What are Managed Funds?

When you invest in a managed fund, you will be issued units in the fund.  These units represent your share in the range of investments that the fund manager selects for the fund.  The price of the units in the fund will rise and fall according to the value of these underlying investments.

The earnings a fund has generated over the financial year, will be distributed to investors and will vary depending on the performance of the fund.

Managed funds are an effective way to make the most of your investment dollars.  By pooling your money with that of other investors through a managed fund you can diversify into a wide range of assets, access investment markets that may not otherwise be available to you, tailor your portfolio specifically to your needs, benefit from professional investment management, and have the day to day administration taken care of.

Managed Funds – Advantages and Risks

Why invest in a managed fund?

Managed funds are an effective way to make the most of your investment dollars.  By pooling your money with that of other investors through a managed fund you can:

• diversify into a wide range of asset types (such as shares, property, fixed interest and cash).  Managed funds generally offer a wider spread of investment than is otherwise possible for most investors, through the pooling of funds.  Investors are able to achieve a lower level of risk through wide diversification of an investment portfolio.  Large, well managed funds also offer investors the prospect of superior returns because the funds have the resources to acquire prime investments usually out of the reach of individual investors.
• access investment markets that may otherwise be unavailable to you as an individual investor such as international markets.
• tailor your portfolio specifically to your needs – whether they are for a regular income or capital growth.
• benefit from professional management - have your money managed by a team of experienced investment managers.  Managed funds offer several very important advantages over direct investment.  Firstly, the funds offer the prospect of superior returns, due to experienced professional management by investment experts.  The fund managers are responsible for seeking out the best possible returns through careful selection of investments and by monitoring political and economic factors that may affect the performance of particular investment sectors.
• benefit from administrative ease - Managed funds are also convenient for the investor because the manager handles the day to day administration.

How do they work?

When you invest, you will be issued units in a fund.  These units represent your share in the range of investments that the fund manager selects for the fund.  The price of the units in the fund will rise and fall according to the value of these underlying investments.

The earnings a fund has generated over the financial year, including any taxable capital gains (from the sale of shares or other investments within the fund) or income (from dividends or interest), will be distributed to investors in the form of ‘distributions’.  Most funds are designed to pay distributions regularly, usually quarterly, the amounts of these distributions will vary depending on the performance of the fund, in fact, there is no guarantee that investors will receive any distributions.

Risks of investing in Managed Funds

All investments involve varying degrees of risk.  There is a risk that after you have invested in a managed fund the value of the managed fund’s underlying investments decrease, if that occurs the managed fund’s unit price decreases and consequently the value of your investment decreases.   If you were to sell (redeem) your investment in that managed fund at that time you may incur a loss i.e. you may receive back less than you initially invested.

There are many factors, which may impact on the performance of a managed fund.  There is the risk that the fund manager you invest with may not perform according to your expectations.

In addition, the risks associated with investing in managed funds also vary depending on the types of managed funds you invest in.  Each type of managed fund has its own risks.  Below we have explained the different types of managed funds and their relevant risks.

Australian Share Funds invest in shares that are listed on the Australian Stock Exchange.  Shares (also known as Equities) are units of ownership in a company.  If the business performs well, the company will generally pass on some of its earnings to shareholders in the form of dividends.  Shares generally carry more investment risk than other investments because share values rise and fall in response to many factors, such as, changes in the company’s operations or its business environment, company’s profits, industry trends, economic conditions, interest rate movements, regulatory conditions, market sentiments, political events, environmental issues, technological issues and movements in the overall share market.  However, shares traditionally outperform other asset classes over the long term.  Therefore while over the longer term (greater than 7 years) Australian Share Funds should provide strong returns they can experience periods of volatile returns and even negative returns.

International Share Funds invest in shares listed on share markets outside of Australia.  The value of these shares rise and fall in response to factors relating to the specific companies and factors within their respective countries.  These factors are listed in the description of Australian Share Funds.  By investing in International Share Funds it further diversifies your investment portfolio because it exposes you to industries that are not well represented in Australia and there may be times when the Australian sharemarket is weak but some overseas markets are performing well.  However, International Share Funds also carry additional international investment risks, which can impact on investment values and access to the funds on withdrawals.  These risks include; less information available for investment decisions, actions of foreign governments, political & social instability, regulatory restrictions, market liquidity issues, and a rise in the Australian dollar may negatively impact the value of the investment and their returns.   Therefore while over the longer term (greater than 7 years) International Share Funds should provide strong returns they can experience periods of volatile returns and even negative returns.

