12 About funds

Introduction

Most books on investing in the stock market are concerned with buying and selling individual shares, and indeed much of this book deals with this subject.  However, for many people, investing in funds is likely to be significantly more rewarding than investing in individual shares.

This chapter describes the most common types of fund, the advantages and disadvantages of investing through funds as opposed to individual shares, and provides some insights into the fund management industry and its performance.

In the context of the stock market, funds are pooled investments in companies with a fund manager.  The most popular types of fund are mutual funds in the US and open-ended investment companies (OEICs) in the UK, which have a similar structure. OEICs evolved from unit trusts.  The fund manager buys shares in a number of companies to create a fund and invites investors to buy units – or shares – of the fund.

Mutual funds and OEICs are bought and sold on a forward-pricing basis, i.e., they are not bought and sold in the market in real time.

Types of funds that are traded on the stock market in real time are investment companies, or trusts, where the fund manager sets up a company which invests in a range of companies, and exchange traded funds (ETFs), which are growing in popularity globally.

ETFs facilitate investment in many asset classes, including commodities and stock market index products.

A significant shift is underway from actively managed funds to passive funds, which simply track a stock market index.  This is a serious consideration for the retail investor.

Many investment commentators are perhaps a little too negative on mutual funds and OEICs, citing in particular high management costs.  However, if you can identify good funds that consistently ‘beat the index,’ the management costs are worth paying. […]