Managed funds, also known as mutual funds, are not the popular choice for ASX investors as they once were. With the rise of popular alternatives like exchange-traded funds (ETFs) and listed investment trusts (LITs), many investors have left the managed fund on the side of the road.
So what is a managed fund, and do these investment vehicles still have a place in a modern portfolio?
What does a ‘managed fund’ mean?
A managed fund describes an investment vehicle that is managed by a fund manager. Simple enough. Its basic structure involves a type of trust called a unit trust. The trustee (or fund manager) manages a portfolio of investments (such as ASX shares) for the beneficiaries of the trust. In order to become a beneficiary, you must buy shares or ‘units’ of the trust. The number of units you own represents a proportional interest in the trust (similar to shares of a company). Think of buying into a managed fund as pooling your capital with other investors, with the fund as the manager.
A managed fund can invest in a single asset class, such as ASX shares, international shares, corporate bonds, or otherwise a mixture, depending on the fund’s objectives and profile. You can have share-only funds, bond-only funds or a fund that will invest in anything it deems appropriate at a given occasion.
Advantages of a managed fund
Managed funds are one of the oldest investment vehicles around, far predating ETFs. The appeal of a managed fund is relatively simple.
Firstly, it enables an investor to pool their capital with other investors in order to invest in assets that might be out of reach for an individual, such as property, mortgage-backed securities or corporate or government bonds.
Secondly, it provides an easy way for an investor to invest in shares or other assets without having to manage the money themselves. If you have money to invest, but don’t know anything about investing, managed funds are always an easy option.
Thirdly, some investors prefer the managed fund structure as it is relatively cheap and easy to periodically add funds. Shares or units of an ETF or an LIC have to be bought on the share market, which means that there is a $500 minimum investment and (usually) brokerage costs to be paid. In contrast, units of a managed fund are traded ‘off-market’ rather than on an exchange.
That means you can directly apply for additional units for the fund straight from the manager. These will normally be issued after market close at a fund-determined price. As such, you can often invest as little as $50 or $100 at a time without paying brokerage fees (although the fund manager may charge a small spread), which works well for a dollar-cost averaging strategy.
Disadvantages of a managed fund
Despite the advantages of a managed fund, this structure does have its fair share of critics.
Foremost are fees. Managed funds often charge far higher fees than an ETF or even an LIT or listed investment company (LIC). A managed fund will often ask a fee of 1%, 1.5% or even 2% per annum (often with an additional performance fee as well). In contrast, it’s not uncommon to find index ETFs with management fees of 0.1% per annum or lower.
This is partly because managed funds are far more expensive than an ETF to run. The fund manager and their team have to be paid, of course (not an issue with a passive ETF), and the costs of running an off-market trust are far more numerous than an index-tracking, algorithm-driven ETF.
So in order for a managed fund to be ‘worth it’ for an investor, it has to consistently deliver post-fee market-beating performance – a feat many managed funds struggle to accomplish.
Another problem that many investors run into with managed funds is their open-ended nature. Unlike an individual company or an LIC, there is not a finite amount of shares on issue for a managed fund. That means when investors buy in, units are created, and when investors sell out, those units are destroyed. Under normal circumstances, this isn’t a concern because (unlike with a company) supply and demand will not affect the performance of the fund’s unit prices for its remaining investors.
But it can be a problem during a market panic or crash. If a managed fund receives a massive sell-out of its units, it can quickly run into trouble if its underlying investments are not sufficiently liquid. Take a property-focused managed fund, as an example. If half of its investors decide to sell their units on a single day, the fund manager can’t sell half a house in order to redeem those units. Because of this phenomenon, many managed funds retain the option to ‘freeze’ withdrawals in situations like these. If you really need to pull your money out, you might not be able to until the fund can balance its books.
The bottom line
There is nothing wrong with the managed fund structure, and there are many managed funds out there today that have delivered market-beating performance for their investors. However, there are some clear disadvantages that a managed fund faces as well, so picking the right one for your portfolio is of utmost importance.