What do you need to know about the mutual fund?
A mutual fund is a pool of money jointly owned by investors and managed by a fund manager on the basis of a pre-determined investment policy. Investors receive investment units in proportion to their investment.
The establishment and management of the investment fund is regulated and defined by law.
A fund manager may, of course, manage several funds defined on the basis of different investment policies.
You can get more information about the performance of investment funds e.g. on the BAMOSZ (Assosiation of Hungarian Investment Fund and Asset Management Companies) website.
What is the investment policy?
The investment policy is different for each investment fund. This is the set of rules that determines where the fund manager can invest the money. They can’t deviate from that. The level of risk taken, the investment period are recorded, and they are described as to which assets the fund manager can choose and in what proportion. These factors also have an impact on the yields available.
What is an investment unit?
A transferable security securing property and other rights. The unit-holder is the owner of the unit in proportion to his units.
The unit has mandatory formalities.
What is an investment unit good for?
Investors have the right to share in the performance (return) of the investment fund in proportion to their units.
Of the total assets, the value per unit is shown by the price of the unit, which is nothing more than the net asset value per unit.
The net asset value must be known and disclosed by the investment fund manager on an ongoing basis, this value is already a cost-adjusted value. If all unit-holders investing in a given mutual fund were to ask for their money back at the same time, they would be reimbursed that value.
Important information related to the investment fund
Although the use of mutual funds gives investors an easily accessible, well-regulated opportunity to build a properly diversified portfolio, there is no legal protection against the risk of changes in the exchange rate of the investment.
The net asset value of an investment fund is constantly changing, depending on the value of the investments owned by the fund. Unlike a bank deposit, unitholders share not only the returns but also the risks of these underlying investments. The good news, however, is that risk and return go hand in hand. For higher risk, investors also expect a higher possible return.
Although unit-holders provide the capital to set up mutual funds, they nevertheless have no right to directly influence the fund manager. Unlike joint stock companies, the unit does not carry voting rights. If investors are dissatisfied with the performance provided by the fund manager, they can sell their units in an open-ended fund and direct their money to another investment fund.
Benefits of mutual funds
Mutual funds allow individual investors to invest their money safely, easily and cost-effectively, while mitigating risk.
One of the advantages of open-ended mutual funds over many other investments is that they can be monetized at any time at minimal cost.
Atomization of risk
With the use of the investment fund, the diversification that can be heard in many places is achieved by itself. That is, not investing your money in one place. Even if you choose a single mutual fund, that single mutual fund can be made up of hundreds or even thousands of securities. This means to you that if one is not performing well, there are many, many others besides it that will balance your profits.
Cost-effectiveness through economies of scale
Economies of scale are already well known in the business world. The higher the volume produced, the lower the cost per product and thus the profit increases. The same is true for investments. There are securities whose price, or even other cost, would take away the profit of individual investors. However, due to cost-effectiveness, it is already worthwhile for investors to address these directions through an investment fund.
Entry as a large investor
By directing your money to a single location through the mutual fund, you yourself can be a large investor. This way, you also have the opportunity to benefit from directions that you would not otherwise be able to because of the entry limit. An example is a real estate fund, where you can also profit from the real estate market through a real estate fund, even if you do not have the money to buy an entire office building.
Because mutual funds and fund managers are subject to very strict regulations, investors can be confident that their money will be directed to a place where strict controls must be met.
Security is enhanced by fund managers’ disclosure obligations, which provide anyone with insight into the operation of an investment fund.
Passively managed index tracking funds are selected with due care before their launch. Actively managed funds are managed on a daily basis by portfolio managers who are experts in that particular sub-market.
Key concepts related to the investment fund
The fund manager invests the money accumulated in the investment fund. He determines, in accordance with the fund management regulations, in which assets and in what proportion the fund’s assets are invested. This ratio is not set in stone, he can change it at any time according to the investment policy.
Fund management, depositary fee
This fee is charged by the investment fund manager or custodian for asset management. It is set on an annual basis but is drawn on a daily basis. This means to you that if the fund management fee is 1%, your total capital in the fund will be reduced by 365ths of 1% per day. The fund management fee is one of the biggest cost items of investment funds, as we typically talk about long-term and large-scale investments in connection with investment funds, so even a tenth percent difference means a significant difference.
