AFCE

What is mutual fund and why to invest in mutual funds?

Worldwide, investing in mutual funds is a favorite form of evaluation of free financial means. In recent years it has been one of the most frequent and recognized investment alternatives. Investors having experience with capital markets never invest their financial means only in one share or bond, because they know, that value of these securities may fluctuate a lot and the risk of loss is too high. Therefore their investments are distributed among more securities, for not all exchange rates of securities move in the same direction. Decrease in exchange rate of securities may be on the other hand compensated by increase in exchange rate of other securities in a portfolio. We say, that profit from two such securities are negatively correlated. Decrease in rate of some securities in a portfolio then has not that big influence on overall amount of investments. That means, that risk of loss is lower. Mutual funds portfolio management is based on similar principle, i.e. on risk diversification.

Principle of collective investing is to gather monetary means from public in order to invest them in assets, while observing principles of limitation and distribution of risk. Mutual funds are created from the means united by individual investors. Assets in mutual fund are coparcenary of shareholders and are created by securities, monetary means and other asset values, in which the mutual fund invested. Property rights of shareholders are represented by share certificates.

Asset management company manages assets of shareholders in mutual funds via its mutual funds managers. Role of managers is to achieve the highest profit possible at a certain risk. At the same time, a manager puts accent on provision of necessary liquidity.

Which mutual fund to choose?

Act No 203/2011 Coll. on Collective Investing as amended by the later regulations defines open-end and close-end mutual funds. Open-end mutual fund is a mutual fund, whose shareholder has the right to be paid share certificates from assets in this mutual fund at his/her request. The asset management company, that manages the open-end mutual fund, is obliged to pay the shareholder the submitted share certificate. That means, that the shareholder need not to look for a buyer. Sum, that is obtained by the shareholder when paid the share certificate, is equivalent to mutual fund net asset value falling on given share certificate owned by the shareholder, decreased by termination charge. This value is published by the mutual fund, so the shareholder always knows, how many financial means will he/she obtain after selling the share certificate.

Another type is close-end mutual fund, which is according to the foregoing Act specified as follows: close-end mutual fund is a mutual fund, whose shareholder has no right to be paid share certificates from assets in this mutual fund at his/her request. The asset management company, that manages the close-end mutual fund, is not obliged to provide the shareholder with the payment of the submitted share certificate. Therefore, share certificates of close-end mutual funds are traded at secondary capital markets and their value depends on demand and supply.

In addition to decision between open-end and close-end mutual funds, the investor decides also according to the strategy of the given mutual fund. The investor should choose priorities of investing via responses to these questions: What do I want to achieve by investing in mutual funds? What risk am I willing to take and for what period do I want to invest? What profit do I expect from such invested financial means? Response to the questions is to select one of the investment strategies or their combination.

Basic investment strategies:

• Monetary fund – invests in short-term assets, such as treasury notes, bonds with maturity up to one year and short-term time deposits and other monetary market instruments in domestic or foreign currencies.

• Bond fund – invests in fix-interest securities.

• Blend fund – invests in income securities, bonds, and stock. They represent a balanced combination of investments in bonds and stock. Indvidual blend funds differ by invested monetary means ratio in bonds and stock.

• Stock fund – invests a large part of monetary means in stock.

• Fund of funds (FoF) – invests sharholders’ means exclusively in shares of other mutual funds.

Advantages of mutual funds investment

• Low investment – one of the advantages of investing in mutual funds in comparison with traditional investing, is low initial investment, which reflects in less costs when buying securities. For some investors, investing in securities is unaccessible in terms of high initial investment required and high costs connected with the purchase of such security. Mutual fund takes advantage of this fact, for its assets include many small investments of individual clients and its investments are less expensive than investments of small clients. Advantage of lower investment in share certificate enables to use advantages resulting from investing large amount of financial means.  

• Professional management – activity of asset management companies and their funds are managed by experienced managers, who have long-time experience in the field of financial markets. Their work is to permanently monitor domestic and foreign financial markets and use all information systems and apply obtained information in favor of investment strategies of individual funds. It is very difficult for a small investor to monitor this market and react professionally on all changes. Therefore, it is better for him/her to engage in his/her activities, family and friends and leave the management of financial means to professional managers. For the client, investing in mutual fund means especially time and financial means saving and also professional securement against financial market risks.

