex and unique to the financial industry.
Therefore, in order to aid the education of novice investors, some of the most common terms associated with the global investment landscape are presented below alongside clear definitions of what they mean and how they are applied in real-world situations.
An Investment Fund is a fund into which investors with similar objectives pool their money together. This money is then invested by professionals, who manage the fund for a fee, with the intention of generating profit.
By aggregating the funds of a large number of small investors into a specific investments (in line with the objectives of the investors), an investment company gives individual investors access to a wider range of securities than the investors themselves would have been able to access.
Investment Funds are also known as unit trusts (UK) or mutual funds (USA)
A mutual fund is the American term given to an Investment Fund (see above).
A Unit Trust is a common UK term for an Investment Fund (see above).
An Investment Trust is a public limited company which invests shareholders’ funds for a profit by buying, selling and holding shares.
Investments are made in other companies and consist of diversified portfolios that are professionally managed. They follow a wide variety of investment policies, usually specialising in a type of investment or particular geographic region. The money raised is invested by the trust and if the underlying investments do well the share price of the investment trust rises.
The number of shares in issue is normally fixed and the price varies according to market demand.
Open and closed-end funds are both collective investment funds. Both pool the money of investors into professionally managed schemes in order to maximize diversification within a set strategy and to meet specific investment objectives.
An open-ended fund is one which has unlimited availability as it can issue and sell an unlimited number of shares to its investors.
An open-end fund issues and redeems shares on demand. When an investor buys open-ended fund shares the fund’s assets rise as money is added to the asset pool, however if an investor liquidates shares the fund’s assets decline as money is taken from the pool. The value of open-ended funds is therefore equal to their Net Asset Value (NAV) which can grow and shrink as money flows in and out.
A closed-ended fund is a collective investment fund which has a limited number of shares. Just like any other limited company, it issues a set number of shares in an initial public offering and they trade on an exchange. Its share price is determined not by the total value of the assets it holds, but by investor demand for the fund based upon its success. Once the fund’s capital is fully issued, investors must buy shares in a secondary market from existing shareholders.
An equity fund (or stock fund) is a fund that invests in equities more commonly known as stocks and shares with the aim of providing long-term capital growth. Some equity funds concentrate on a particular country, while others cover a region, a sector or all the world’s major markets. The value of the Fund will be affected by changes in the market price of those equities invested in.
Equity funds are sometimes known as equity participation units.
A cash fund is a collective investment scheme which trades currency for profits.
They invest most of their assets in cash or near-cash instruments traded on the money market. These include bank deposits, certificates of deposit, very short-term bonds or floating rate notes.
Cash funds are highly liquid funds and are also sometimes known as money market funds.
A bond fund is a collective investment scheme that invests in bonds and other debt securities including corporate, government or municipal bonds.
Bond funds typically pay periodic dividends that include interest payments on the fund’s underlying securities plus periodic realized capital appreciation.
Also known as fixed-investment funds they can offer a lower risk alternative to investing in equity funds and Greater potential returns than cash.
Emerging markets is the term applied to the financial markets within developing countries that are experiencing rapid and significant social or economic growth. Investment in these markets can yield greater returns but there is more risk attached as the markets can sometimes prove volatile and unstable.
The BRIC nations – Brazil, Russia, India, China – are considered to be the world’s biggest emerging markets followed by the CIVETS nation – Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa.
Developed markets is the term applied to the financial markets within countries that have sound, well-established economies and are therefore thought to offer safer, more stable investment opportunities than developing markets.
The USA, UK and Japan are considered to be examples of developed markets.
Investment Portfolio Manager
An Investment Portfolio Manager is the term given to the person, persons or firm that is responsible for creating a strategy and managing the investment of a mutual, exchange-traded or closed-end fund’s assets.
Choosing a successful portfolio manager is vital in order to meet the profit objectives of investment activity.
Investment Portfolio Diversification
Portfolio diversification is the process of limiting the risk exposure of investors by spreading what a particular fund is invested in.
If embarking upon a strategy of diversification a portfolio manager will look to invest in a wider range of different industries and companies so that any potential downturns to specific industries and companies will not result in a large and unmanageable loss for the investment fund.
This process is ultimately designed to reduce the volatility of a portfolio because different assets should be rising and falling at different times and as such the returns of a diversified portfolio should be more predictable and secure.
ISAs (Individual Savings Accounts)
ISAs are tax-efficient savings accounts that allow a mixture of cash, shares, or collective funds such as unit trusts, investment trusts or OEICS to be held. Each individual has an annual allowance of £11,280. This may all be used for a stocks and shares ISA or split with up to £5,640 for cash.
By using an ISA, investments can be made in cash or longer-term investments such as stocks and shares or insurance. Investors will not pay tax on most of the income and capital gains tax is not paid on profits either (this is why it is called a tax wrapper).
JISA (Junior Individual Savings Accounts)
The JISA is an efficient and effective way for parents to plan for, and safeguard, their child’s future in an uncertain financial world. They are a tax-efficient investment wrapper that enables parents, grandparents, friends and/or guardians to invest on a child’s behalf, with any income and profits earned on the investment accumulating tax efficiently.
Just as with an adult ISA, all investment returns are free from income or capital gains taxation. However, unlike the adult ISA, investments cannot be cashed in before the JISA – and the child – mature at 18 to ensure they provide maximum benefit for the future financial stability of the child.
A total of £3,600 can be set aside each tax year for a child in a JISA wrapper, and the account can be accessed on their eighteenth birthday. A range of accounts are available for selection dependent upon individual circumstances. As with adult ISAs, these include stocks and shares and cash options, provided by banks and building societies, to benefit from the tax advantages. Junior ISAs are available toUKresident children under 18 who do not have a Child Trust Fund.
Self-Invested Personal Pension (SIPP)
A SIPP is a specialised form of personal pension where the individual investor is able to choose where and how their pension fund is invested, rather than entrusting their money to one insurance company or fund manager.
A SIPP accumulates a pension fund in a tax efficient way and offers greater control and flexibility in terms of how investments are made and when benefits are taken.
Approved by the UK Government, a SIPP allows individuals to make their own investment decisions from the full range of investments approved by HM Revenue & Customs (HMRC). The fact that an investor can choose from a number of different investments, unlike other traditional pension schemes, means that SIPPs offer greater levels of control over where money is invested.
Please do remember, the eligibility to invest in an ISA, Junior ISA or SIPP will depend on your individual circumstances, and all tax rules may change in the future.
The value of investments can go down as well as up and you may get back less than you invested.