It is also organisationally separate from the fund manager. His responsibilities include managing the investment fund account as well as the securities account. In addition, controlling the fund manager and, on a daily basis, finding the net asset value, and thus the daily exchange rate.
It carries out sales (so the distribution).
Be sure to pay attention to these when choosing an investment fund
The currency of the fund
I have seen more than once that the currency of an investment has had a negative effect on the performance of an investment fund. In vain did the underlying investment perform well when the change in the exchange rate had just extinguished it. Of course, with a properly selected investment fund, the same can happen the other way around.
The other important question about currency is: what currency is your contract in? I have seen a contract registered in euros before, which also offered funds registered in dollars. At that time, the customer first converted his forint into euros to pay the annual fee, and then they exchanged it for dollars, and returned the same upon payment.
Investment fund costs
The cost of an investment fund depends on many things. In the case of active management, the portfolio manager fee must of course be paid, which you can save if you choose passive management.
The TER will give you more information about the costs. This indicator shows the total costs related to the investment fund in%.
In general, the riskier a fund is, the higher the cost deducted. Higher costs are often associated with higher yield prospects, but this is not set in stone. There are many good examples of this, but be careful before choosing a counterexample for yourself.
Taxation of the investment fund
The tax is not directly the cost of the investment fund, yet you have to reckon with it as an expense. Taxation of an investment fund works in the same way as taxation of any other investment, it is regulated differently by each state.
The performance of the investment fund compared to the benchmark so far
The benchmark is nothing more than the average of mutual funds investing in a similar location. So if you compare the fund you choose to the benchmark, you will find out whether the fund is performing well or poorly compared to the market average.
Before I explain this, an important fact is that the return on investment cannot be predicted in any way, past returns do not provide guidance for future performance.
What makes this an important point is that if the average of the mutual funds investing in a similar market segment (i.e. the benchmark) has not yet been surpassed by the mutual fund you are looking at, then don’t expect it to suddenly turn out simply because you put money into. Since you have to pay for your costs every time, it does matter to you if it perform well compared to the others.
As you can see in the picture below, there is also a significant difference between the performance of funds investing within the same category.
Grouping of investment funds
The investment fund may be public or private.
Units of a private mutual fund may only be purchased by investors who meet pre-defined conditions.
Anyone can buy from the units of a public mutual fund.
Thus, if the investment fund is offered to you for purchase, the above grouping is unlikely to affect you.
Grouping of mutual funds on the basis of redeemability
Based on redeemability, mutual funds can be open-ended or closed-ended.
In the case of a closed-end investment fund, the investment fund is wound up at the end of the term, at which point the total value is distributed among the unit-holders. However, the depositary will not redeem the units earlier, nor will it issue a new unit after the issuing period. Closed-end mutual funds have existed for much longer than open-end ones, but the economic crisis of the 1930s has shown their setbacks. With many people unable to access their money when needed it because of the closed end, open-end mutual funds became increasingly popular.
The open-end investment fund has no maturity, the fund manager continuously issues and buys the units at the daily exchange rate set by the depositary. This exchange rate depends largely on the current performance of the investment portfolio compiled on the basis of the investment policy.
In the case of open-end mutual funds, you can sell your own unit at any time and buy someone else’s at any time. However, fund managers may decide to issue new units or to accept only those created during the issuing period.
Grouping by investment management
The funds accumulated in investment funds can be managed actively or passively.
We talk about active asset management when a portfolio manager actively makes a decision about which assets should be included in the portfolio that constitutes the investment fund’s assets and which assets should be removed from it. The advantage of this solution is that the expert can use his previous experience to make a favorable decision in rapidly changing (volatile) markets. The downside, however, is that the expert has to be paid even if the market is just performing poorly.
In the case of passive asset management, a stock index is copied by the composition of the fund. As the price of the securities that make up the stock exchange index changes, the system automatically reweights the assets in the investment fund. It basically copies the performance of the market. You can achieve good results in emerging markets, with the added advantage of being cheap compared to active asset management. The disadvantage, however, is that you do not have the opportunity to deviate from the given stock index, so for many companies it is left out of the upswing. Such management is implemented by the index-tracking fund and the ETF.
Grouping by type of investment
Real estate funds
The real estate fund invests in real estate development and real estate management. This can be done directly (they also have real estate physically) or indirectly (they only buy another real estate fund).
