ABC of funds - Overview of collective investment schemes
Once upon a time, the idea was that "small savers" would also be given the opportunity to participate in the capital market. Over the past decades, this idea has given rise to a financial industry of enormous proportions. There is hardly a securities account today that is not enriched with fund investments. Often, collective investments even outweigh direct investments. Particularly in asset management mandates, there is now a targeted and broad-based use of fund units, ETFs and the like. Fund investments are also very popular in the "pots" of pension assets.
The core idea was that with investment funds a broadly diversified investment is possible and also the "small investor" can let his "savings penny" flow risk-free into the most diverse investment themes ... supposedly risk-free. However, a classic mistake is still often made today in advising investors by suggesting that targeted diversification in a fund also massively minimises the risks. This is correct in principle, but only with regard to the default or bankruptcy risks of an individual fund component. With regard to the overall market risks (stock crash, interest rate fluctuations, political risks, etc.), even the fund investor is not immune to (temporary) book losses. Nevertheless, a fund investment is generally a very good thing, especially if you use it as an admixture or to participate in special investment themes.
In connection with fund investments, there are many questions to be clarified beforehand and often as well. In the following, we will try to clear up any clouds of fog and briefly illuminate some interesting facts about this topic. Let's start with a table on the legal framework in Switzerland:
|CISA||Collective Investment Schemes Act; Federal Act on Collective Investment Schemes|
|KKV||Ordinance on Collective Investment Schemes|
|CISO-FINMA||Ordinance of the Swiss Financial Market Supervisory Authority on Collective Investment Schemes|
|FINMA||Circular of the Swiss Financial Market Supervisory Authority|
|SBA||Guidelines of the Swiss Bankers Association|
|SFAMA||Publications of the Swiss Funds & Asset Mgmt. Assoc.|
The legal interrelationships in the fund business are very complex in some parts. However, it is primarily the banks, fund companies and other bodies involved that are called upon to deal with this. The Federal Act on Collective Investment Schemes (CISA) can be found under the following link:
For the investor, the KAG is only of marginal importance. Rather, one should deal with specific questions before buying fund units. A not seldom large "puzzle" arises already with the name of the fund shares; also to it we described the "puzzle solution" in detail. But let's start one after the other:
Overview of the individual questions and contents
A fund is an independent legal entity that is managed by a fund management company. Funds can be independent or operate as subsidiaries, e.g. of a financial group. Each fund has a fund management team that makes the investment decisions for the various fund-specific securities and subjects the fund portfolio to an ongoing analysis process.
Each individual fund pools securities according to various predefined criteria or themes. For example, there are equity funds, bond funds, real estate funds, money market funds, country/regional funds, sustainability and other theme funds, commodity funds, etc. Within such criteria, there are gradations according to currencies, distribution types, legal forms, etc. Furthermore, investments can also be made in mixed funds that cover various criteria or themes at the same time.
Funds are accountable and must comply with the various legal requirements, as shown on page 1.
The fund is best thought of as a large pool into which the many individual investors contribute a variable portion of their assets. In return, the investor receives a certain number of fund units corresponding to the amount invested. The gross value of a fund share is calculated on the basis of the value of the investments held within the fund, while the net value (NAV - net asset value) is calculated after deduction of all costs. And as a result, you automatically participate in the fluctuations in value of the pooled investments.
The aim of any fund is to achieve the broadest possible diversification within the investment objective. This deliberately reduces the risk of loss compared to a direct investment. Take the example of an equity fund: if the market price of a share held in the fund falls to the point of total loss, the other shares in the fund can generally absorb such a setback.
There are further advantages for investors: You are already involved with small sums and you do not have to worry about price and market developments on a daily basis.
Here the matter can already become quite confusing, especially since there are no limits to the creativity in naming a fund. As a rule, the investment purpose is still recognizable, but in addition there are usually many different abbreviations or specific technical terms, which even not every professional understands at first go. If you have any questions regarding fund names or in general, it is always advisable in such cases to consult the factsheet of the relevant fund investment... or you can refer to this guide:
For the individual explanations, we use the following fund as an example:
Swisscanto (LU) Equity Fund Systematic Responsible Japan (JPY) CT - Valor: 44,399,635 / ISIN: LU1900092203
- Fund purpose: This fund of the Swisscanto fund company invests in shares of companies in Japan using its own model-based investment approach. Stock selection is based on factors such as value (low-valued stocks), quality (good-quality stocks) and momentum (stocks with a positive trend). The portfolio is sector neutral. The sustainability approach is described in the factsheet. The fund is suitable for investors who have a long-term investment horizon, wish to participate in the development of the Japanese equity market, are interested in high capital growth ("who are not") and can cope with major price fluctuations.
