All About Funds

 

funding, investing

A fund is a source of money that will be allocated to a specific purpose. A fund can be established for any purpose whatsoever, whether it is a city government setting aside money to build a new civic center, a college setting aside money to award a scholarship, or an insurance company setting aside money to pay its customers’ claims.

Individuals, businesses and governments all use funds to set aside money. Individuals might establish an emergency fund or rainy-day fund to pay for unforeseen expenses, or a trust fund to set aside money for a specific person.

Individual and institutional investors can also place money in different types of funds with the goal of earning money. Examples include mutual funds, which gather money from numerous investors and invest it in a diversified portfolio of assets, hedge funds, which invest the assets of high-net-worth individuals in a way that is designed to earn above-market returns. Governments use funds, such as special revenue funds, to pay for specific public expenses.

Emergency Funds

An emergency fund is an account used to set aside funds needed in the event of a personal financial dilemma, such as the loss of a job, a debilitating illness or a major expense. The purpose of the fund is to improve financial security by creating a safety net of funds that can be used to meet emergency expenses as well as reduce the need to draw from high interest debt options, such as credit cards or unsecured loans.

Most financial planners recommend that an emergency fund contain enough money to cover at least three months of living expenses. Note that financial institutions do not carry accounts labeled as emergency funds. Rather, the onus falls on an individual to set up this type of account and earmark it as capital reserved for personal financial crises.

Investment Funds

An investment fund is a supply of capital belonging to numerous investors used to collectively purchase securities while each investor retains ownership and control of his own shares. An investment fund provides a broader selection of investment opportunities, greater management expertise and lower investment fees than investors might be able to obtain on their own. Types of investment funds include mutual funds, exchange-traded funds, money market funds and hedge funds.

With investment funds, individual investors do not make decisions about how a fund’s assets should be invested. They simply choose a fund based on its goals, risk, fees and other factors. A fund manager oversees the fund and decides which securities it should hold, in what quantities and when the securities should be bought and sold. An investment fund can be broad-based, such as an index fund that tracks the S&P 500, or it can be tightly focused, such as an ETF that invests only in small technology stocks.

Institutional Funds

A fund that targets high value investors with low management fees, but very high minimum investing requirements. Institutional funds refers to funds that aim to manage money for large institutional investors, such as pension or endowment funds. These funds will typically offer much lower MERs (market expense ratios) than retail funds, but also mandate a minimum investment much greater than most other funds, some hedge and private equity funds withstanding.

These funds must indicate within their prospectuses or name that they’re institutional and typically solicit managers of retirement plans, institutional investors and large endowment trusts. These funds can take almost any form, be it a mutual fund, private equity fund, hedge fund or venture capital fund. The defining trait of institutional funds are the clientele they cater their services to.

Global Funds

A type of mutual fund, closed-end fund or exchange-traded fund that can invest in companies located anywhere in the world, including the investor’s own country. These funds provide more global opportunities for diversification and act as a hedge against inflation and currency risks.

Many people confuse a global fund with an international, or foreign, fund. The difference is that a global fund includes the entire world, whereas an international/foreign fund includes the entire world except for companies in the investor’s home country.

Debt Funds

A debt fund is an investment pool, such as a mutual fund or exchange-traded fund, in which core holdings are fixed income investments. A debt fund may invest in short-term or long-term bonds, securitized products, money market instruments or floating rate debt. The fee ratios on debt funds are lower, on average, than equity funds because the overall management costs are lower.

The main investing objectives of a debt fund will usually be preservation of capital and generation of income. Performance against a benchmark is considered to be a secondary consideration to absolute return when investing in a debt fund.

Fund of Funds

A fund of funds (FOF) – also referred to as a multi-manager investment – is an investment strategy in which a fund invests in other types of funds. This strategy invests in a portfolio that contains different underlying assets instead of investing directly in bonds, stocks and other types of securities.

The fund of funds (FOF) strategy aims to achieve broad diversification and appropriate asset allocation with investments in a variety of fund categories that are all wrapped into one fund. These are fund of funds characteristics that attract small investors who want to get better exposure with fewer risks compared to directly investing in securities. However, if the fund of funds carries an operating expense, investors are essentially paying double for an expense that is already included in the expense figures of the underlying funds. Historically, a fund of funds showed an expense figure that didn’t always include the fees of the underlying funds.

