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Characteristics of an investment fund

What is an investment fund?

An investment fund is a vehicle that allows a number of separate and unrelated investors, a group of individuals or companies, to make investments together. By pooling their capital, investors can share costs and benefit from the advantages of investing larger amounts, including the possibility of achieving a broader diversification among a number of different assets and thus spreading their risks. There are many possible arrangements in the way an investment fund can be set up and operated, generally depending on the needs of the fund’s investors.

The number of investors in a fund is not fixed. Investment funds can be designed in different forms, for example as an investment company with a board of directors and the investors as shareholders, or as a contractual agreement between the investors and the management company. Funds can be initially set up with an indefinite lifespan, or for a fixed period. They can hold traditional financial assets such as shares and bonds, or investments as exotic as vintage wines, paintings or copyright rights. They can generate income for investors, or seek to maximise the capital value of their investments. They can be open for sale to any individual investor, or be restricted to sophisticated investors such as financial institutions or very wealthy families.

Luxembourg’s fund laws cover many different kinds of fund, but the most important category is UCITS funds, which are set up according to the strict rules prescribed by the European Union and may only invest in certain investment classes. UCITS funds can be purchased by investors in any European country where they are authorised for sale, and in a number of countries in other regions or on other continents where they are permitted, such as certain Asian countries. Luxembourg is home to nearly three-quarters of all the European funds that are sold to investors in more than one country.


FCPs and SICAVs are two of the most important fund types in Luxembourg. Both kinds can be set up as UCITS funds. FCP stands for the French expression "Fonds Commun de Placement", meaning a common investment fund. Like a unit trust in the UK, an FCP is set up in the form of a contract between the fund manager and the investors, in a similar way to a partnership, and is not a separate legal entity in its own right. Instead, the legal entity is the management company setting up the fund. Investors hold units in an FCP.

SICAV stands for "Société d’Investissement à Capital Variable",or open-ended investment company, whose ownership is in the form of shares. With SICAVs, the fund itself is a stock corporation and thus a legal entity. The company's capital depends on the amounts paid in by investors. As with an FCP, shares in a SICAV are bought and sold on the basis of the value of the fund’s assets, or net asset value. In accordance with applicable law and regulations, a SICAV can either appoint a separate management company or can be self-managed.

Technically, it makes little difference in practice whether a fund is an FCP or a SICAV. However, there may be personal tax implications and you should consider this carefully with your financial advisor.

Accumulation v. distribution

Some investors want to receive regular income from their fund investments. However, others want to build up the value of their initial investments by reinvesting any profits in the investment fund. Therefore, funds offer a choice between distribution units, which pay out earnings (e.g. from any interest or dividends received) at regular intervals, and accumulation units, which automatically reinvest earnings on fund assets back into the fund.

An investment fund with distribution units may be the right choice if you need extra income from your investments on a regular basis, while accumulation units may be better suited for your needs if you are investing for a long-term goal such as retirement. The value of distribution shares may rise in value over time, but the increase will probably not match the rapid growth experienced by an equivalent investment in accumulation shares, since distributions decrease the fund's assets, and thus, its unit price.

As a rule, the reinvestment of earnings with accumulation units is free of charge and occurs automatically. By contrast, if you first had the earnings credited or paid out as you would with distribution units and then reinvested that amount in additional units in the fund, you might pay a sales charge of several percent. Depending on the laws of your country of residence, the tax treatment of distribution and accumulation shares may be different, and you should carefully consider this with your financial advisor.

Umbrella funds

Many Luxembourg investment funds are so-called umbrella funds, which consist of multiple sub-funds that in effect function as separate investment funds but form a single legal entity. This enables funds with different strategies or that are designed for different types of investor to be established within the same legal structure, which can reduce the funds’ costs. Generally, the cost of shifting assets from one fund to other is low for investors if both funds belong to the same umbrella fund. Depending on the rules in your home country, however, shifting assets could also entail tax consequences.