With the "interpretation" of the designation "Systematic Responsible" alone, the fund purpose is hardly discernible without a factsheet!
- Country of domicile of the fund: In the name of our example fund it says (LU), which is synonymous with the issuing country, in this case standing for Luxembourg. Other abbreviations are e.g. (CH) for Switzerland, ( DE ) for Germany, (US) for the USA or (XS ) for the European Union. As you can see above, the country of domicile can also be derived from the ISIN (International Identification Number).
The country abbreviation is also important with regard to the authorisation of the fund. The investor must clarify, or the bank or online platform will inform him, whether the fund in question is authorised in Switzerland or not.
- Fund currency: The name of our example fund also states (JPY), which indicates the underlying currency of the fund. The investor is therefore investing directly in Japanese yen here. Here, the other common abbreviations apply, such as (CHF) for the Swiss franc, (USD) for the US dollar or (EUR) for the euro.
However, if you do not want to take on any exchange rate risks when investing in a fund in a foreign currency, look for the designation (hedged) or just the letter (h) in the fund name or in the factsheet; these abbreviations indicate currency hedging. In our example, none is linked to the fund terms.
- The "dear" fund tranches (unit classes): Here the matter with the abbreviations becomes somewhat more "troublesome", among other things because the individual fund companies maintain different standards in scope and labelling. The tranches are aimed at different investor groups, for example, and may also contain different provisions in other respects, not least in terms of fees. You will find both letters and numbers in the "tranche salad".
In our fund example, you will see the letter "C" for the tranche; the "T" then stands for the distribution form (see next section). For illustration purposes, we only list the various Swisscanto tranches here and, also as an example, only assign the concrete conditions to the first two classes (the rest is beyond the scope):
The A class is offered to all investors. A flat-rate management commission is charged.
The B class is only offered to investors whose financial intermediary has concluded a cooperation agreement with Swisscanto Fondsleitung AG. A flat-rate management commission is charged.
Furthermore, Swisscanto has the fund classes C, D, F, M, N, Q, R and V.
- Type of distribution: The primary distinction here is between accumulating and distributing funds. By definition, the term "reinvestment" refers to the direct reinvestment of distributions (interest, dividends) within the fund. This is reflected in the unit value and thus the investor benefits from the compound interest effect. In the case of direct "distribution", the interest and dividend income is paid out to the investor.
In the case of our Swisscanto example, the investor can therefore see from the letter "T" that it is an accumulating fund. In this respect, one also finds the abbreviations "Acc", which stands for "Accumulate", or "C" or "Cap" for "Capitalisation". For distributing funds, we find the abbreviations "A" (distribution), "Inc" (income) or "Dist" (distribution).
- Type of investor category: Here, the target group is then indicated by a letter. For example, a capital "I" in the fund name indicates the category of institutional investors, a "P" or "R" indicates private individuals, a "V" may specifically indicate pension funds, and a "Q" may indicate qualified investors. Depending on the fund company, these abbreviations may also vary, as is the case with the share classes.
- Regulatory designations: Here the matter becomes more complex again, especially since certain laws and regulations are formulated in great detail. We will limit ourselves to the overriding main features. The following additions may appear in the fund name:
This abbreviation stands for "Société d'Investissement à Capital Variable"; company with variable capital. The term SICAV is used as a legal form for funds where the number of shares is not fixed in advance, which is equivalent to an open-ended fund.
A small nuance, but a significant difference. Here the full name is "Société d'Investissement à Capital Fixe"; company with fixed capital or closed-end fund.
Both of the above-mentioned legal forms have in common that they must provide investor protection on the basis of an EU directive, combined with the obligation to provide investors with important fund information. The abbreviation UCITS is synonymous with "Undertakings for Collective Investments in Transferable Securities".
In the case of active funds, the fund managers have an ongoing duty. Like any other portfolio manager, they analyse the individual companies under consideration, the markets, the valuations and much more. If the fund manager is successful in selecting the individual fund components, this has a corresponding effect on the positive performance of the respective fund.
Passive funds are structures that use predefined investment instruments. As a rule, these are index funds that simply replicate the underlying index 1:1 without any great expertise. This category also includes the widespread ETF products (Exchange Traded Funds). For example, if you buy an ETF on the SMI (Swiss Market Index), you know that the ETF will invest in all the shares included in the SMI, with exactly the same weighting as the index. Weighting adjustments are made automatically. With regard to the costs, it should also be mentioned that these are lower for passively managed products.
The fees of a fund can quickly lead to lower returns, especially if at the same time the investment or performance leaves much to be desired. When buying fund units, the investor usually pays a front-end load, which is added to the purchase price. This surcharge varies depending on the type of fund (equity fund, bond fund, etc.) and the distribution channel (financial intermediary, stock exchange, etc.). In any case, it covers distribution and advisory costs.