• Risk / Profit – This form of investing offers the possibility of higher profit than in traditional time deposits, however, at higher risk. Purpose of every investor, as well as mutual fund manager, is to minimize risk and maximize overall profit. This purpose may be achieved by the portfolio diversification. Therefore, mutual fund manager places the investments to more securities issue, thus lowering the portfolio risk. Even the risk of investor, who is shareholder of such fond, is lowered, because he/she buys share in whole fund portfolio. The client may affect the investment risk at the beginning via choosing the fund with conservative strategy intended especially for debt securities.

• Liquidity – the second most significant attribute after risk and profit. For the investor it is important, in what period he/she may change his/her share certificates to financial means and vice versa. We can compare the liquidity of share certificates with bank products, where the investor has no possibility to obtain his/her financial means before the period, for which the deposit was placed, elapses, i.e. for too high cancellation fees. When investing in open-ended share certificates, profit comparable to bound bank products is achieved, while the investment is at disposal at all times. Share certificate payment period is usually 3-5 days, depending on the fund type.

• Available information – only true and reliable information are basic precondition for the right decision on handling the savings. Wihout information on offered mutual funds the client is not able to evaluate quality and risk of offered product reliable. Potential client should acquaint himself/herself with relevant documents of mutual funds before investing:

- statute, that is an inseparable part of the shareholder’s contract with the asset management company, 

- sellable leaflet, or simplified sellable leaflet of the mutual fund, 

- management reports and assets in the mutual fund, 

- current share price, purchase share price and open-end mutual fund net asset value and other information may be obtained from national periodic press publishing stock news, or on the website of Alico Funds Central Europe správ. spol. a.s.

- At the same time it is possible to communicate with employees of the asset management company, who will provide all other requested information.

•   Emitter risk – risk of interest profit and bond principal non-repayment. It may be lowered via portfolio diversification.
•   Market risk – this risk can not be removed via portfolio diversification. It is influenced by politic, budget and financial state policies. Stock (market) indices give the best picture of it.      

Profit amount

There is a certain risk connected with investing in mutual funds and asset management companies do not guarantee profit amounts. Mutual funds profit achieved in the past do not guarantee future profit. While investing, an important role is played by the amount of enrollment and exit charges and investment period. Investment in share certificates represents long-term investing with recommended time period of 3-5 years. This time period enables mutual funds managers to apply selected investment strategy in order to achieve expected profit from mutual fund assets. However, that does not mean, that the open-end mutual fund shareholder can not ask for repayment of his/her share certificate anytime. However, he/she must reckon with the fact, that when he/she return the share certificate, the investment does not have to bring expected profit.

Protection of investors

Although the investment in mutual funds is not subject to Act No 118/1996 Coll. on Deposit Protection as amended by the later regulations, protection of the investor (share certificate owner) is provided in the field of collective investing. Basic protection is provided by Act on Collective Investing No 203/2011 Coll. (hereinafter referred to as “ZKI“) as defined in the 8th section. National Bank of Slovakia supervises shareholders’ interests protection and performs its activity in accordance with Act No 747/2004 Coll. on Financial Market Supervision. Another guarantor, who supervises the activity of the asset management company is depository. Depository of a mutual fund may be only a bank or branch office of a foreign bank, which in its permit, according to individual acts, has defined additional investment service, that is keeping or management of investment instruments. Depository of open-end mutual fund, whose share certificates are publicly offered in the territory of a member state in accordance with § 60, may be only bank with seat in Slovak territory or foreign bank with seat in a member state, which has a branch office established in Slovakia. Depository performs activities in accordance with § 72 of ZKI and also supervises, whether issue and repayment of share certificates and their cancellation is performed in accordance with ZKI and the statute, supervises concordance of using mutual fund profit with ZKI and with the statute. It supervises concordance of orders of the asset management company with ZKI, and whether value of assets acquired into mutual fund assets or sold from mutual fund assets is determined in accordance with ZKI and with the statute.