Property Funds invest in property investments.  Property Investments include direct property and property securities.  Property securities are property trusts listed on the Australian Stock Exchange and property related companies.  By investing in property securities the fund is indirectly investing into shopping centres, office towers, hotels and industrial properties.  Property investments provide income in the form of rent.  The value of the property may also appreciate over the longer term.  Historically, property investments are less volatile then shares.  Property investments rise and fall in response to many factors such as economic conditions, interest rate movements, market sentiment, political events and movements in the various property markets.  In addition as property securities are listed on the Australian Stock Exchange their values are also affected by the same factors that affect the value of shares, which are detailed in the description of Australian Share Funds.  Therefore while over the longer term (greater than 7 years) Property Funds should provide strong returns they can experience periods of volatile returns and even negative returns.

Australian Fixed Interest Funds invest in Australian fixed interest securities.  Fixed interest securities offer more security than shares and property, however they historically have earned less.  Fixed interest securities are normally issued by governments, semi government authorities, statutory bodies and corporations.  When the fund invests in fixed interest securities it is in essence lending money to these organisations.  When the issuers are companies there is exposure to credit risk i.e. the risk that the company will be unable to meet interest payments or to repay the loan.  In return for the investment (loan) the issuer pays a pre-determined rate of interest for an agreed term.  When this term is over (maturity date) the original capital investment (loan) is repaid to the fund.  Before fixed interest securities reach their maturity date, their capital value can fluctuate based on interest rate movements.  A fall in interest rates increases the capital value of fixed interest securities, whereas a rise in interest rates reduces the capital value of fixed interest securities. Therefore, a dramatic rise in interest rates could cause the fund to incur a negative return.

Mortgage Funds mainly invest in commercial mortgage loans.  Most Mortgage Fund lending is to fund commercial assets including offices, industrial properties, retail properties and residential development properties.  Mortgage Funds require first registered mortgage security over properties for their loans.  Mortgage Trusts earn income through the interest they charge to borrowers.  From this interest they pay investors a regular income.  Generally speaking Mortgage Funds provide investors a regular and stable income return higher than prevailing cash rates.  While Mortgage Funds are stable investments they are not capital guaranteed.  Mortgage Funds can incur losses if there is a fall in property prices and a large number of borrowers fail to meet interest payments or are unable to repay their loans.  Because there is no capital growth with investments in Mortgage Funds there is a risk that the value of the investment may not keep pace with inflation.  Mortgage Funds are often classified as Australian Fixed Interest investments.

International Fixed Interest Funds invest in fixed interest securities issued by organisations outside Australia.  These International Fixed Interest Funds operate in a similar manner as Australian Fixed Interest Funds and have the same risks (refer to description of Australian Fixed Interest Funds).  In addition, International Fixed Interest Funds also carry additional international investment risks, these are explained in the description of International Share Funds.

Cash Funds invest in short term money market securities with high security and high liquidity.  Returns fluctuate with movements in short term interest rates.  Cash Funds receive interest from these investments.  Cash Funds are a very low risk investment, but returns are also generally low and may be eroded by inflation.  The likelihood of a negative annual return is negligible.

Diversified Funds invest in a diversified portfolio of the major asset classes, Australian Shares, International Shares, Australian Fixed Interest, International Fixed Interest, Property, Mortgages and Cash.  A Diversified Fund is exposed to all the risks mentioned in the other managed funds listed above to the extent it has invested in their relevant asset classes.  Diversified Funds are designed to reduce the impact of ups and downs in any one particular market by investing across a wide range of asset classes both in Australia and Internationally.  By investing across a range of asset classes, which experience good performance at different times, the high returns received from one type of investment can work to offset lower or negative returns received from another.  Diversified Funds are suited to investors looking for an investment solution where their exposure to different markets will be managed for them over time by experts.

What level of risk do you feel comfortable with?

There is a simple rule about risk, which generally holds true for all investments: the higher the possible return, the greater the risk of loss over the short term.  However, if you plan to invest over the long term, these risks can be reduced, even for more volatile investments like shares.

For this reason, funds with a higher exposure to growth assets such as shares and property are best suited to those looking to invest for strong returns over longer time periods (greater than 7 years) – and are prepared to experience short term volatility along the way.

Funds with a higher exposure to more conservative investment types such as Australian fixed interest and cash are less volatile but lead to generally lower returns.

A diversified fund may reduce the risk further to provide a more consistent return from year to year.  By investing across a range of asset classes which experience good performance at different times, the high returns you receive from one type of investment can work to offset lower or negative returns you may be receiving from another.

Handling Volatility and Negative Returns with Managed Funds

If you get caught in a time of high market volatility with falling prices you may find that the value of your managed fund may also fall.  In these situations it is easy to panic and lose sight of the long term view.  Most investors are very uncomfortable with negative returns because they fear a further drop in the value of their investments.

These periods of low or negative returns are a normal part of most markets.  In fact, it is important to expect some disappointing low returns in some years and high returns at other times.

Only those investors who sell will turn a short term loss into a permanent loss.  History shows us that markets do recover but sometimes it takes a year or more.

It is important to remember that markets go through regular ups and downs.  While it’s tempting to sell out of an investment after its value has fallen, historically investors who stick with their strategy generally go on to recover and prosper.