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What is a mutual fund?
A mutual fund builds you a portfolio of varied stocks and/or bonds by making investments on your behalf. Essentially, funds pool investors’ money to invest in a spread of shares, bonds or other securities.
Every investor in the fund owns shares of the mutual fund, which represent a portion of the fund’s holdings. Unlike with stock shares, investors in mutual funds have no voting rights.
Chief among the benefits of mutual funds is diversification, since each share of the fund represents investments in that fund’s whole portfolio of stocks or bonds rather than just a single holding.
Active vs passive
As well as having different strategies and objectives, all funds can be divided into two main types: active and passive.
Actively managed funds
Actively managed funds are headed up by a manager who uses their own experience and expertise to pick and choose what opportunities the fund invests in. The manager monitors the performance of the fund, deciding when to buy and sell different assets in an attempt to beat the market. Since this requires a big time commitment, actively managed funds tend to incur greater fees than passive ones.
Passive funds track and aim to match a market index or a specific market segment. Unlike with actively managed funds, the securities in which a passive fund invests are decided by a set rule.
Examples of passive funds include tracker funds, such as ETFs (exchange-traded funds) and index funds – essentially any fund that tracks an index such as the S&P 500 or FTSE 100. Another example is our own Fund Twenty8, a passive fund that uses an algorithm to select which startups to invest in while enabling investors to benefit from EIS tax relief.
As passive funds do not require a fund manager to continuously analyse and make the investment decisions, the costs of participating in them are often far lower than with actively-managed funds.
What returns can I get?
As an investor in a mutual fund, you can earn income from dividends on stocks and interest on bonds held in the fund’s portfolio. This is normally paid out to investors on an annual basis via a ‘distribution’, with the option either to receive a cheque for the money or reinvest your earnings for more shares in the fund.
If a fund is eligible for capital gains (i.e. it sells securities which may go up in value), it may pass on these gains to investors in a distribution.
Most mutual funds allow you to sell your shares on any day that stock markets are open, giving you easy access to your money. This means that if the fund shares increase in price (e.g. if fund holdings increase in price and are not sold by the fund manager), you can sell your shares for a profit in the market.
What are the advantages?
Mutual funds allow you to take advantage of the experience, expertise and resources of professional fund managers, who work full-time to actively buy, sell and monitor investments. This may be particularly useful to people who don’t have the time to choose and track their own investments, or those wanting to invest in a sector outside their area of expertise.
Mutual funds can offer a simple way to diversify your investments across a range of sectors or securities starting from relatively little money. By spreading your investment across a large number of diverse assets, mutual funds can minimise the risk of one asset type experiencing a big shift and dragging down your entire portfolio (basically, it stops you putting all your eggs in one basket).
Large mutual funds can own hundreds of different stocks spanning multiple sectors, while those dealing in early-stage equities tend to have a smaller focus on around five sectors (an exception is our passive EIS fund, Fund Twenty8).
Since mutual funds use the collective cash of many investors to buy and sell securities, they can invest in certain assets available only to institutional investors or take greater positions than would be possible for a smaller investor. Because funds invest in bulk, their transaction costs are lower than those for individual investors.
While mutual funds tend to charge fees and have a set minimum investment for people wishing to take part, these normally prove less costly than if the individual investor were to buy the same securities independently.
Most mutual funds allow you to sell your fund shares on any day that stock markets are open, so you have easy access to your money. It is worth remembering that the value of your shares may be more or less than the original cost.
What are the drawbacks?
Different funds will charge different fees, with actively managed funds normally charging greater fees than passively managed ones. These fees go to cover everything from the fund manager’s salary to your quarterly investment reports.
Since mutual funds do the legwork of investing for you, they can charge an initial fee, management fee, performance fee and so on, with actively managed funds likely to incur transactional fees that stack up year on year. Every fund is different, so be sure to look at the fee structure before you invest.
This is the other side of the diversification coin. While diversifying your portfolio reduces risk, it can also lower your chances of getting a significant return.
Since mutual funds often have small holdings across many different companies, even high returns from a few investments may not make much difference on the overall return. Dilution is also the result of a successful fund growing too big. When new money pours into funds that have had strong track records, the manager often has trouble finding suitable investments for all the new capital to be put to good use.
Choosing a fund
There are thousands of funds to choose from, divided by geography, investment type, maturity level and sector. This means you will have plenty of options, whether you’re looking to invest in shares, bonds, commodities or property. While the wealth of options available gives you a lot of freedom, it can also make picking a single fund difficult.
It is recommended that you speak with an independent financial adviser to help pinpoint the fund best suited to your financial goals.
You can invest in two EIS funds through our platform.
Fund Twenty8 (passive)
As the UK’s first and only passive EIS fund, Fund Twenty8 focuses on diversification. By using a specialised algorithm, the fund follows the investment decisions of some of the country’s savviest private investors to automatically build you a portfolio of no fewer than 28 EIS-qualifying businesses across different sectors.
Growth Fund (active)
Our Growth Fund complements Fund Twenty8 by targeting six or more later-stage companies from SyndicateRoom’s portfolio. Since we’ve worked with these businesses in the past, we are able to draw on our established relationships to cherrypick which businesses to back.
Additionally, as we do not want to miss out on any external rounds we think are outstanding, we do reserve the right to invest outside of SyndicateRoom alumni.
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