Funds trading

The place to LEARN all about investing in funds

What is a fund?

 

A fund is a collection of money – or a pool of money – from a number of investors. These money pools are (or will be) managed by a professional portfolio manager, who will invest in securities according to the structure of the fund.

 

There are many types of funds. They can be categorized according to their structure, their investment strategies, their active or passive approach, the type of securities they trade in, the fund allocation, their risk appetite and so much more.

2024 celebrates the 100 year anniversary of open-ended funds i.e. mutual funds. Although they are not as sought after by the average/active online day trader, it is still an asset class to be understood – take a look at their history

Comparing types of funds

Open-end, Closed-end and UIT

Funds are investment companies that invest in various asset classes i.e. stocks, bonds, currencies, commodities, cryptocurrencies. Funds can be structured into three main types, open-end, closed-end and unit investment trusts. All three types have distinct characteristics relative to their structure, management and tradability.

A comparison of open-end and closed-end funds.

Unit Investment Trust (UIT)

Type

investment company (corporation or trust)

Structure

no board of directors or corporate office

Regulation

registered with the Securities Commission

IPO

holds an initial fund offering to raise funds

Investments

fixed, unmanaged portfolio of assets

Duration

pre-determined life expectancy

Net Asset Value (NAV) of funds, per share.

A fundamental term when trading funds (including ETFs) is the Net Asset Value, also known as NAV. The NAV represents the price per share value of the fund’s assets minus its liabilities. In the case of mutual funds (open-end), the NAV is calculated daily, at market close. An investor that places a new order in a mutual fund, knows what the purchase price will be only when the new NAV is calculated.

Net Asset Value (NAV) calculation, assets and liabilities of funds.

Is funds trading a new language for you? Visit our database with basic and advanced definitions

trading terms

Active Funds Vs Passive Funds

There are two main approaches regarding how a fund is managed. Traditionally, a fund is built to track an index or benchmark. This requires little to no intervention, since there is no goal of high returns, hence the word passive.

Investors looking for higher returns, would opt for a fund that plays with the constituent’s weights, by purchasing more or less as needed to outperform the benchmark. Known as an active fund, it incurs costs associated with the workload.

Historically, active funds tend to underperform if the costs associated with the management are taken into account. Only constant outperformance, can beat these odds.

Note: Past performance is not indicative of future results.

Active Funds
Active Funds

Target: outperform the markets
Action and reaction
Buy, sell, hold
Active portfolio manager
Higher costs

Passive Funds
Passive Funds

Target: Track an index
No action, no reaction
Balance, rebalance
No portfolio manager
Lower costs

Types of mutual funds

Investors considering trading funds, must have a thorough understanding of their investment objectives, risk appetite and decide on fund types that match their individual preferences. There are funds that meet any type of investor and profile, from active / higher risk, to passive / lower risk, and proper due diligence must be assigned to the fund and its management (if applicable).

Please follow guidelines from your local regulator for better use of fund investments. Major regulators include the US SEC, ESMA in Europe, ASIC in Australia and other local regulatory bodies. A great source to begin with, would be the US SEC guide to mutual funds, link here.

Below we outline major types of investment funds with their characteristics.

Share classes

In addition to multiple fund types, investors can select how their costs will be incurred through the share classes assigned to each fund.  

Although there are standards followed with share classes, each fund assigns terms to the classes at their discretion. Investors must read the prospectuses carefully to make educated decisions relating to costs. 

Class A Shares

Has a “front-end load” payment (an upfront sales commission) charged at the time of joining the fund. If the charge is 4%, on a $1,000 investment the fund would take a front-end load of $40 and invest the rest of the $960 in the fund.

 

Annual fee called 12b-1 fee, that covers administrative as well as marketing and distribution costs of the fund.

 

Reductions:

  • Since front-end load classes get the payment in advance, they are able to offer lower fees than their counterparts.
  • These reductions can happen in scales based on the investment amount. The larger the amount, the lower the fee.
  • Reductions can also happen if the investors hold a closer relationship with the fund via investing in other funds of the group, or have a network (of family, friends, associates) that also invest in the group, or have plans and commit to invest more in the fund moving forward.
  • Rights of accumulation and letters of intend, are used to solidify these commitments that can trigger reductions.

Understanding CDSC on Class B and C Shares

To understand how these two classes charge, we need to understand what a Contingency Deferred Sales Charge -or CDSC – is. When investors redeem their shares earlier than specified periods of time, a fee is charged by the fund.

