What it means
A fund issues units to investors and uses the pooled cash to buy a portfolio of assets, which might be shares, bonds, property, loans or a mixture of all four. The manager makes the buying and selling decisions within a mandate set out in the fund documents, and every unit holder shares in the results in proportion to the units they hold.
Funds matter to business people in two directions at once. Your company treasury may park surplus cash in a money market fund, and your pension scheme almost certainly invests through funds, so the mandate and the fee schedule affect real money you are responsible for.
The price of a unit is the net asset value, usually shortened to NAV: everything the fund owns minus everything it owes, divided by the number of units in issue. Open-ended funds create and cancel units on demand at that NAV, while closed-ended funds have a fixed number of shares that trade on an exchange and can sit above or below NAV.
Costs are the part most people underestimate. An annual management charge, custody fees, audit fees and dealing costs all come out of the fund before the return an investor sees, which is why published performance is normally quoted net of fees.
Funds come in active and passive varieties. An active fund pays a team to select holdings and charges accordingly, while an index tracker simply replicates a market at a fraction of the cost, and the gap between those two fee levels compounds year after year.
In practice
Real-world examples.
Example
A manufacturing group holds $8,000,000 of surplus cash in a money market fund yielding 4.2% rather than leaving it in a current account at 0.5%. The treasurer accepts the fund's next-day settlement in exchange for roughly $296,000 of extra annual income, and documents the liquidity risk in the board pack.
Example
A charity's trustees move their $12,000,000 endowment from four separate share holdings into a single multi-asset fund. Their reason is governance rather than performance: one mandate, one quarterly report and one manager to hold accountable is far easier for a volunteer board to oversee.
Example
A closed-ended property fund listed on an exchange trades at $8.60 a share while its NAV per share is $10.00. The 14% discount reflects investor doubt about the valuations of the buildings, and a would-be buyer must decide whether the discount is an opportunity or a warning.
Formula
Calculation
Formula: Net asset value = total assets - total liabilities. NAV per unit = net asset value / units in issue. Annual management fee = net asset value x fee rate.
Worked example: a diversified equity fund holds investments and cash worth $250,000,000 and owes $6,000,000 in accrued fees and unsettled purchases. Net asset value is $250,000,000 - $6,000,000 = $244,000,000. The fund has 20,000,000 units in issue, so NAV per unit is $244,000,000 / 20,000,000 = $12.20.
The manager charges 0.75% a year, accrued daily and deducted from the fund. That is $244,000,000 x 0.0075 = $1,830,000 for the year. An investor holding 5,000 units owns 5,000 x $12.20 = $61,000 of the fund and therefore bears $61,000 x 0.0075 = $457.50 of that charge, which is never invoiced but quietly reduces the unit price.Case study
Seen in the real world.
Harbourline Asset Partners is an invented firm used for this illustrative case study. It launched an open-ended fund that grew to $244,000,000 of net assets across 20,000,000 units, giving a NAV per unit of $12.20, and charged 0.75% a year for the mandate.
Three years in, a corporate client compared the fund's net return with a low-cost index tracker covering the same market. The active fund had returned 6.9% a year after fees against the tracker's 7.4%, a gap that on a $61,000 holding meant roughly $305 a year of forgone return.
The illustrative point is not that active management always loses. It is that the client only discovered the comparison because someone finally read the fee line, and any fund holding deserves that same annual sanity check against a cheap alternative.
Watch out
Common mistakes.
- Believing that owning one fund means you are diversified, when a single-sector technology fund can be more concentrated than a handful of directly held shares across different industries.
- Comparing a fund's headline return with a market index without checking whether the return is quoted before or after fees, which can swing the comparison by a full percentage point.
- Chasing last year's top-performing fund, since strong returns often come from one sector having a good year rather than any repeatable skill.
Questions
People also ask.
What is the difference between a fund and an ETF?
An ETF is a fund whose shares trade on an exchange throughout the day, while a traditional open-ended fund is priced once daily at net asset value.
Do I pay the management fee separately?
No, it is deducted from the fund's assets before the unit price is struck, so it reduces your return rather than arriving as an invoice.
Can a fund refuse to give my money back?
In stressed conditions some funds, particularly property funds, can suspend dealing to avoid selling buildings at fire-sale prices, which is why liquidity terms belong in your due diligence.
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