How a fund price is determined

The price of a unit (FCP) or a share (SICAV) in an open-ended investment fund is determined by the value of its assets and is measured as its Net Asset Value (NAV). The NAV is calculated as the market value of the fund’s assets, minus any liabilities such as expenses or other debt. This figure is then divided by the number of shares or units in the fund that have been issued to investors. For example, if a fund has assets valued at €100 million and liabilities of €5 million, it has net assets of €95 million. If 10 million shares or units are held by investors, its NAV per share or unit is €9.5. That is the price at which shares or units can be bought in the fund or sold back to it, minus (for sales) or plus (for purchases)any fees and commission charges.

Understanding costs and fees

Investors face various fees and charges when they buy and sell fund units, and the investment fund itself will be subject to various fees that are paid out of the fund’s assets. Investment in funds often involves an initial charge that may be as much as 5% of the value of the initial investment. Normally, this surcharge is not retained by the fund company but rather serves to cover costs of distribution services, as with commissions paid to fund distributors such as banks or other financial advisors. Some funds also charge deductions when fund units are sold or redeemed, especially where the units have only been held for a very short period of time.

The ongoing costs incurred by the investment fund are usually measured as its Total Expense Ratio or TER. This comprises the fee paid to the fund management company for deciding on and managing the fund’s investments, as well as other costs involved in operating the fund. These include safekeeping of assets by the fund’s custodian bank, calculation of the Net Asset Value, legal fees, auditing and marketing costs.

An important component of the investment fund’s cost structure will be the fee charged by the fund manager, which depends on the complexity of the fund’s investment strategy. This means that the TER of actively managed funds can be as high as 2% or even more for very specialised or exotic funds. By contrast, the TER of a passive fund that aims to replicate a specific index is usually less than 1%.

Understanding investment fund information

You can receive information about an investment fund from a variety of sources, the three most important being the fund prospectus, the fund's annual or semi-annual report and the fund's marketing material (including the fund manager's website). All of these sources have the goal of providing investors with information about the characteristics of the fund, although they all put the focus on different aspects and have different ways of providing the information. It is important to read as much information as you can and discuss it with your financial advisor before you make your investment choice.

The fund prospectus is the key document from the investment fund. It provides comprehensive details of the fundamental mechanics of the fund, along with an in-depth assessment of the related risks. While the fund prospectus is an important document it can also be a daunting one. The amount of information can often be overwhelming and jargon-heavy, and investors may need the help of a financial advisor.

Until June 2011 UCITS funds were also required to produce a ‘simplified prospectus’ providing a summary of the main prospectus, but this has not proved as user-friendly as originally intended. To replace this, the UCITS IV directive requires fund managers to produce a Key Investor Information Document (most often referred to for short as the KIID, but also sometimes as the KII or KID). This consists of a concise yet comprehensive overview of the fund’s main features, written in plain language and produced in a standard format. In most cases it covers two A4 pages. Although a tree-page variant exists for structured funds.

Key Investor Information Document

The Key Investor Information Document is a short document that aims to describe the fund in terms that investors should find straightforward and easy to grasp. Its aim is to improve understanding among retail clients of how funds operate and what risks they entail. Fund managers must produce a KIID for every UCITS fund they market and they may choose to produce a separate document for each distinct class of shares or units in a particular fund, for example because performance may vary as a result of the currency of the investment or the distribution policy of the shares or units in question.

The KIID is intended to be self-sufficient; the investor should not have to read the fund’s prospectus in order to obtain enough information to make a decision on whether the fund is an appropriate investment for their needs and investment profile. The UCITS IV directive stipulates that at a minimum, it should contain the name of the fund, a short description of the fund’s investment objectives and policy, a description of past performance or performance scenarios, details of costs, and the fund’s targeted risk/reward profile, as calculated by a measure known as the Synthetic Risk and Reward Indicator (SRRI). It should be written in plain language and predefined form, content and length, enabling investors to compare one fund with another more easily. 

