What is a fund?

An investment fund (or a collective investment scheme) is an investment vehicle that allows a large number of people to pool their money together in order to invest in a range of different securities such as stocks, bonds, property or commodities. Funds have differing objectives such as to deliver a regular income or capital growth for the investor. Funds are grouped together into categories determined by this aim, their risk, and by where in the world the underlying stocks or bonds are from.

Type of funds

  • Mutual Funds (including Unit Trusts and OEICs)

These funds are open-ended funds, meaning they can get larger or smaller depending on the number of investors who wish to buy into them. As more people invest in the fund, the number of underlying shares grows; as they sell, the number reduces. In the majority of cases these type of funds are actively managed. An example of this would be the Robeco US Large Cap Equity Fund. The aim of the fund is to invests in largecap stocks in the US market.

  • Exchange Traded Funds (ETFs)

Exchange traded funds (ETFs) are similar to the funds mentioned above except that they act like a share themselves. ETFs are openly traded on stock exchanges such as the London Stock Exchange in the UK or the Nasdaq in the US. Most ETFs aim to perform in line with a specific index (e.g. S&P 500) or commodity (like gold) and often have low management fees. An example of an ETF would be the Vanguard S&P 500 ETF (VOO) which invests in stocks that are part of the S&P 500.

  • Investment Trusts

These are funds registered as public limited companies (PLCs) with their own management teams and boards of directors. They can invest in public and private companies, have a specific number of shares in issue (therefore considered as close ended) and are traded on a stock exchange themselves. An example would be the City of London Investment Trust (CTY).


Types of Fund Management approaches

  • Passively managed Funds

A fund can be passively managed where the investor can gain exposure to a particular index or commodity, providing that investor with the same returns as the underlying market. A type of passively managed fund is an Exchange Traded Fund (please refer to ETF section above) which tracks the S&P500.

  • Actively Managed Funds

Actively-managed funds invest in a collection of companies the fund manager feels can outperform the index. (For instance for a UK Equity Fund the index to beat would normally be the FTSE 100 index. This index includes the biggest 100 companies in the UK market). To identify companies where to invest in, fund managers analyse company fundamentals, meet the management and work to maintain a balance of good companies that will perform better than the market average in various market conditions. Unlike passively managed funds, these funds don’t track the movement of a particular stock market index.

Active managed funds are suitable for investors who do not have the time or expertise to construct and monitor a portfolio themselves. They require a smaller investment than picking individual stocks or bonds allowing the investor to gain access to a far greater number and variety of securities.

  • Fund of funds (Multi Manager Fund)

A fund of funds invests primarily in other investment funds, which can be a mix of actively and passively managed, rather than directly into individual companies. They provide an alternative to putting together your own portfolio of funds, monitoring and making changes. They provide ready-made portfolios managed by expert fund managers. An example would be the Jupiter Merlin Growth Portfolio (see fact sheet below).


How is a price of a fund calculated?

When investing in a mutual fund, you would actually hold ‘units’ in the fund and these units would reflect a price.
The easiest way to find out the price of a mutual fund is to look at its net asset value (NAV). NAV is the total value of a mutual fund's assets, less all of its liabilities. Many mutual funds use this number to determine the price for transacting units of the fund. When you buy and sell mutual funds, you typically do so at the NAV.

For most mutual funds, the NAV is calculated daily since a mutual fund's portfolio consists of many different stocks. As each one of these stocks may be changing in price frequently throughout the day, an exact value of a mutual fund is difficult to determine. Thus, mutual fund companies have chosen to value their portfolio once daily, and each day this is the price at which investors must buy and sell the mutual fund.

Funds are also quite liquid since the majority of them deal on a daily basis with the price updated at the end of each trading day. This however works a bit different from traditional investments like shares and bonds which can trade at different times during the day.

In simple terms it means that if for example you place a trade today, the fund will settle in your account in two or three business days although the price taken would that of today.  Different funds might have longer dealing periods so it is always important to check the prospectus. 



