Managed Funds

A managed fund is a way for you to invest money alongside others, hopefully, to get some benefits by being in a group, as opposed to making your investment directly.

The way a managed fund works is that you buy 'units' in the fund directly from the fund manager and, at some point in the future, sell these units back to that same manager. The value of units is re-calculated on a regular basis as the market value of the assets in the fund rise and fall.

There are other managed investments that you might consider as alternatives to managed funds such as Exchange traded funds(ETFs), Listed investment companies (LICs) or Separately managed accounts (SMAs).

Let's explore managed funds in more detail:

 How to invest

If you are thinking about investing in one of the 12,000 managed funds, the starting place is to match the type of fund with your investment objectives. Read the paragraphs below and work your way through the Investing in Managed Funds Checklist.

The ASIC web site Moneysmart  gives further guidance and the Australian Investors Association compiles a list of top performing funds annually.

 Pros & cons

A managed fund might offer the following benefits:

  • You are using professional investment managers who have access to information, research and investment processes which you believe offer the prospects of better returns and/or reduced risk.
  • You have access to different asset classes and can diversify more than would be feasible for you investing directly and this theoretically reduces risk.
  • You share costs with a pool of other investors which should reduce your cost of investing.
  • You can make relatively small investments into asset classes which have large minimum investments because you are sharing the investment with others.

You should consider the possible disadvantages of investing via a managed fund which include:

  • Most of the funds on offer are 'open ended' which means that when you (and anybody else) invest some money with them, their funds under management grow and they need to invest this extra money into the underlying assets. Conversely, when you want to cash in your units and withdraw your money, the fund needs to sell some assets to make the money available. So some purchases and sales are made because of the flow of funds in and out which may be at less than optimal times as far as share prices are concerned. If large withdrawals are made, the fund manager may have to sell their most liquid investments. Sometimes, especially if there are problems in the market, there is a rush of investors trying to cash in and funds and this may cause a halt on redemptions so your investment might be illiquid.
  • There are fads in any market and investors may flock to a particular fund which has outperformed. This may mean that the fund is buying assets even though the assets are expensive. If a downturn happens and investors withdraw funds, then the forced selling by the fund may push asset prices down further creating a spiral of redemptions.
  • There may be unknown tax issues. As all units are equal as far as tax is concerned, units you buy may inherit tax liabilities on gains you didn't benefit from. In Australia, funds do not have to disclose potential tax liabilities and these are likely to be highest in the best performing funds which have low turnover in their assets. On the other hand, if your fund has had a period of poor performance, new investors dilute any unrealised tax losses which disadvantages existing unit holders. Buying and selling the underlying assets may have tax consequences for your units. Capital losses in a managed fund cannot be distributed to you to offset against any capital gains outside that fund.

The main disadvantage to investing in managed funds is that there are often below average returns which are amplified because of fees. Investors should be aware that many funds perform so poorly over a long period of time that their yields are below the long term rate of inflation.  There are so many funds with such large sums to invest that it is statistically impossible for the majority of managers to outperform the broad indexes. You should understand the fees that any fund charges and the likely impact on performance.

 Investment styles

There is a wide variety of managed funds offered in Australia and, according to the Australian Bureau of Statistics (ABS) at time of writing the Australian managed funds industry had $1,824.3 billion funds under management.  Review the current figures for funds under management for up to date information.

Each managed fund has a specific investment style which may be based around a single asset class (e.g. equities), a geographic region (e.g. Australia), an investment  style (e.g. growth) or maybe a multi-strategy fund. Retail funds are often offered by one manager who then uses an underlying manager so they are able to offer retail investors access to a fund without a high initial investment. You frequently find the same underlying manager offered by numerous retail managers e.g. the Platinum International Fund has a minimum direct investment of $25,000 but is offered by ANZ, AXA, Access, BT, MLC, OnePath and Perpetual with various minimums.

Morningstar has a continually updated database of virtually all of the funds on offer which details more than 12,000 active funds. You may see lists of funds in investment magazines or newspapers but these lists are usually sourced from Morningstar.  

Morningstar currently groups funds by the following 44 categories and you can refer to the downloadable list of the 44 fund categories for more information.

 Impact of fees

There may be an upfront entry fee, an exit fee or a buy/sell spread. If you are using a financial advisor, there may be a commission element which comes out of any upfront fee - possibly as much as 5%. Some funds charge an upfront fee, even if you are not using an advisor and just hold on to it.

Some funds pay trailing commission to an advisor every year, typically of about 0.5% per annum. Some funds deduct trailing commissions anyway without any option to avoid it.

There are organisations on the internet which rebate up front fees but these will still collect at least some of any trail fees.

All funds charge a Management Expense expressed as a ratio or MER. The MER covers expenses for investment management, It is expressed as a percentage of your investment account balance. You can expect to pay from 0.7 per cent to 2 per cent. The more actively managed the fund and the more complex the investment strategy, the higher the fee.

Many funds charge performance fees. These are a percentage of returns achieved by the fund manager, typically those returns over and above either a set percentage or some accepted index. The purpose is to reward the fund manager for generating returns that are better than the market rather than returns generated simply by movement in the market as a whole. Some funds have 'high water marks' so they must make up any losses from previous periods before earning performance fees. Performance fees are typically from 10% to 20% of the outperformance.

You may see fees expressed as the Indirect Cost ratio or ICR which was a term introduced by ASIC to try to standardise fee reporting. The ICR normally includes the management fee, an estimate of any performance fee and also includes all the real expenses incurred by a fund as a percentage proportion of its average net asset value through a year. These expenses generally include legal, accounting, auditing and other operational and compliance costs. Because of the average calculations, these may be given as an approximate value. Some funds quote a management fee and may quote a separate ICR if the annual costs exceed the total of fees charged directly.

When comparing the ICR between funds, it's important to bear in mind that different fund managers may take different views. If a fund uses gearing, this may affect the ICR. If a fund invests in other funds, the head fund may not gross up all the lower level costs to their own ICR. If a fund is relatively new or has not been earning performance fees, the estimate of performance fee may be lower than another comparable fund that has earned performance fees.

Fees are charged to the fund simply by reducing the value of the units you are holding.

It is worthwhile to consider the likely impact of fees on your returns. If you accept that the long term return on Australian equities has been about 8% (including dividends of 4%), then giving a fund manager 2% is a massive 25% drag on your actual return. You pay this in good years and bad. You could also take the view that, given that you can achieve about a 6% return on guaranteed term deposits at the time of writing, by using a managed fund you are losing virtually all of the risk premium for investing in shares.