For the modern investor, the abundance of choice can be overwhelming. The scale of investment options and new asset classes has coincided with a similar expansion in fund offerings to provide convenient entry into these investments. Exchange-Traded Funds (ETFs) in particular, have dramatically grown in popularity in the past 20 years.
“The 21st Century began with fewer than $100 billion in Exchange-Traded Fund assets and now counts $4.7 trillion and an ever-expanding number of products.” — BlackRock, May 2018
But what are investment funds? And why would an investor choose a fund over a single asset investment?
Investment funds are vehicles used to pool capital from multiple investors and used to collectively purchase investments. These types of vehicles provide considerable benefits over investing in individual assets.
It is well documented that diversification lowers investment risk. On a risk-adjusted basis, single assets do not match the performance of a well-diversified portfolio.
Most funds will invest across a wide variety of assets in order to mitigate the downside risk of holding single assets.
It is human nature to back winners. This means that investors are more likely to invest in assets that are already performing well without considering that these assets may be close to their peak. Funds can provide investors with natural, automatic diversification by holding groups of assets independent of individual performance.
The benefit, from a practical perspective, is that funds invest in dozens and in some cases hundreds of assets which would be difficult for investors to individually acquire and potentially rebalance. In a fund structure, you can access all these investments through a single convenient instrument.
2. Economies of scale
Consolidating investments gives a fund purchasing power. This means that funds can take advantage of their size to lower transaction costs and benefit from volume rebates on trades.
Firms that broker securities will often charge the same fixed commission for the trade of a single asset or multiple assets. This means that a fund can significantly lower the costs of trading by moving larger trades than retail investors.
Funds also rebalance fairly frequently (e.g. weekly, monthly, quarterly) which would result in significant trading costs for individual investors attempting to replicate the fund’s asset allocation — not to mention that it would be extremely time-consuming, essentially a full-time job!
3. Professional management
Many people lack the skills, knowledge or time to make investments. By employing a dedicated manager, investors in a fund receive the benefit of the skills and risk management oversight that a professional fund management team brings to the table.
While fund managers cannot guarantee better returns, the research and dedicated time they provide can certainly improve the due diligence and the asset selection process.
Liquidity is essentially the time it takes and the cost of converting an investment back into cash. This is an extremely important consideration from a financial planning perspective since limited liquidity may mean realizing an investment at a discount or not at all.
High volatility typically impairs liquidity. This is because it is harder for a trader to exit a position at their desired price since spreads widen during times of volatility. Funds, however, can improve liquidity for investors simply through diversification as a basket of assets is less susceptible to broad market swings. Most funds provide this liquidity through systematic subscriptions or redemptions and in some cases via secondary market trading.
Purchasing a wide variety of investments can be a cumbersome and costly process. Funds provide a mechanism to own a broad basket of investments without having to acquire the underlying assets individually. The rebalancing and portfolio composition is managed by a professional team on the investor’s behalf.
Other benefits of funds can include low investment minimums which mean that retail investors can invest small, frequent amounts instead of having to wait to accumulate funds to purchase the entirety of some of these assets on their own.
“Sweeping developments within the investment management industry are putting ETFs on course to gather more assets over the next five years than in the previous 25 years combined.” — BlackRock, May 2018
It is clear that there are a number of benefits to using funds as investment vehicles. The fund industry continues to grow in leaps and bounds as investors better understand the advantages of using these vehicles to better manage their investment portfolio.
Published by Invictus Capital a leading innovator in the asset management space, offering investors the benefits of using investment funds coupled with the significant efficiency gains derived from using blockchain rails.
Top 5 Advantages of Investment Funds was originally published in Data Driven Investor on Medium, where people are continuing the conversation by highlighting and responding to this story.