Significant changes to the fund, such as in its risk/reward profile or in its personnel – will require amendment of the KIID (as well as notification of regulators in all the EU countries where the fund is marketed). In addition, the document should be updated at the end of each year and the new version issued within 35 working days of the year-end. Funds established up to July 1, 2011 benefit from a ‘grandfathering’ clause that gives them up to 12 months to publish a KIID for the first time, but all funds launched from that date onward must have the document ready immediately. The KIID must be published in one or more of the official languages of any member state in which the fund is marketed, or any other language approved by the financial regulator in a particular country.

The format and content of the KIID is controlled by the fund’s regulator, the CSSF in the case of Luxembourg-based funds. For the investment fund industry, the document is a means of delivering information in a more user-friendly form than ever before, which should help to increase investors’ trust in fund managers and their products. All Luxembourg UCITS funds will operate under the same rules, but other EU member states may set slightly different rules for funds established in their jurisdiction on what the KIID should contain and how the information is presented.

  • What the KIID contains

The document is headed by the name of the fund and any multi-compartment umbrella structure of which is may be a sub-fund, the share or unit class if appropriate, the name of the fund management company and any bigger corporate group it may belong to.

The first section covers the fund’s objectives and investment policy. The fund’s goals may include generating income, producing capital growth or in many cases a mix of the two. The investment policy should state what kind of assets the fund invests in, including the type of securities and the characteristics of the companies that issue them, notably the countries in which they are based and the economic sector (such as mining, agriculture, steel, transport, manufacturing, technology or service industries) in which they are active. For example, an investment policy might state that 75 per cent of the assets of the fund may be invested in the shares of banks and financial services companies based in or active in the United States. This section may mention any relevant benchmark, such as a market index used as a measure of comparison for the fund’s performance. It may also include a recommendation, if any, about the minimum period of investment that may be necessary in order to benefit from the fund’s investment strategy, for example one year.

The Synthetic Risk and Reward Indicator indicates the fund’s position on a scale between 1 (the lowest level of risk, but potentially bringing a lower reward) and 7 (the highest level of risk, with a potentially elevated reward to match). The document should explain in greater detail what the fund’s risk level means, some of the factors that might produce changes in its performance, and why the fund has received this particular rating. It may also mention other risks, for instance exchange rate fluctuations that might affect returns from emerging market funds.

The KIID will detail charges taken from individual investments or from the fund’s assets that will reduce the returns received by the investor. These include charges for purchase or sale of the fund’s shares or units, as well as for switching between different compartments of an umbrella fund, all calculated as a percentage of the investment value. The document will also list the most recent year’s charge against the fund for management fees and other expenses, as well as any additional performance fee that the manager may charge on returns above a specified level. 

The KIID includes details of when the fund was launched, its base currency and the currency in which its performance is calculated, if different. It should chart performance as the year-on-year change (in percentage terms) in the fund’s net asset value, as well as the corresponding figure for any benchmark the fund uses. This calculation takes into account ongoing management charges and other expenses paid by the fund, but not entry, exit or switch charges paid by the investor.

Finally, the document should include practical information such as the identity of the depositary bank that provides safekeeping for the fund’s assets and where they can find further information including annual (and semi-annual) reports, the most recent net asset value figure, information about other share classes or sub-funds and how to switch between them. All this information should be published on the web site of the fund’s manager or promoter.

Fund prospectus

Information within a fund prospectus falls into four main categories: investment objectives and strategies, risk, performance and information for investors. Before reading a fund prospectus, you should first look for the publication date, since changes can be made to a prospectus over time. Investors should make sure that they have the most up-to-date version. A prospectus can normally be found on the fund management or fund promoter’s website along with any updates on fund details. By contrast with the KIID, there is no obligation to translate the full prospectus and financial accounts of the fund into the official or other languages of countries where the fund is marketed if these are already available in “a language customary in the sphere of international finance” – in practice English.

  • Investment objective and policy

All investment funds are launched with a clearly defined investment objective or policy. The prospectus will explain what investment policy the fund will follow and what asset classes it will use to achieve its goals. In many cases the prospectus names the benchmark figures, such as indices, that will be used to assess the performance of the fund. Information could also be provided about the benchmark index, particularly in the case of passively managed funds, which aim to track this index as closely as possible.

