What it means
The pooling is the point. A saver with $5,000 cannot sensibly buy fifty different companies, but a fund holding several hundred million dollars can, so each unit holder gets a slice of a diversified portfolio for a modest sum.
Equity funds come in two broad flavours. Active funds employ managers who research companies and try to beat a benchmark index, while passive or index funds simply hold the constituents of an index in proportion, which costs far less to run.
Charges matter more than most investors expect. An ongoing charge of 1.5% a year against a passive alternative at 0.15% is a difference of well over a percentage point of return every year, compounding relentlessly over a working lifetime.
Funds are usually categorised by what they invest in: geography, company size, sector or investment style such as growth or value. That label tells you the risk profile, since a fund holding small companies in a single emerging market will behave very differently from one holding large global businesses.
The price of a unit is its net asset value, calculated by valuing everything the fund owns, subtracting liabilities and dividing by the number of units in issue. Most funds price once a day, so investors buy and sell at a value calculated after the order is placed rather than at a live market price.
In practice
Real-world examples.
Example
A company pension scheme moves its default fund from an actively managed global equity fund charging 0.85% to an index tracker charging 0.12%. On $40,000,000 of member money that saves roughly $292,000 a year in fees, which stays in members' pots.
Example
A cautious saver five years from retirement shifts 60% of her holding out of an emerging markets equity fund into a bond fund. The move cuts her expected return but also cuts the risk of a large fall just as she needs to draw the money.
Example
A charity's investment committee holds an income focused equity fund that pays quarterly distributions. The distributions cover about a third of the charity's running costs, so the trustees monitor dividend cover in the underlying holdings closely.
Think of it
“Equity fund invests in stocks-ownership stakes in companies.
Formula
Calculation
Net asset value per unit = (total value of fund assets - fund liabilities) / units in issue
A global equity fund holds shares and cash worth $250,000,000 and owes $2,000,000 in accrued fees and unsettled trades. Its net assets are $250,000,000 - $2,000,000 = $248,000,000. With 10,000,000 units in issue, the net asset value per unit is $248,000,000 / 10,000,000 = $24.80.
Charges then work on the return. An investor puts $50,000 into the fund, and over the year the portfolio delivers a gross return of 8% while the fund's ongoing charge is 0.75%. The net return is roughly 8% - 0.75% = 7.25%, giving a gain of $50,000 x 0.0725 = $3,625 rather than the $4,000 the gross figure suggests, with the $375 difference going in charges. Held for ten years at that net rate, $50,000 would grow to about $100,700, whereas the same money compounding at the full 8% would reach about $107,900.Case study
Seen in the real world.
This is an illustrative and entirely fictional example. Kestrel Growth Fund, an invented actively managed equity fund, marketed itself on a five year record of beating its benchmark by an average of 1.8% a year. Money poured in and the fund grew from $180,000,000 to $2,400,000,000 in under three years.
The manager's edge had come from taking meaningful positions in smaller companies, which is difficult at scale because buying enough of a small company moves its price. As the fund grew, the manager drifted towards larger holdings that were easier to trade, and performance settled close to the index while the 1.4% charge stayed exactly where it was.
Investors in this fictional example ended up paying an active fee for something that increasingly behaved like a tracker. The lesson the illustration is meant to make is that past performance and current size interact, and a strategy that worked at $200,000,000 may not survive at ten times that.
Watch out
Common mistakes.
- Choosing a fund purely on last year's performance, when short term rankings are heavily influenced by whichever sector happened to do well.
- Assuming a fund is diversified because it holds many companies, when a portfolio of forty technology shares still carries a single sector risk.
- Ignoring the ongoing charge because the percentage looks small, when a one percentage point difference compounds into a large sum over decades.
Questions
People also ask.
What is the difference between an equity fund and an index fund?
An index fund is one type of equity fund that simply tracks a benchmark, whereas an equity fund can also be actively managed with a manager selecting holdings.
Do equity funds pay income?
Many do, distributing the dividends received from their holdings, though accumulation units reinvest that income instead of paying it out.
How risky is an equity fund?
Riskier than cash or most bond funds, since share prices can fall sharply, and the usual guidance is to treat it as a holding for five years or more.
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