What it means
A capital appreciation fund collects money from many investors and puts it into a portfolio chosen for price growth. Because the objective is growth, these funds typically hold shares in expanding companies rather than high dividend payers, bonds or cash.
The label matters because it tells you what trade-off you are accepting. These funds normally show stronger gains in rising markets and sharper falls in weak ones, and they distribute little cash along the way.
Investors judge them on total return, which combines any distributions with the change in net asset value, the per unit value of everything the fund owns after costs. Performance is usually compared against a growth oriented market index over at least five years, because shorter periods tell you more about the market than about the manager.
Two practical details catch people out. The fund's published objective is a statement of intent rather than a promise, and the ongoing charges figure, often somewhere between 0.1% and 2% a year depending on whether the fund tracks an index or is actively managed, is deducted from returns before you see them.
The nuance is that a growth objective does not define the risks taken to reach it. Two capital appreciation funds can hold completely different things, from large listed technology companies to small overseas businesses, so the objective must be read alongside the actual holdings.
In practice
Real-world examples.
Example
A 34 year old employee choosing a pension investment option moves her contributions into a capital appreciation fund because she will not draw on the money for 30 years. She accepts that the balance may fall by a quarter in a bad year in exchange for a higher expected long-run return.
Example
A charity with a permanent endowment splits its portfolio, keeping 70% in a capital appreciation fund for long-term growth and 30% in an income fund that covers this year's grant programme. The split lets the trustees spend without being forced to sell growth assets in a falling market.
Example
A financial adviser reviews a retired client's holdings and finds 80% sitting in a capital appreciation fund that pays almost nothing out. Because the client needs $3,000 a month to live on, the adviser moves part of the portfolio into income producing holdings to avoid selling units every month.
Formula
Calculation
Fund Total Return = (Ending Net Asset Value - Beginning Net Asset Value + Distributions Per Unit) / Beginning Net Asset Value x 100. A capital appreciation fund starts the year with a net asset value of $40.00 per unit, ends it at $46.00 per unit and pays a small distribution of $0.40 per unit. The return is ($46.00 - $40.00 + $0.40) / $40.00 = $6.40 / $40.00 = 0.16, or 16%. An investor holding $25,000 at the start of the year therefore has $25,000 x 1.16 = $29,000 at the end, of which $250 arrived as cash distributions, being $0.40 on each of the 625 units bought at $40.00, and the rest as a higher unit price.Case study
Seen in the real world.
Kestrel Horizon Growth Fund is an invented, illustrative fund used here only to show how these products behave. Over a fictional ten year run it returns an average of 11% a year against 7% for a broad market index, but it does so with two separate years in which units fall by more than 20%.
In this illustrative scenario two investors buy at the same time. One reads the objective, understands that the fund exists for growth and holds through both falls, ending with roughly $28,400 on an initial $10,000. The other sells after the first bad year, moves to cash and ends with about $8,900.
The fund did exactly the same thing for both investors. The difference in outcome came from whether the holding period matched the fund's stated objective, which is why advisers spend as much time on time horizon as on fund selection.
Watch out
Common mistakes.
- Buying a capital appreciation fund for money that is needed within two or three years, when a fall at the wrong moment cannot be waited out.
- Judging the fund on one year of performance, which mostly measures the market rather than the manager's skill.
- Ignoring the ongoing charges figure, because a 1.5% annual fee compounds into a large share of the final balance over several decades.
Questions
People also ask.
Do capital appreciation funds pay dividends?
Some pay a very small distribution because the underlying shares pay something, but income is not the objective and should not be relied on.
How is this different from a growth fund?
In everyday use the two labels mean much the same thing, and the real differences are in the stated benchmark, the holdings and the charges.
Are these funds riskier than balanced funds?
Usually yes in terms of swings in value, because they hold a higher proportion of shares and little or nothing in bonds or cash.
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