What Are Investment Funds and How to Choose the Right One?

What Are Investment Funds and How to Choose the Right One?

What is an Investment Fund and How Does it Work?

Definition of an investment fund

An investment fund is a financial tool that pools money from multiple investors to allocate it into a diversified portfolio of assets. The idea is simple: by combining resources, investors can access opportunities that would be costlier or harder to reach individually. Each investor holds shares that represent their proportional stake in the fund’s total assets.

The main purpose of a fund is to optimize returns while minimizing risk through asset diversification, including stocks, bonds, real estate, or money market instruments.

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The role of the management company

The management company is responsible for making investment decisions by selecting the assets that make up the fund’s portfolio. These are experienced professionals who follow a defined investment strategy, stated in the fund’s prospectus.

They constantly monitor the markets, adjusting the portfolio’s composition to respond to changes and to maintain the right balance between risk and return for the investors.

How the net asset value is calculated

The net asset value (NAV) is the price of each fund share and is calculated by dividing the total fund assets by the number of outstanding shares. It is usually updated daily and reflects the current market value of the assets in the portfolio.

NAV is an essential indicator for investors as it determines how much their investment is worth at any given time.

Why Invest in Investment Funds?

Risk diversification

One of the biggest advantages of investment funds is diversification. By investing in different assets across sectors, geographies, and types, the risk of losses due to poor performance in one area is significantly reduced.

This strategy allows small investors to build a well-balanced portfolio more affordably than doing it on their own.

Professional management

When you invest in a fund, your capital is managed by professional fund managers, who analyze markets continuously and make informed investment decisions.

This level of expertise and attention would be difficult to replicate for individual investors managing their own portfolios.

Transparency and regulatory oversight

Investment funds operate under strict regulatory frameworks. Bodies like CNMV in Spain or SMV in Peru ensure that funds adhere to transparency and investor protection rules.

Investors receive a detailed prospectus and regular reports outlining the fund’s performance and strategy.

Tax efficiency

In some countries, like Spain, one of the key benefits is the tax deferral advantage. Investors can switch between funds without paying taxes until they make a withdrawal. This allows for strategic portfolio adjustments with no immediate tax impact.

Types of Investment Funds

Fixed-income funds

Fixed-income funds mainly invest in debt instruments, such as government bonds, corporate debt, or promissory notes. These products offer predictable returns, as their interest payments and capital repayment are generally guaranteed (barring defaults).

These funds are especially attractive to conservative investors seeking capital preservation and moderate yields without assuming high levels of risk.

Equity funds

Equity funds focus their investments on stocks of companies, either domestic or international. Unlike fixed income, the performance of these funds depends on the stock market’s fluctuations, resulting in higher risk, but also greater long-term return potential.

They are ideal for investors with a dynamic or aggressive profile, willing to face volatility in exchange for greater profitability.

Mixed funds

Mixed funds combine both fixed income and equities in their portfolio, aiming to strike a balance between safety and profitability. The asset distribution may vary depending on the risk profile: from conservative mixed funds (more fixed income) to aggressive ones (more equities).

They are suitable for those looking to diversify their portfolio and tailor it to their risk tolerance.

Sustainable funds (Articles 8 and 9 SFDR)

The rise of responsible investing has led to the growth of sustainable funds, classified under Articles 8 and 9 of the SFDR regulation. Article 8 funds promote environmental, social, and governance (ESG) principles, while Article 9 funds have a specific goal of achieving positive sustainability outcomes.

These funds aim not only for financial returns but also to contribute to key global challenges like climate change, gender equality, and sustainable development.

Active vs Passive Management

What is an actively managed fund?

An actively managed fund involves a team of professionals continuously making decisions about buying and selling assets with the aim of outperforming a benchmark index.

Fund managers conduct in-depth market analysis to identify opportunities and mitigate risks, actively adjusting the portfolio to generate the best possible returns for investors.
This approach typically involves higher fees, as it requires constant monitoring and decision-making by skilled managers.

What is an index fund or ETF?

In contrast, index funds and ETFs (Exchange-Traded Funds) follow a passive management strategy. Their goal is to replicate the performance of a specific market index, such as the S&P 500 or Euro Stoxx 50.

These funds do not require active asset selection. Instead, they mirror the composition of the chosen index, resulting in significantly lower fees and expenses.
For many investors, especially those focused on the long term, index funds are a cost-effective way to gain broad market exposure with minimal effort.

Discover: Active vs Pasive Management

Which strategy is right for you?

Choosing between active and passive management depends on your investment profile:

• If you aim to beat the market and rely on expert management, active funds may suit you better.
• If you value low costs, simplicity, and consistent market exposure, passive options like ETFs or index funds are often more effective.

In both cases, it’s important to consider factors such as risk tolerance, investment horizon, and associated fees to make the right choice for your goals.

Types of Investment Fund Fees

Subscription fee

The subscription fee is charged when an investor makes their initial or additional contributions to the fund. It is calculated as a percentage of the invested capital and can be up to 5%.
Not all funds charge this fee, so it’s important to check the prospectus before investing.

Redemption fee

The redemption fee is applied when the investor decides to sell all or part of their fund shares. This fee may also reach a maximum of 5% of the redeemed amount.
Some funds only charge this fee if the investment is withdrawn before a minimum holding period.

Custodian fee

This fee is charged by the custodian entity, which is responsible for safeguarding and administering the fund’s assets. It tends to be relatively low and cannot exceed 0.2% per year of the managed assets.
Although small, over time it can slightly affect your net returns.

Management fee

The management fee compensates the fund management company for its investment services.
It is typically one of the most significant costs and can be as high as 2.25% per year of the fund’s assets.
Actively managed funds usually have higher fees than index funds or passive funds due to their hands-on approach.

Performance fee

The performance fee is only charged when the fund manager exceeds a specific return benchmark as stated in the fund’s documentation.
The fee is capped, usually at 18% of the excess performance. This fee aligns the manager’s incentives with those of the investor, rewarding only actual performance gains.

Key Factors to Consider When Choosing an Investment Fund

Risk profile

Before investing, it’s essential to understand your risk profile.
Not all investors have the same tolerance for potential losses or market volatility. Some are more conservative, aiming to preserve capital, while others are aggressive, seeking higher returns and accepting greater risk.

Identifying your personal risk profile helps ensure you choose a fund that aligns with your financial goals and emotional comfort.

Investment horizon

Your investment time frame is another key factor.

• If your goal is short-term (less than 3 years), conservative or fixed-income funds may be more suitable.
• For long-term investments (over 5 years), you may consider equity or mixed funds, which offer better potential returns over time.

The longer the horizon, the more time you have to ride out short-term volatility in search of stronger long-term performance.

Costs and fees

Fees directly impact your net returns.
Comparing costs across different funds is crucial. A fund with lower fees can be more profitable over time, even if it generates similar gross returns as one with higher costs.

Always consider all types of fees—subscription, management, custodian, redemption, and performance fees.

Investment policy

Each fund follows a specific investment policy, outlining the types of assets it invests in, its geographic focus, risk level, and strategy.
Before committing your money, review this policy carefully to ensure it matches your expectations and investment goals.

It’s highly recommended to read the prospectus thoroughly and, if needed, seek professional financial advice to fully understand the fund’s strategy and associated risks.

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