One of the major cornerstones of fund management is diversification. This is because it is considered a key investment strategy for helping preserve wealth by diversifying across different asset classes (equities, government bonds, corporate bonds, property, cash etc) as well as across geographical regions.

This approach helps to manage and mitigate the risk of any one asset type underperforming over time, ensuring you are not over exposed to any given asset type, country, sector or stock. At the same time the aim is to provide the highest potential return for your risk profile.

As an investor one can either pick a number of different funds that focus on different strategies, regions, asset classes and currencies and construct an overall portfolio or else choose fewer fund of funds which are already diversified themselves.


Fund Manager Mandates

Every fund which is created would have a mandate written on the prospectus that provides the guidelines of what a fund manager can or cannot do in that particular vehicle. Here are a couple of examples for different mandates available:

Equity funds – manager can invest in equities across the globe or else more specific to a particular region (e.g. Emerging Markets) or country (e.g. China)

Market Cap biased Equity funds – manager can either have a holistic mandate (All cap approach) or else more specific (e.g. Large Cap only or Small Cap only stocks).

Growth or Income Equity Oriented funds – manager would either go for shares which generate a good level of yield or else focus on price appreciation for stocks in order to increase the capital return over time.

Sector Specific funds – manager can invest in specialised sectors (e.g. Financials, Bio-technology, Healthcare).

Government Bond Funds – manager invests in government or governmental relate bonds. These can either be country specific, regional or across the globe and in different currencies.

Corporate Bond Funds – manager invests in corporate bond funds. These can either be country specific, regional or across the globe and in different currencies.

High Yield Bond funds – manager will invest in high yield bond funds. These can either be country specific, regional or across the globe and in different currencies.

Absolute Return Funds - the aim of the manager is to generate positive return irrespective of the market conditions.

Property Funds – manager invests in direct property or indirect property instruments (real estate investment trusts or property related equities).

Commodity Funds – manager invests in commodities (e.g. gold and oil), or commodity related instruments like mining shares or oil producing companies.

Multi Asset blended Funds – Managers can of course blend different strategies and asset classes in their mandate and thus diversify their offering.

How to evaluate funds?

  • Performance

Looking at absolute numbers is helpful but in order to make sure that the investment is sound, you would need to know if the fund is actually overperforming the market/benchmark or not (i.e. the relative performance). For instance you might think that a fund which increased in value by 15% is a good thing. If on the other hand you notice that the fund is underperforming the benchmark by say 10%, it means that had you invested passively in an index your investment would have increased by 25% and not 10%!

Apart from comparison against benchmarks, funds are also compared to sector averages (or peer groups). These are basically return figures reported in one figure which include a collection of average fund returns that would have the same objective as the fund you are analysing. Sector averages are generally compiled by data providers like Morning Star, TrustNet, City Wire and S&P.

Fund managers generally also quote the Quartile Ranking figures which are basically a measure of how an investment is performing in its peer group. It is measured by ranking the performance of all the funds in a particular sector over any period, into four sections. The first (or top) quartile will be the top 25% in terms of performance, the second quartile will be the next 25%, the third quartile will be the next 25% and the fourth quartile will be the last 25%.

Sector averages and quartile rankings tend to provide a ‘fairer’ comparison because you would be comparing fund managers in the same sector with each other whereas with a benchmark you would be comparing the manager with an index which has no management or administration fees being taken for active management.

Fund performance and statiscial data can be analised on a monthly basis by looking at the fund fact sheets issued by the respective fund houses. Some example of fund fact sheets below....

  • Risk/Return metrics

Apart from absolute and relative performance numbers, it is of importance to understand the risks involved in generating a particular set of returns. Two investments can both generate 10% return each over the year however you cannot say that they are the same if one investment is riskier and more volatile in comparison to the other. These are a couple of risk/return metrics commonly used in fund management:

Standard Deviation - tells us how much the return on a fund is deviating from the expected returns based on its historical performance. Eg. A more volatile fund will have a high standard deviation while the deviation of a stable bluechip fund will be lower. Therefore, a high value of standard deviation means higher degree of risk because the predictability of returns is much less certain.

