In this article, we'll show you how an investment fund works . However, before delving deeper into this topic, it's essential to understand some key aspects that will help you grasp its operation.
Possibly in your search for options to increase your profitability, you may have heard of participating in an investment fund, however, do you know what it is?
First of all, what is an investment fund?
Basically, an investment fund is a financial instrument that allows savings; but, you should know that its conception goes a little further. In financial terms, it is a Collective Investment Institution (CII), which will allow you to access a financial asset exchange market (securities, fixed income, shares, among others) under very favorable conditions.
These collective investment institutions are professional entities that specialize in attracting and managing the capital of a large number of savers, taking it en masse and seeking the highest profitability through operations in financial markets, where the savers, by themselves, do not would have the conditions to participate in these.
In this way, it seeks to diversify the investments of savers in a more efficient way. Therefore, these collective investment institutions will ensure at all times to evaluate participation in the markets according to the risks and levels of return sought by investors.
In short, an investment fund is an instrument through which we become participants ; that is, we deposit a sum of money in exchange for a certain number of shares in the fund. This will generate a return based on the market in which it operates, and this return will be directly proportional to our investment amount.
If you want to learn about other concepts, we invite you to read our article on what an investment portfolio is , to increase your knowledge about financial tools.
The Management Company and the Depository Entity
Other aspects that we must be clear about are the essential figures for the operation of these funds. Among them we have the management company and the depositary entity.
The Management Company
The investment fund as such, lacks legal personality. Therefore, it is related to the financial market through the management company. This is a type of company that evaluates and adopts the investment decisions of the capital contributed jointly by the savers.
Likewise, the management company is in charge of carrying out the administrative and representative functions of the investors in the financial market, therefore, they are obliged to inform about the nature of each investment of the fund and provide the prospectus of its characteristics. In a more complete way, we detail the main functions of the investment fund management company:
- As we mentioned before, the main one is to manage and represent the IIC.
- Manage the capital of savers on behalf of third parties.
- Provide financial advice to the Collective Investment Institution in matters of the fund and in the issuance of placements of the same.
- Calculate the Net Asset Value of the fund, daily and inform the IIC.
- Report periodically on the behavior of the fund, its profitability and any changes that have occurred, as well as the pertinent decisions that have been taken.
- Publish daily the profitability of the fund's portfolio, as well as the corresponding financial ratios.
We must take into consideration that the management company is anonymous and therefore does not respond to its own interests, which makes it more autonomous and independent in its decisions.
The Depository Entity
The depositary entity is basically a custody entity. It is a legal person or institution that safely safeguards titles, securities and all kinds of financial instruments that make up the assets of collective investment institutions.
As we can see, the depositary entity represents a kind of safe where financial market assets are deposited, managed and monitored; therefore, they are responsible for the collection of the contributions, dividends and benefits that may arise, as well as for the purchase and sale of securities. To do this, it charges a custody fee.
These entities are regulated by organizations with financial competence. This implies that a depositary entity must have the guarantee of being duly authorized after fulfilling a series of legal requirements that safeguard the interests of savers or investors, the depository entity fulfills, among other functions, mainly the following:
- Keep client positions up to date.
- Timely inform the investor or saver of the operations that require their authorization.
- Allow the facility to exercise the rights derived from the possession of titles in their custody.
- Make known the details related to the operation of the client's account.
- Inform the rights to which it takes place, as well as the obligations that the client must fulfill.
How does the investment fund work?
Once we have reviewed the previous concepts and the essential figures that participate in it, we will explain below how the investment fund works. In advance, we can say that it is quite simple.
When you decide to participate in an investment fund, you are acquiring a small part of its portfolio. Remember that collective investment institutions manage the capital of a large number of savers and each of them acquires a part of the same portfolio.
These small parts or portions act like shares of a company or a bond coupon. That is, they represent a percentage of the total number of portions that make up the total capital, and each of these parts of the fund is called a participation.
Of course, this participation has an amount or a value that varies daily and for which the management company is responsible. This quotation or value is what is called the Fund's Net Asset Value and, in a nutshell, is the price of a share at a given time.
To exemplify the relationship of the participation with the net asset value of the fund, let us suppose the following example: if we decide to invest 750 euros and be participants in an investment fund, whose net asset value is 50 euros, then we will receive a total of 15 shares from that background.
As for the portfolio
As you could see, the investment fund generally has a portfolio of financial instruments. This is because the capital is generally allocated to different instruments in order to reduce the risks of the investment.
This portfolio is mainly made up, among others, of company shares, monetary assets, fixed income shares and even Spanish public debt bonds or a mixture of all of them according to the policy established by the investment fund.
Being a participant in the fund, the management company takes the money and adds it to the fund by investing in the financial instruments mentioned above. In this sense, the total of the money that is in the fund, both in liquid form and in the form of investment, constitutes the fund's assets and assets. Together, these two elements are what we call the fund's portfolio.
If we invest in the fund, we receive participation in a small portion of that portfolio. In a simple and hypothetical case, suppose we decide to invest 100 euros in an investment fund where its assets are 1.000.000 euros of assets in BBVA (30%) and Caixabank (20%) shares. This means that, of what was invested, we have 30 euros in BBVA shares and 20 euros in Caixabank shares.
