What Funds Invest in and How this Affects Your Investment Goals

When you invest in unit trusts, mutual funds or whatever managed fund, it's important to be sure that the fund's investment thrust aligns with your investment goals. Funds have specified investment objectives and operational guidelines, enshrined in the instrument setting them up. They can only legitimately operate within those approved limits, which you will find in their investment statement. What this means is than when you examine each fund, you will clearly know where it is mandated to invest. The fund manager, who has discretion over his investment choices and decisions, must however work within the scope of the circumscribed investment framework. This works to the interest of the intending investor who, by this, is given a wide breath of options to choose from between different funds that specialise in different investment areas. Historically, the following are some familiar areas of investment focus by different funds, a factor that defines classes of funds:

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Equity Funds
This is actually a broad classification as many fund categories come under it. Equity funds obviously invest in equities, that is, they invest in stocks. An equity fund may be a general equity fund, free to invest in any equity. Because a wide range of equity assets exist, funds may specialise in growth stocks (growth funds), large, mid or small capitalisation companies (large-cap funds, for example), value stocks (value funds), a mix of value and growth stocks (blend fund), foreign stocks (foreign stock or international funds), etc. Whatever their specific targets, equity funds seek to capitalise on the high returns potential of the stock market. They also reflect the higher risk profile of that market. Equity funds will therefore attract those that aim for capital appreciation and are willing to bear the risk of the volatility of the stock market.

Income Funds
These are funds that aim to meet income-generation objective for investors. Such funds consequently focus more on fixed income securities whose income stream has a regular pattern. Bonds will therefore feature prominently in the portfolio selection of such funds. When your target is to invest in a fund to boost income capacity, your interest is best met in such income-oriented funds.

Bond Funds
These are pure bond funds which focus exclusively on bond investing. They are income-driven and also meet the objective of cautious investing. Bonds are generally safer than stocks, and when they are national government-issued, they become virtually risk-free. They however pay for this relative safety by providing generally lower returns than equity funds.

Money Market Funds
Look for money market funds when you don't mind lower earnings for the benefit of relatively safer and largely liquid investment. Such funds will invest mainly in Treasury bills and other treasury securities of short-term maturities. Bank deposits can also part of this portfolio. The securities profile of this fund type will be dominated by money market instruments and this easily means a conservative investment posture, devoid of the high risk exposure of equity funds. The chance of capital appreciation is however eliminated.

Balanced Funds
These are funds that choose to balance the variables of returns and risk by investing in equities, fixed-income securities and even money market investments. A proportion of their holding will therefore go to each of those asset classes. Obviously, such funds have a more diversified outlook, striking a balance between the various investment objectives. It retains the prospect of capital growth in the stock component, maintains a level of liquidity and low risk in the money market investments, while bonds also provide safety and an income stream.

Sector Funds
These are more specialised funds that focus on specific sectors or industries. Because of high specialisation, they understand the sector better and could earn good returns. However, the concentration implies more risk, since sector focus substantially reduces diversification. A sector fund might, for example, invest in the oil and gas sector, telecommunications, etc.

Index Funds
An index fund holds its investments in companies that are part of a particular market index. Internationally, for instance, the S&P 500 is a Standard & Poor's index of 500 large-cap mostly US stocks. That index could just be followed by a fund, simply investing in the companies included in the S&P 500. This is somehow a more hassle-free approach, as serious stock analysis is eliminated for the manager who simply follows the S&P 500. A fund can use any other index for this same objective.

Other Fund Types
What is clear from the above is that funds can focus in a whole lot of areas of investment of their choice, as what is listed here is not exhaustive. Your interest is in identifying what the fund's thrust is, evaluating how this relates to your investment objective and, where there is a strategic fit, you have a fund that you can invest in, other things being equal.

How Your Earnings Are Affected
How the fund chooses to invest will of course affect your overall earnings from the investment and this will work for or against unitholders, depending on how successful the fund's strategy is. The key areas of returns include:

• dividends and interest from securities the fund has invested in. These are usually distributed to unitholders of the fund;
• capital appreciation of securities held by the fund: if it sells and realises the gains, these become distributable to investors;
• growth in value of the fund: this is a direct effect of the appreciation in value of underlying assets of the portfolio. When these are not sold, they reflect in increased value for the fund. This translates to higher net asset value for each unit of the fund, which the individual can realize if he chooses to redeem his investment.

So, don't just get into a fund without knowing what it's investment thrust is. Choose a fund that has investment objectives that agree with your interest and promises to advance your returns expectation. If, for instance, you have a self-managed stock portfolio which you want to diversify with bond investment but you don't have interest in bond purchases, you can just invest in a bond fund as a way of spreading your overall portfolio. As you can see, the fund choice there is meant to serve a clear objective in your investment strategy. That's as it should be.

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