Two different investment funds may have the same investment goal but use different methods to achieve it. The prospectus will outline what investment restrictions and limits the fund is operating within – for instance, the maximum amount that can be invested in a single asset, and whether and how the manager may use derivatives. Using this description, investors can decide whether the fund’s investment goals and policy are in line with their own investment needs.

  • Risk

Investors should always be clear about the type of risk an investment fund will incur in order to achieve its goals, and should also understand the different types of risk. The prospectus explains which risks the fund is exposed to – such as credit, liquidity, interest rate, currency and market risk. Beside the risk profile of the fund you may also see details about the risk profile of a typical investor who might consider this type of fund. This information and the data on the level of risk to which the fund is exposed will help determine if the fund is a suitable investment choice for you.

For instance, the prospectus of an equity sector fund should explain that, in general, the fund is exposed to a significantly greater degree of risk because it invests exclusively in securities from a single sector. The prospectus of a bond fund may highlight the typical quality and creditworthiness of securities from industrialised regions compared with those from emerging economies.

  • Performance

A prospectus may contain performance information including a historical review of the investment fund’s performance over specific time periods. This information also allows you to see whether the fund has met its performance goals in the past. In some cases, charts are used to show the evolution of the fund’s performance and provide a clear visual analysis of its price fluctuations (volatility). You can also use this information to compare the performance of funds that have similar goals but different fund management.

It should not be forgotten that investment funds that resemble each other in terms of their investment policy or investment objective are not necessarily managed in the same way. Comparing fund documentation can help you identify differences in structure and strategy. Furthermore, every fund prospectus will state clearly that past performance is not a predictor of future performance – something investors always need to keep in mind.

  • Investor information

This section of the prospectus will include information on how the investment fund is valued and details of how the net asset value (NAV) at which you buy or sell units in the fund is calculated. Here, you will also find out how you can buy and sell fund units as well as the costs associated with doing so. If applicable, the prospectus also provides information about a mandatory minimum investment amount when purchases units.

Annual report

An investment fund's annual report provides you with information about how well the managers have been performing. It is an important document that presents the fund’s operations over a specific period and its overall financial position. In the introduction by the fund manager you will find a review of the fund’s overall performance and a discussion of the markets and investments. Using the annual report, you can assess whether the fund has properly implemented its investment policy, and whether it remains suited to your needs and investment profile. An annual or semi-annual report will set out the fund’s return, the assets it holds and expenses incurred. The annual report will also contain a report from the fund’s independent auditor, who will have checked and certified the accuracy of the fund’s accounts.

Marketing documents

Marketing documents place a particular emphasis on the advantages of investing in a given fund (the KIID is not marketing material). They are presented in a style and tone that are aimed at the reader and often refer to the benefits of the investment fund in connection with a specific lifestyle-related theme, such as retirement or funding an education. The purpose of marketing materials is to win new investors. While the paper may be glossy and the images attractive, it should also contain important information about the fund, which might include the fund’s investment goals and investment policy as well as figures related to the fund’s past performance. Marketing material should always be read in conjunction with the fund prospectus.

How to buy or sell fund units or shares

The investment fund’s prospectus will explain how often fund units or shares can be bought (subscription) and sold (redemption). Most UCITS funds offer daily subscription and redemption, although some restrict this to once a week or twice a month. Sometimes funds may be closed for new subscription and therefore investors cannot purchase units, or fund units can only be purchased by existing investors in the fund.

The purchase (subscription) costs and sales (redemption) proceeds will be equal to the value of your share of the fund’s assets, plus or minus any fees and commission charges. This information is also included in the fund’s prospectus.

The way fund units can be purchased and sold varies from country to country and may differ as a result of the distribution channels used by the management or investment company. This information will be available from your financial advisor or the fund management company. The fund prospectus should also provide details about distribution channels, paying agents and any other agents that can provide this information.

Updated on 30/01/12  
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