The Fund's Valuation
We have seen that investment funds are an excellent tool to invest our savings. Similarly, we can participate through these investment funds, in markets where we could not do so individually.
Therefore, any individual can interact in an investment fund, either by acquiring shares through their purchase or by selling them.
This purchase of shares is called a subscription, while the sale of shares is called a redemption. These interactions in one way or another have a direct impact on the fund's assets. That means that it will fluctuate according to the prominence of subscriptions or redemptions.
Additionally, the assets in which the fund invests present natural oscillations of the movement of the financial markets and that can positively or negatively influence the equity and therefore, its net asset value.
Characteristics of the investment fund
Knowing how the investment fund works is not enough to ensure financial success. You must bear in mind that investment funds have notable benefits and advantages for small investors in contrast to the investment that they could make through other types of instruments individually.
These advantages are the main characteristics of this type of investment. Among many, we can list the 5 main and potential advantages:
A Professional Management
The investor can count on the absolute certainty that the funds deposited by him will be managed by professional analysts and specialists in the financial area.
These agents have relevant first-hand information about the financial behavior of the markets. This constitutes an element of great interest when making decisions aimed at obtaining greater benefits.
Higher Profitability
By having professionals in the area of financial markets, there is a greater propensity to obtain higher returns from the small investments made. This is due to the fact that the management company is aware of the evolution and preference of the markets in which to invest.
Immediate liquidity
Investment through these funds is a simple transaction through subscriptions or redemptions of shares, as they have the technological platforms for this purpose.
Risk reduction
As a result of the diversification of the investment within the investment fund portfolio, the investment risk is reduced. In addition to this, these funds allow access to a wide variety of assets that are difficult to access individually.
Truthful information
The management company is obliged to provide the participants with timely and periodic information on the behavior of the investment fund. As well as the state of the heritage and the decisions made.
Information that the investment fund must provide to its participants
Once we know how the investment fund works, we must take into account that the management company is obliged to periodically provide information on the behavior of the fund, its profitability and any changes that have occurred, as well as the relevant decisions that have been taken. We can detail these:
Periodic reports
Whether on an annual, semi-annual or quarterly basis, the management company must send each investor information on the operation and administration of the assets that make up the portfolio and the composition of the fund's assets up to date, among other data of financial interest.
Background position states
The management company must issue, at least annually, a report on the investor's participation in the fund and its position in relation to the capital invested in it. This is the product of the subscriptions or redemptions that occur during the time horizon of the investment in the fund.
Core notices
In a timely manner, the participant must be informed about variations or modifications that must occur or have been made in the fund in a pertinent manner. This, in order that investors have accurate information that allows them to exercise or not their right to withdraw from the investment fund.
Other data of financial interest
Among these data, we can mention those of fundamental interest to the investor, such as the financial policies of the investment fund, its objectives, the level of risk of the instruments, the historical evolution, the expected profitability, the expenses and commissions, among others, for a certain moment.
The Brochure
It is essential that the management company deliver the fund's prospectus. The prospectus is a simple version of the financial policy document of the investment fund and its respective regulations. In addition, it is a key document to have the endorsement of the National Securities Market Commission (CNMV).
This brochure must detail information on the operation and functionality of the investment fund, managers, guarantee of return, as well as the time horizon of the investment and the risk levels. Additionally, the information of the management company and the depositary entity.
Important aspects when evaluating how the investment fund works
When investing in this financial instrument, you should evaluate other aspects that will ensure you understand even better how the investment fund works. These will determine how convenient it is for you to proceed with the investment. We detail below:
The time horizon of the investment
The time horizon of the investment is the period in which the participant would be willing to maintain his capital investment in the investment fund, without anticipating recourse to reimbursement for other purposes.
This term must be evaluated based on the investment product. In the case of these guaranteed investment funds, there is a recommended horizon. If you resort to early repayment, there may be a penalty that translates into a dissuasive commission, since it could affect profitability expectations and the guarantee would not be effective. In short, it could generate some loss.
Risk levels
The participant must take into consideration the levels of risks that arise according to the nature of the fund, there are financial instruments that represent a high risk compared to others, by virtue of this, an expectation of high profitability will always be subject to classifications of higher risk. If the participant decides to reduce the risks of his investment, he must give up part of the return.
Fund Objectives
Participants must take into consideration that investment funds do not have objectives. This, since they are guaranteed funds. If you invest in a fund that seeks profitability as its objective, you must assume that the final result depends on the administration and decision of the management company and the behavior of the financial markets.
The level of commissions
One of the aspects to evaluate when knowing how the investment fund works, corresponds to the payment of commissions for management, deposit, subscription and reimbursement.
There are funds with better investment strategies than others and, therefore, they have more sophisticated tools that usually generate higher management fees, and that will ultimately translate into higher returns.
Similarly, the investor's interest in permanence in the fund may be determined by the level of commissions. If these are greater for redemption or subscription cases, this will determine the advantage of investing or not in the fund.
The transfer of funds
It is an automated and simple process that generally occurs when we are not happy with our investment. In this case, we request the total or partial reimbursement of the fund and we simultaneously subscribe this amount in a different investment fund within the same management company.
If you would like more information on this last point, we invite you to read our article on how to cancel an investment fund , so you can improve your profitability without much hassle.