Index Funds

An index fund is a type of mutual fund with a portfolio constructed to match or track the components of a market index, such as the Standard & Poor’s 500 Index (S&P 500). An index mutual fund is said to provide broad market exposure, low operating expenses and low portfolio turnover. These funds adhere to specific rules or standards (e.g. efficient tax management or reducing tracking errors) that stay in place no matter the state of the markets.

Indexing is a passive form of fund management that has been successful in outperforming most actively managed mutual funds. While the most popular index funds track the S&P 500, a number of other indexes, including the Russell 2000 (small companies), the DJ Wilshire 5000 (total stock market), the MSCI EAFE (foreign stocks in Europe, Australasia, Far East) and the Barclays Capital Aggregate Bond Index (total bond market) are widely used for index funds.

Pooled Funds

Pooled funds are funds from many individual investors that are aggregated for the purposes of investment, as in the case of a mutual or pension fund. Investors in pooled fund investments benefit from economies of scale, which allow for lower trading costs per dollar of investment, diversification and professional money management. Along with the added costs involved in the form of management fees, the main detractor of pooled fund investments is that capital gains are spread evenly among all investors — sometimes at the expense of new shareholders.

Groups such as investment clubs, partnerships and trusts use pooled funds to invest in stocks, bonds and mutual funds. The pooled account lets the investors be treated as a single account holder, allowing them to buy more shares.

Mutual Funds

A mutual fund is an investment vehicle made up of a pool of moneys collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and other assets. Mutual funds are operated by professional money managers, who allocate the fund’s investments and attempt to produce capital gains and/or income for the fund’s investors. A mutual fund’s portfolio is structured and maintained to match the investment objectives stated in its prospectus.

Mutual funds give small or individual investors access to professionally managed portfolios of equities, bonds and other securities. Each shareholder, therefore, participates proportionally in the gains or losses of the fund. Mutual funds invest in a wide amount of securities, and performance is usually tracked as the change in the total market cap of the fund, derived by aggregating performance of the underlying investments.

Exchange Traded Funds (ETF)

A twist on the mutual fund is the exchange traded fund, or ETF. These ever more popular investment vehicles pool investments and employ strategies consistent with mutual funds, but they are structured as investment trusts that are traded on stock exchanges, and have the added benefits of the features of stocks. For example, ETFs can be bought and sold at any point throughout the trading day. ETFs can also be sold short or purchased on margin. ETFs also typically carry lower fees than the equivalent mutual fund. Many ETFs also benefit from active options markets where investors can hedge or leverage their positions. ETFs also enjoy tax advantages from mutual funds. The popularity of ETFs speaks to their versatility and convenience.

Money Market Funds

The money market consists of safe (risk-free) short-term debt instruments, mostly government Treasury bills. This is a safe place to park your money. You won’t get substantial returns, but you won’t have to worry about losing your principal. A typical return is a little more than the amount you would earn in a regular checking or savings account and a little less than the average certificate of deposit (CD). While money market funds invest in ultra-safe assets, during the 2008 financial crisis, some money market funds did experience losses after the share price of these funds, typically pegged at $1, fell below that level and broke the buck.

Bond Funds

Bond funds invest and actively trade in various types of bonds. Bond funds are often actively managed and seek to buy relatively undervalued bonds in order to sell them at a profit. These mutual funds are likely to pay higher returns than certificates of deposit and money market investments, but bond funds aren’t without risk. Because there are many different types of bonds, bond funds can vary dramatically depending on where they invest. For example, a fund specializing in high-yield junk bonds is much more risky than a fund that invests in government securities. Furthermore, nearly all bond funds are subject to interest rate risk, which means that if rates go up the value of the fund goes down.

Income Funds

Income funds are named for their purpose: to provide current income on a steady basis. These funds invest primarily in government and high-quality corporate debt, holding these bonds until maturity in order to provide interest streams. While fund holdings may appreciate in value, the primary objective of these funds is to provide a steady cash flow​ to investors. As such, the audience for these funds consists of conservative investors and retirees. Because they produce regular income, tax conscious investors may want to avoid these funds.

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