- Liquidity funds: invests in assets with a maturity of up to 3 months.
- Money market funds: similar to liquidity funds, with the difference that the maturity of the assets does not exceed 1 year.
- Bond funds: relatively low-risk (moderately volatile) funds that containing government securities and corporate bonds. Depending on their maturity, they can be short-term bond funds (with a maturity of 1 to 3 years) or long-term bond funds (with a maturity of more than 3 years).
- Mixed funds: include bonds and equities. According to their proportions, they can be bond overweight mutual funds as well as equity overweight mutual funds.
- Equity fund: the name of asset funds that contain at least 70% of the shares. These exchange rate fluctuations can be significant, so are investment funds with a higher-than-average risk rating. These solutions are typically recommended for longer-term investment, with a higher return prospect than other asset funds in the longer term.
Other classified funds
- Derivatives: funds investing in derivatives (futures, options)
- Fund of Funds: An investment fund that invests in other investment funds
- Commodity market funds: invests in commodity market products (oil, industrial metal, precious metals, agricultural products). They do not own the commodity market products, only get results from their exchange rate changes.
Mutual funds can be grouped in many ways, either by guarantee level (guaranteed funds), by way of money management (index tracking funds), or by the proportion of domestic and foreign securities (international funds).
How can you invest in an investment fund?
You can invest in an investment fund in two ways, in both cases IPF and NDIF are behind you. IPF performs if your investment would disappear (e.g. due to a crime), and NDIF would perform if e.g. the bank holding the account would go bankrupt. None of them are liable for damages resulting from poor investment decisions.
In a bank, through a securities account
You will then place your money through a banking relationship. Be aware that not all banks sell all mutual funds, so be sure to familiarize yourself before opening an account.
Through an insurance company
Through unit-linked insurance. Then you can choose between lump sum and continuous fee solutions.
Note that it is mainly continuous fee schemes that plan for the long term, and there may be a significant difference in the performance of the mutual funds behind the contracts. Before signing, properly read whether the particular contract is right for you, as these contracts deduct the most costs in the first three years of the contract. So if you make the wrong choice, you will get the most costs instead of returns.
Investment fund risk
There is no investment that does not contains any risks, and mutual funds are no exception. We will now say a few words about the most important risks.
You direct your money into the mutual fund to let your money work at a given level of risk. The fund manager must make decisions that serve this. Units can be redeemed at any time by anyone and can be served during normal operation. Liquidity risk means that in the event of a panic, you may not get your money. They may suspend trading in the fund’s units or sell the underlying investments below price. This means a depressed exchange rate for you on redemption.
Although the fund manager reviews the underlying investments very closely, it has no effect on an unexpected market situation. Even with the most careful choice, the company to which you directed the money may go bankrupt. That part of the fund is then reduced to zero.
Foreign exchange risk
Most investment funds do not invest in domestic currency. For you, this means that if the domestic currency weakens against a given foreign currency, you will have to pay more for the same investment. Then you will see an increase in the exchange rate for the value expressed in domestic currency, and a decrease in the exchange rate for the strengthening of the it. Foreign exchange risk means two things to you:
- also that although you can choose the direction of the investment, you have no influence on the currency exchange rate
- as there is a time difference between receiving and executing a buy / sell order, you do not know the exchange rate at which your order will be executed.
Interest rate risk
Investors dream of high returns with low risk. You can see the effect of interest rate risk when the return on risk-free or very low-risk investments increases. Then they either expect extra returns from the riskier forms or divert their money elsewhere. If the redirection is significant, it is accompanied by a fall in the exchange rate.
By using mutual funds, you have the opportunity to diversify your investment portfolio even if you do not have a large amount at your disposal. Although you also benefit from the risk of investing here in against bank deposits, the return on your investment is also shared with you.
An investment fund with the right composition and level of risk to suit the needs of any investor is available to you, but that does not mean that any investment fund is right for you.
- Have you used an investment fund before? What did you choose?
- What can make it difficult for you to use mutual funds?
- Based on the above, which type of investment fund is most sympathetic to you?
Before making a choice, plan the time horizon of your investment and pre-determine your level of risk according to your goals. I will be happy to help you with this, you can contact us here.