Managed funds, also known as mutual funds, are not as popular withASX investors as they once were. With the rise of 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 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’ 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 with the aim of maximising your returns.
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 time.
Advantages of a managed fund
Managed funds are one of the oldest investment vehicles around, far pre-dating 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 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 having to manage 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 easy to periodically add funds. Shares or units of an ETF or an LIT 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 in 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 fee or spread), which 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 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 to run than an ETF. The fund manager and their team have to be paid, of course (not an issue with a passive ETF because it requires virtually no management), 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 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 an individual company or an LIC, there is not a finite number 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 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-out 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 in order to redeem those units. Because of this phenomenon, many managed funds retain the option to ‘freeze’ withdrawals in situations like these. 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 there are many managed funds out there today that have delivered market-beating performances for their investors. However, there are some clear disadvantages to managed funds as well, so picking the right one for your portfolio is of utmost importance.