Funds ABC

What is an investment fund?

An investment fund is an organization that collects money the subscribers and invests it in securities for their benefit. It is managed by a fund manager based on the principle of spreading risk.

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An investment fund is an organization that collects money from the subscribers and invests it in securities for their benefit and it is managed by a fund manager based on the principle of risk spreading.

Imagine that you are visiting a new Chinese restaurant with your friends. You have no experience with these dishes so you decide to order many different dishes and share them with your friends. This way everyone gets to try several new things and nobody will be totally disappointed if they do not like some dishes. This is the same thing investment funds do. Money from people with the same interests is collected and placed in the fund, which in turn puts the money into equities, bonds, other funds, bank deposits, real estate and to other investment vehicles according to the rules in the fund's prospectus.

By putting money into the fund the investor buys fund shares that give the investors co-ownership of the fund. Every share represents a small part of the fund's investment portfolio. For example, if 5% of the fund's assets are invested in Tallinna Vesi equities, then the owner of a 100-euro fund share indirectly has 5 euros worth of Tallinna Vesi equities. 

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Fund types

The world of investment funds offers many different investment possibilities. Funds can be divided by asset classes or by investment styles. The existence of different types of funds allows investors to choose funds with a suitable risk level and investment horizon to spread risks.

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The world of investment funds offers many different investment possibilities. Funds can be divided by asset classes or by investment styles. Different types of funds allow investors to find funds with suitable risk level and investment horizon. Also different funds offer a good possibility to spread risks.

Different types of funds offer very different risk and return relationships. The funds's level of risk and return may vary significantly depending on the content of the investment portfolio. A given bond fund, for example, may consist only of risky but high-yield bonds. Or a specific equity fund may only hold stocks of large and stable companies.

Generally funds may be collated by risk and return ratio as follows:

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Fund net asset value

Investment funds calculate their net asset value (NAV) on a regular basis, usually each working day. The calculation determines the value of fund assets (stocks, bonds, deposits, etc.) and from that subtracts fund liabilities. If we divide a fund's net asset value by the number of shares in the fund, we get the net asset value per share, which is usually indicated as the NAV (Net Asset Value).

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Investment funds calculate on a regular basis (usually each working day) the funds net asset value (NAV). With the calculation of asset value fund assets (stocks, bonds, deposits etc) are evaluated and from that fund liabilities are subtracted. If we divide the fund net asset value by the number of shares in the fund, we get the share’s net asset value, which is usually indicated as the NAV (Net Asset Value).

Unlike stocks, whose prices can change during the day, a fund's NAV is calculated once a day, typically (or even less frequently in some cases). If an investor buys fund shares, the price of one unit is based on the NAV with the possible addition of a service fee.
Investors should note that when entering the payment order, the share price is not known because the NAV of that day has not been calculated yet. These details are explained thoroughly in a fund’s prospectus and rules.
Unlike with stocks, with funds you do not have to buy full shares. So for example if you want to invest 5000 euros and the price per share is 21.4 euros then you get 233.645 shares of the fund.
One fund can have many different types of shares, which differ from each other in currency or in service fees. Different types of shares usually are marked with letters (A-, B-, E-, I-shares, etc.). Due to different fees and currency conversion, the rate of return for different shares of the same fund may not be equal even though all the share types are related to the same investment portfolio.

Unlike stocks, whose prices can change during the day, a fund's NAV is calculated once a day, typically (or even less frequently in some cases). If an investor buys fund shares, the price of one unit is based on the NAV with the possible addition of a service fee.

Investors should note that when entering the payment order, the share price is not known because the NAV of that day has not been calculated yet. These details are explained thoroughly in a fund’s prospectus and rules.

Unlike with stocks, with funds you do not have to buy full shares. So for example if you want to invest 5000 euros and the price per share is 21.4 euros then you get 233.645 shares of the fund.

One fund can have many different types of shares, which differ from each other in currency or in service fees. Different types of shares usually are marked with letters (A-, B-, E-, I-shares, etc.). Due to different fees and currency conversion, the rate of return for different shares of the same fund may not be equal even though all the share types are related to the same investment portfolio.

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Fund owner rights

The law provides investment fund owners with many protective rights. The main right is to sell fund shares back to the fund manager. For open-end funds, transactions with shares can be made on all banking days, but there are also funds that you can sell only once a month or once a quarter.

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The law provides investment fund owners with many protective rights. The main right is to sell fund shares back to the fund manager. For open-end funds, transactions with shares can be made on all banking days, but there are also funds that you can sell only once a month or once a quarter.

When selling back fund shares, the fund owner must receive a portion of fund earnings according to his/her share type and amount. Note that if the rate of return is negative, then the owner gets back less than he or she originally put in.

The second right fund owners have is the right to give away or sell their shares to others. A fund owner also has the right to get information about the fund.

An owner of fund shares is not personally responsible for fund liabilities. And a fund share owner has no right to interfere in the fund’s investment activities.

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Expenses and fees

With fund investments also come fees that you have to pay even if the fund has not been successful.

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With fund investments also come fees that you have to pay even if the fund has not been successful.

Usually the following fees are applicable:

Issue fee: a percentage by which the price is increased on issuing fund shares. For example if the share NAV is 10 EUR and the issue fee is 2%, then an investor must pay 10.2 EUR for each share. For some funds the issue fee can be quite high (5% or more). From that sum the fund manager pays the fund agents who sell the shares. These fees are referred to as “front-end loads”.

Redemption fee: a percentage by which the price is reduced when selling fund shares. For example if the share NAV is 10 EUR and the redemption fee is 2%, then an investor receives 9.8 EUR for each share. Fees for entering and leaving the fund seek to motivate investors to prolong the investment period. For that reason higher fees apply for riskier funds to avoid speculation, with investors rapidly selling and buying fund shares, because that could lead the fund manager to sell stocks at the wrong time, which in turn could influence the value of the whole portfolio. For some funds, a high redemption fee is applicable only for the first year and so is not of concern for an investor with a long investment horizon.

Management fee: a certain percentage of fund assets. The management fee goes to the fund manager and is constantly subtracted from the NAV.

Success fee: a certain amount of fund assets that the fund manager takes for the fund’s profit. The amount from which the fee is applicable is always specified – for example, it may be calculated based on total revenue or just on the part that exceeds a benchmark index or rate or the risk-free rate of return (for bond funds). Success fees are usual for hedge-funds, but less common for open-end funds. In general, actively managed funds have higher fees and more passively managed funds have smaller fees.

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Risks

Expenses do not depend on rate of return

Investor does not have any control over investments

Investor cannot control assets market value in real time

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Expenses do not depend on rate of return. When giving your money to fund managers, remember that the management fee has to be paid even if the fund does not generate any profits. That is one reason why the rate of return for many investment funds is below the markets average.

Investors do not have any control over investments. Although fund managers must follow the rules stated in the law and the fund prospectus as well as the organization’s internal policies, they can make investment decisions as they like – and that is what they are paid for. But this also means that an investor does not have any possibility to influence a fund manager’s decision-making even if the investor thinks he or she is smarter.

Investors do not have real-time control over the market value of assets. Even in a very dynamic market that may go up and down several times a day, they cannot use these short term changes to enter or leave the fund because NAV is calculated only once a day.

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