 

It’s called “deferred” because it is postponed until the redemption happens, that’s why its also called “back-end load”. If investors redeem their shares after the specified periods, the CDSC is reduced or even eliminated completely.

Class B Shares

This class has a CDSC charge, usually on a period of less than 6 years. Year on year, the CDSC is reduced and past the 6 years, might be completely eliminated. Because there is no upfront payment, the yearly expense ratio and 12b-1 fees are higher than Class A Shares.

 

These shares are also convertible to Class A Shares after the elimination of the CDSC. The reason is to give the investor the lower yearly expense ratios of Class A Shares, after holding the investment for all that time period.

Class C Shares

This class has a CDSC charge, usually on a period of less than one to one and a half year. Same as with Class B Shares, the expense ratio and 12b-1 fees are higher since there is no upfront sales charge.

These shares are not convertible to Class A Shares so the annual expense ratios and the 12b-1 fees continue to be charged, for as long as the investment is held.

The fact that they have no upfront cost, these shares are very attractive to investors with a short-term investment horizon, since they can be less costly than their counterparts.

If investors wish to change their investment to other funds in the same group, Class C Shares offer the flexibility to do so without the burden of the front-end load charge.

Class R, I, X, Y, Z & N Shares

Different fund groups may offer share classes that don’t fit in any of the criteria mentioned above. The fund managers themselves will qualify investors based on parameters like the type of investment or certain programs that run periodically.

Some examples could be retirement classes (Class R Shares) that only employers are participating in, they have a small 12b-1 fee and no load. They could also be institutional classes (Class I, or X, Y, Z Shares) that have higher minimum thresholds to enter, but no load. Others could have capped 12b-1 charges and no load (Class N Shares).

Fees and charges

Some examples of fees and share classes to go through include Vanguard, Fidelity, Charles Schwab

Funds fees, front-end load charges.
Front-end load is an upfront payment, deducted directly from the investment amount. From the example above, a $1,000 investment, would incur a load of $50. The fund would deduct the $50, and put $950 into the investment pool.
Funds fees, back-end load charges.
Also known as Contingent Deferred Sales Charge (CDSC) - is only deducted upon redemption of the shares and according to how long the investor holds the investment. The longer the investor holds the investment, the more the fee gets reduced.
Funds fees, no load charges.
Under Shareholder fees, the fund can outline expenses that don’t fall into either of the load categories. This means that no third party fees are involved, so these fees are paid directly to the fund. See below fees paid to the fund:
Purchase fees

These are fees deemed required by the fund and they are charged every time a purchase takes place

Redemption fees

Charged on redemption of shares to discourage investors from redeeming. Regulators impose caps on fee charges

Account fees

To encourage investors to meet minimum thresholds, funds might impose maintenance fees on the accounts

Exchange fees

Funds allow cost-free transfers from funds of the same group, but some may impose an exchange fee

Annual Fund Operating Expenses

Management expenses

Can be related with the portfolio manager, with the tools needed for the effective management of the fund or administrative fees that are not included in other expenses

Direct management expenses

Fees paid to the portfolio manager. They can be asset based (can be tiered), incentivized, might not be applicable if there are losses, can be based on a one off or a per hour rate

Indirect management expenses

Fees related to tools required by the portfolio managers (reports, access to news, data, pricing, charts, platforms, technology). Also service fees for investors to open accounts.

12b-1 fees

Related with distribution, marketing and in some cases service costs (advertising, print, marketing for selling the fund). A US creation authorizing cost payment from fund assets

Other expenses

Audit, legal/compliance matters, transactions, reports and statements, prospectuses, financial reports for taxes, submission fees for filing with the regulator and so on

Waiver Reduction – Reimbursement

Portfolio managers can decide to maintain a specific fee structure on their portfolio. After all expenses are calculated, they can waive a portion of the fee to balance the charge

Management expense ratio (MER)

A MER consists of three main components that include Management fees, Operational fees and Taxes

MER

[Investment Management + Operating Expenses + Taxes / AUM] x 100

Example
[100,000 + 50,000 + 20,000 / 10,000,000] x 100 = 1.7%

Investment Management
Operating Expenses
Taxes

Risks associated with funds

How to trade funds?

Directly from the company managing the fund

Through online brokers

Morningstar provides a good report on US mutual fund family companies with ratings and assets under management. See it here

Research and education is key

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