Sharpe Ratio (or Risk/Reward ratio) - measures risk-adjusted performance. In other words, it measures the excess return for any extra unit of risk. The greater an investment's Sharpe ratio, the better its risk-adjusted performance. Sharpe Ratio tells us whether portfolio returns are due to smart decisions or as a result of excess risk. If one fund can get higher returns, it is only good investment if those returns do not come with too much risk. A negative Sharpe ratio indicates that a risk-less asset would perform better than that particular fund. Sharpe ratio should be more than zero and ideally higher than one.

Sharpe Ratio can be calculated as follows:

                                      Expected Portfolio Return – Risk Free Rate (eg: 10 year T-bills)
                                                         Standard Deviation from Portfolio

Beta - is a measure of the volatility of a fund in comparison to the market. A beta of 1.0 indicates that the investment price will move in lock-step with the market. A beta of less than 1.0 indicates it will be less volatile than the market, and a beta of more than 1.0 indicates that it will be more volatile than the market. Eg. a beta is 1.2 means investment is theoretically 20% more volatile than the market.

Alpha - is the measure of a portfolio's risk-adjusted performance relative to a benchmark. In performance terms, Alpha refers to the difference between the portfolio's actual return versus the expected return using its volatility (Standard Deviation) relative to the market as measured by the beta coefficient (see Beta). It measures the manager's contribution to performance due to security selection or market timing. A positive Alpha indicates that the portfolio did better than the benchmark on a risk-adjusted basis, and a negative Alpha indicates the portfolio under-performed the benchmark, given the expectations established by the fund's beta.

For example, if the alpha is +1, it means that the fund managed to outperform the index by 1% whereas it is underperforming the index by 1% should the alpha be -1.

Information Ratio (IR) - measures a fund manager's ability to generate excess returns relative to a benchmark, but also attempts to identify the consistency of the investor. The higher the IR the more consistent a manager is.

Tracking Error (TE) - the standard deviation of returns relative to its benchmark.  The lower the tracking error, the more faithfully the fund is matching its index (Attained more through a ‘passive strategy’ by investing broadly according to the market).

Max drawdown: A drawdown is an economics and finance term for a decline in the value of an asset from its highest, peak value. The maximum drawdown (MDD) is the greatest drop that has occurred from the highest value of an asset over a course of time. The maximum drawdown is used in finance to evaluate how risky an investment is.

Other things to take into consideration when looking at funds:

• Age of the fund - Do you want a fund with an established track record or you want to get in early when a new fund is launched and hence maximising returns?

• Number of holdings - a fund which has fewer holdings is considered more aggressive than the one having a higher number of underlying instruments.

• Size of fund - This indicates the fund’s popularity and past success at attracting investors. However, some funds can be so large it’s difficult for the fund manager to run it. A small fund is sometimes easier to manage but might impose higher fees and contain more risk.

• Fund manager tenure - Consistent fund performance often relies on a fund manager having managed it for some time. Ofcourse ‘star’ fund managers can change jobs from time to time.

• Independent ratings - Companies such as Morningstar, Standard & Poor’s, TrustNet and CityWire provide independent ratings for funds’ performance, creditworthiness and consistency of management.

• Charges - Look closely at all the fund charges—are the ongoing charges excessive, are there penalties for withdrawing your money? Are the charges being levied on the income before paid out or on the capital?

Benefits and Drawbacks of Active Fund Management


  1. Investments chosen can be of higher quality due to educated/infromation investment selction by managers
  2. Can provide better protection of capital in down markets
  3. Can quickly react to take advantage of market movements
  4. A much broader range of markets and strategies available to investors
  5. Funds can be tailor made for the specific needs of the client
  6. Funds can be constructed to target specific outcomes
  7. Provide the opportunity to outperform the market over the longer term and with less risk


  1. More expensive as fund management houses need to employ more people and resources.
  2. More opaque -it's harder to know what you specifically own at a point in time
  3. Some managers do not really practice active management but just track indices and charge a fee for it.
  4. Finding good active managers is not easy