What is a managed fund?

Image of fund managers on laptops with share price chart overlaid
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Managed funds, also known as ‘mutual funds’, are not as popular with ASX investors as they once were. With the rise of alternatives like exchange-traded funds (ETFs), listed investment trusts (LITs), and listed investment companies (LICs), 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 ‘managed fund’ mean?

A managed fund describes an investment vehicle that is looked after 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 trust's beneficiaries. 

To become a beneficiary, you must buy shares or ‘units’ in 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 a fund manager monitoring your investments and making decisions on your behalf to maximise your returns.

A managed fund can invest in a single asset class, such as ASX shares, international shares, corporate bonds, or a mix of assets, 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 time.

Advantages of a managed fund

Managed funds are among the oldest investment vehicles around, far pre-dating ETFs. The appeal of a managed fund is relatively simple. 

Firstly, it enables investors to pool their capital with other investors to invest in assets that may 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 managing the investments 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 it’s easy to add funds periodically. Shares or units of an ETF or LIT have to be bought on the share market, which means a $500 minimum investment and 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 in the fund straight from the manager. These will typically 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 fee or ‘spread’). This works well for a dollar-cost averaging strategy. 

Disadvantages of a managed fund

The managed fund structure does have its fair share of critics.

The foremost disadvantage is fees. Managed funds often charge far higher fees than ETFs or even LITs or LICs. 

A managed fund will typically ask for 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 a management fee of 0.1% per annum or lower. 

This is partly because managed funds are more expensive to run than an ETF. The fund manager and team have to be paid, which is not an issue with a passive ETF because it requires virtually no management, and the costs of running an off-market trust are numerous compared to an index-tracking, algorithm-driven ETF.

So, for a managed fund to be worthwhile to an investor, it has to consistently deliver a post-fee, market-beating performance every year – a feat that many managed funds struggle to accomplish.

Another problem with managed funds is their open-ended nature. Unlike individual companies or LICs, there is not a finite number of shares on issue with a managed fund. That means when investors buy in, units are created. When investors sell out, those units are destroyed. 

Under normal circumstances, this isn’t a concern because 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 there is a massive sell-off of a managed fund’s 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 the investors sell their units in a single day, the fund manager can’t sell half a house to redeem those units. Because of this phenomenon, many managed funds retain the option to freeze withdrawals in these situations. That means you might not be able to pull your money out until the fund can balance its books. 

The bottom line

There is nothing wrong with the managed fund structure, and many managed funds out there today have delivered market-beating performances for their investors. However, there are some clear disadvantages to managed funds, so picking the right one for your portfolio is of the utmost importance.

Last updated 21 April 2022. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.