Pros and Cons of Managed Funds
Managed funds are a modern way of achieving your investment goals. I do own some direct property and direct shares, but I use managed funds for the majority of my investments. As with anything, Managed funds have their pros and cons. Let's take a look at some of the bigger ones.
The Pros of Managed Funds
- Managed funds take the hard work out of selecting which assets to invest in and having to monitor their performance. They are, therefore, a very easy and time-effective means of investing
- When you invest in a managed fund you effectively employ a team of investment professionals whose combined experience, knowledge of the markets, investment research capability and exposure to the latest information would be hard to match as an independent investor.
- Investing in managed funds provides a level of diversification well beyond the reach of most independent investors. A single investment, for instance, in a share fund ('share trust' or 'equity trust') could make you an indirect shareholder in hundreds of companies in which the fund has invested.
- Some investment can only be purchased as expensive single items (like city buildings) or in minimum-sized parcels with high ticket prices beyond the reach of small, independent investors. However, these investments are not beyond the reach of many managed funds with their large, pooled financial resources.
- Managed funds can be an effective and relatively painless savings vehicle. Many have a direct debit facility where, say, $300 per month or quarter can be automatically transferred into the fund direct from your cheque or savings account.
- Managed funds can be a regular source of income. Certain funds provide a monthly, quarterly or half-yearly income distribution to unit-holders that reflects the level of income earned by the fund's investments. Unit-holders can take the regular distributions in cash or have them reinvested as additional units in the fund.
The Cons of Managed Funds
- Managed funds charge fees. Normally there are entry, exit and ongoing management fees. Some funds charge no entry fee but have a higher than average exit fee, or vice versa. Some funds only charge an exit fee if you leave the fund within a certain time of first investing. Some funds have no entry and/or exit fees so long as you maintain your investment for a minimum number of years. It varies tremendously and the level of fees is an area of real competition between the funds.
As a guide, entry fees range from 0% to 5% of the value of your deposit. Ongoing annual fees, primarily going to the fund manager and trustee (often referred to as the Management Expense Ration or MER) range from 0.5% to 3% of the value of your balance, and exit fees usually range from 0% to 2% of the value of your withdrawal.
- Managed funds dilute the degree of control you have over your asset selection. For instance, when you invest in, say, a share fund, you invest in the shares of companies that the manager, not you, selects.
- Of course, managed funds (like any other investment) can generate losses. In this case, the capital value of your investment declines.
- Should the fund experience a major devaluation of its underlying assets, or the manager is thought to be or found to be dishonest, a 'run' may be made on it. This is where a number of investors try to bail out and cash their units at the same time. If the fund does not have ample liquid reserves to cope with this rush of redemptions it could be faced with the prospect of a major asset fire-sale in order to raise the necessary cash. This would probably trigger the trustee to step in and 'freeze' the fund, temporarily preventing any further redemptions until the fund could be put in order.
Let me illustrate what can happen. During the 1980s when property prices were booming, unlisted property trusts had no difficulty meeting unit redemptions - the coffers were full of cash because the inflow of investor capital far outweighed the demand for redemptions. This also meant the trusts could offer short redemption times. However, by 1990, when the commercial property market had collapsed and we were having 'the recession we had to have', the demand for unit redemptions increased as investors bailed out of what were, then, very poorly performing investments. The result was that some (unlisted) property trusts found they didn't have enough cash to meet the redemption demand.
To prevent fire-sales of property into a depressed market (in an attempt to raise the necessary cash to meet the level of redemptions) many property trusts indefinitely suspended redemptions altogether or substantially increased the redemption period to 12 months or more.
If fire-sales had been conducted to meet redemption demand, the value of the trusts' units would have been decimated, severely hurting those who were prepared to hang on to their units and ride the recession. It also would have caused the overall property market to decline even further and there would have been enormous realised losses all round.
The approval to extend unit redemption times, or suspend redemption altogether, would normally be granted to the trustee by investors at an extraordinary general meeting. However, the trustee generally has the right to impose changes to redemption policy in order to protect the assets of the fund. Under severe circumstances of mismanagement and/or lack of integrity the fund manager and/or trustee can be sacked and replaced.
For the record, I should point out that institutions as safe as banks can, like managed funds, also experience mass investor desertion and a consequent run on funds - however, such events are very rare.