Investment Fund Industry: Exploring The Intricacies

Investment funds are a way of investing money that allows investors to pool their money together to purchase a portfolio of stocks, bonds, or other securities. This provides individual investors with access to a professionally-managed portfolio and the benefits of working as a group, such as reduced investment risk and lower transaction costs. Investment funds are often referred to as investment pools, collective investment schemes, or simply funds. They are promoted with various investment aims, targeting specific regions or industry sectors. The first professionally managed investment funds were established in the Dutch Republic. Today, investment funds are regulated and structured differently across various jurisdictions, including the US, UK, Europe, Australia, and Canada.

Mutual funds

A mutual fund is a company that pools money from many investors to invest in securities such as stocks, bonds, and short-term debt. The combined holdings of the mutual fund are known as its portfolio, and investors buy shares in the fund, representing their part ownership in the fund and its income. Mutual funds are run by professional money managers who decide which securities to buy and sell.

There are several types of mutual funds, including money market funds, bond funds, stock funds, and target date funds. Money market funds invest in high-quality, short-term investments and have relatively low risks. Bond funds aim for higher returns but carry higher risks. Stock funds invest in corporate stocks, and target date funds hold a mix of stocks, bonds, and other investments, gradually shifting the mix over time according to the fund's strategy.

Investing in mutual funds provides access to a diversified, professionally managed portfolio. It also offers a wide variety of investment strategies and styles, including domestic and international stocks, bonds, and commodities. Mutual funds typically have lower transaction costs compared to individual investors because they buy and sell large amounts of securities at once.

When investing in mutual funds, it is important to consider the fees and expenses associated with them, as these can significantly impact the overall returns. Some common fees include operating expense ratios, loads or commissions, and brokerage fees.

Exchange-traded funds (ETFs)

ETFs are bought and sold like common stocks on a stock exchange. They can be structured to track anything from the price of a commodity to a large and diverse collection of securities. ETFs can even be designed to track specific investment strategies. For example, an ETF might focus on a particular industry or sector, such as oil or pharmaceuticals, or it might track a specific index like the S&P 500 or NASDAQ.

ETFs have lower operating expense ratios (OERs) than actively managed mutual funds, making them an affordable way to access a wide variety of asset classes. They also provide risk management through diversification, as they can span multiple asset classes, sectors, and industries.

There are several types of ETFs, including:

• Passive ETFs: These aim to replicate the performance of a broader index, such as the S&P 500.
• Actively managed ETFs: These do not target an index of securities but rather have portfolio managers making decisions about which securities to include.
• Bond ETFs: These provide regular income to investors, depending on the performance of underlying bonds.
• Stock ETFs: These provide a basket of stocks that track a single industry or sector, providing diversified exposure.
• Industry or sector ETFs: These focus on a specific sector or industry, such as energy or financial services.
• Commodity ETFs: These invest in commodities like crude oil or gold, diversifying a portfolio.
• Currency ETFs: These track the performance of currency pairs, allowing for speculation on currency prices and hedging against volatility.
• Bitcoin ETFs: These expose investors to bitcoin's price movements in their regular brokerage accounts.
• Inverse ETFs: These allow investors to earn gains from stock declines by shorting stocks.
• Leveraged ETFs: These seek to return multiples on the return of the underlying investments, using debt and derivatives.

ETFs have some disadvantages, including trading costs, illiquidity, and tracking errors. However, they are widely considered to be a valuable product for individual investors, providing an affordable and tax-efficient way to access a diverse mix of asset classes.

Real estate investment trusts (REITs)

REITs invest in a wide range of property types, including offices, apartment buildings, warehouses, retail centres, medical facilities, data centres, cell towers, infrastructure, and hotels. Most REITs focus on a specific property type, but some hold multiple types of properties in their portfolios.

There are two main types of REITs: Equity REITs and Mortgage REITs. Equity REITs own and operate income-producing real estate, collecting payments from tenants. Mortgage REITs, on the other hand, provide financing for income-producing real estate and derive their income from interest payments.

To qualify as a REIT, a company must meet several requirements. These include investing at least 75% of its assets in real estate, deriving at least 75% of its gross income from rents or interest on mortgages, and paying out at least 90% of its taxable income to shareholders as dividends. REITs are also required to be managed by a board of directors or trustees and have a minimum of 100 shareholders.

REITs have historically delivered competitive total returns, with high and steady dividend income and long-term capital appreciation. They have a low correlation with other assets, making them an excellent portfolio diversifier that can help reduce overall risk and increase returns.

When investing in REITs, individuals can purchase shares in a REIT listed on a major stock exchange, similar to buying any other public stock. Additionally, investors can choose to invest in a REIT mutual fund or exchange-traded fund (ETF).

Sovereign investment funds

SIFs are expected to play an increasingly influential role at a local, regional, and global level, influenced by three megatrends: digitisation, decarbonisation, and deglobalisation. They are often funded by revenues from commodity exports or foreign exchange reserves held by the central bank.

The funding for a SWF can come from a variety of sources, including surplus reserves from state-owned natural resource revenues, trade surpluses, bank reserves, foreign currency operations, money from privatizations, and governmental transfer payments. They can be used for a variety of purposes and have a range of objectives, terms, risk tolerances, liability matches, and liquidity concerns.

SWFs specifically are a type of investment fund owned by a country's government and are used to generate economic benefits for citizens. They invest in a variety of assets, including equities, debt securities, real estate, resource extraction, and other assets. They can also be used to benefit the economy of the host country, such as through investment in infrastructure or domestic companies.

Some examples of SWFs include:

• Norway Government Pension Fund Global
• China Investment Corporation
• SAFE Investment Company
• Abu Dhabi Investment Authority
• Public Investment Fund of Saudi Arabia
• Kuwait Investment Authority

Alternative investment funds (AIFs)

AIFs are privately pooled investment funds that are not registered with SEBI (India's Securities and Exchange Board). Instead, they are managed by experienced fund managers who are responsible for identifying the right investment opportunities and managing the fund's portfolio. These fund managers are expected to have a strong understanding of the market and the assets they are investing in.

One of the key advantages of AIFs is that they offer investors the opportunity to invest in a diverse range of assets, including private equity, venture capital, real estate, and hedge funds. This means that the investments are not subject to the volatility of the stock market, making AIFs an attractive investment option for those seeking stable returns.

Additionally, AIFs have a low correlation with other asset classes, which can help reduce portfolio risk. However, investing in AIFs comes with certain risks. Since they are not regulated by SEBI, investors must exercise due diligence before investing. The fund managers have the discretion to make investment decisions and may not always act in the best interest of investors. Furthermore, the investments made by AIFs are not publicly disclosed, making it challenging for investors to keep track of the fund's investments.

To assess the credit risk of an AIF, financial institutions can utilize the AIF Scorecard, which provides an intuitive structure to evaluate the creditworthiness of funds and their debt instruments. This scorecard considers factors such as stressed leverage, risk position, funding and liquidity, jurisdiction risk, fund track record, investment performance, risk management, and transparency.

In conclusion, AIFs offer a diverse range of investment opportunities with the potential for attractive returns. However, investors should carefully consider the risks and conduct thorough due diligence before investing in these alternative investment funds.

Frequently asked questions