Investment funds

Investment funds are another important instrument and one of the best known among beginner savers. Omitting academic definitions that are difficult to understand, in order to comprehend investment funds, try thinking of a large piggy bank where the money of both small and large savers goes.

The management of this “piggy bank” is entrusted to an Asset Management Company (AMC) that offers the advantages of a professional investment service to all savers who otherwise, having little capital at their disposal or lacking the necessary skills, could not afford it. The decision of what to buy with the money in that “piggy bank” depends on the investment objective of the fund.

In practice, an investor delegates the choice of how to invest their savings to the fund manager (and this conflicts with my motto).

Investment funds, therefore, are a form of asset management that collects investors’ savings, which are then managed by the Asset Management Company (AMC) through a professional manager, as a single pool of assets, invested in financial assets such as bonds or shares, with the aim of outperforming the market. This is why it is said to have “active” management.

Active management provides a professional manager with a margin of discretion, which allows him to vary the composition of a fund according to his own expectations, so as to favour financial assets which should be more likely to offer above-average returns, thus allowing the fund to perform better than the reference market.

In reality, it isn’t as good as you might think. Investment funds should have the advantage of diversifying investments across more financial assets, thereby reducing risks, on top of being managed by professionals. But because of their “active” management, they have very high costs. Generally, they have:

• entry fees, at the time of purchase of the share;
• management fees, i.e., recurring costs (usually annual) linked to the administration of the fund;
• performance fees, proportional to certain results achieved by the instrument;
• exit fees, at the time of the sale of the share.

These fees are not small either, I assure you (considering that it will be you, with your commissions, who will be paying the salaries of the fund managers). Also, although these funds are managed by professionals who, through active management of the fund’s assets, aim to beat the market, their performance is nonetheless very often worse.

Statistics show that a fund that outperforms its benchmark one year rarely succeeds in doing so the following year, thus suggesting that that outperformance was the result of chance rather than the manager’s skill.

However, you should know that there are funds that claim to implement active portfolio management while in reality, they adopt passive management (which I will explain later). In these cases, you pay fees to the fund manager when you shouldn’t be.

Another “defect” would be the lack of transparency since the saver cannot know in detail or in a timely manner the financial products that constitute the assets of the fund. The data that are disseminated, in fact, are always late and often incomplete.

Unlike other instruments, investment funds have no price limit. When placing your order, you only need to enter the quantity you are interested in and that corresponds to the amount you want to invest. All buy/sell transactions entered will be settled on the basis of the end-of-day value (NAV, Net Asset Value). Therefore, investment funds are bought and sold “in the dark”. Only the day after the operation will you know the price paid or received.

If you have a pressing need for the money you have invested into funds, then these are not for you, because the time it takes to redeem your money is long. Due to a complex mechanism of communication, it can take up to 15 days before you will have access to the money in your bank account.

Given the many flaws that investment funds have, you may be wondering why banks and promoters insist so much on you subscribing to them. The answer is simple, every year, investment funds guarantee lavish commissions that pay, as mentioned above, the managers’ salaries, and also help to fatten banks’ budgets.

So why pay high fees every year if a fund is not able to perform better than the benchmark and, indeed, often performs worse?

If you thought that investment funds were the right thing for you, don’t be disheartened. There is, in fact, a financial product that keeps all the advantages of funds intact and is able to turn their disadvantages into advantages.