In the case of actively managed funds, management fees are also charged to cover the costs of fund management. Funds that are listed on the stock exchange and can therefore be purchased directly through this channel do not incur an issue surcharge because the investor does not receive any direct advice.
Sales via the stock exchange or redemptions of funds that are not traded on the stock exchange are generally net, i.e. without any premiums or discounts. The banks' other commissions (brokerage fees) may be incurred depending on the fee profile. Normally, however, no brokerage fees are charged on the redemption of fund units and the turnover tax and stock exchange fee do not apply.
If you decide to invest in an ETF product, the costs are much lower. There are definitely no issue or redemption fees charged by the ETF itself. As usual, however, the bank's fees (brokerage fees), those of the federal government (turnover tax) and the compensation for the stock exchange (stock exchange fee) remain... Costs, therefore, as with all other stock exchange transactions.
In addition to point 5, here is an explanation of a term that is often heard or read in connection with funds. The TER or Total Expense Ratio. This is nothing other than the management and distribution costs of a fund. These costs are deducted annually from the total return of the respective fund shares. The TER ratio can either be looked up on the relevant factsheet or asked for from the investment advisor at your bank.
In this context, the size of the fund or its invested capital is also important. If the fund volume is only in the double-digit million range, the fund is likely to find it difficult to operate profitably. Basic rule: The higher the fund volume, the better the prospects. But it is also important to consider how long a fund has been in existence.
There are no contractual obligations for the investment period. A key criterion of fund investment is precisely that the investment horizon should be in the longer term. In addition, an open-end fund can be traded at any time (purchase and sale). But here too, "no rule without exception" applies. Open-ended real estate funds, for example, may have holding periods and an investor may have to give early notice of the planned sale of his units. This understandably prevents a real estate fund from being forced to sell properties at short notice in order to repay the seller of the fund units. In such and similar cases, the "closed-end fund" is therefore also applied.
In contrast to open-ended funds, which in principle also always aim to "collect" money without a term, investors in a closed-end fund can only acquire fund units during a fixed time window. At the end of such a period, the fund is "closed". This can apply, for example, as already mentioned in section 6, to major real estate projects or to the acquisition of existing properties. Another suitable example is the construction or acquisition of a cruise ship: if the capital for this cannot be raised by issuing shares or direct financing from investors - a cruise ship is not cheap - the solution could be a closed-end fund.
As a rule, the shareholder in such a case participates in regular profit distributions as soon as the project on which the fund is based is profitable. A closed-end fund is usually dissolved after a fixed term and the resulting assets are divided among the shareholders in proportion to the quotas invested.
The "fund" product was designed not least for security reasons. The probability that an investor will lose the capital invested in the fund is extremely low. If one of the many securities in the fund performs poorly, the many other securities within the fund will generally absorb the loss. Fund investments are therefore definitely safer than direct investments. However, funds are also somewhat "unexciting", especially since the potential for profit is considerably limited, in contrast to direct investments. Otherwise, the same applies with regard to security as with direct investments: "If, for example, a bank goes bankrupt, in addition to the deposit protection of liquidity (CHF 100,000), the non-permissible access to securities investments in the client's custody account also applies, i.e. the investor can transfer his securities to another institution at any time." Similarly, the assets of a fund are also considered special assets, so if the fund company goes bankrupt, investors will be paid the proceeds from the sale of the securities invested in the fund. Investors are given preferential treatment over other creditors.
In addition, the CISA contains the various types of collective investment schemes, including the contractual investment fund, which is the most common type in practice. Investor protection is regulated in detail in the CISA. With regard to the contractual investment fund, the assets transferred to the fund management company are held in separate custody. Strict regulations apply to these assets with regard to safekeeping and use; in particular, they must be strictly separated from the rest of the assets at the custodian bank.
Furthermore, funds that may be distributed to the general public must be approved by FINMA (Swiss Financial Market Supervisory Authority). They are subject to clearly defined regulation. One of the obligations involves diversification. Both in Switzerland and in the EU, no more than 10% may be invested per issuer (there may be exceptions for specific types of funds). There are also restrictions on the handling of loans and the use of derivative products.
Despite the high security requirements, the risks lie, as is often the case with other forms of investment, in the quality, reputation and long-term track record of a fund company. Before investing in a fund, one should therefore separate the "wheat from the chaff" and inform oneself about the quality criteria of a fund company or a fund investment!
This brings us full circle to the risk and investor profile and the resulting asset allocation. When selecting the right fund(s), the final investment decision should also be based on these three basic elements! First of all, it is necessary to evaluate at the highest level which category makes sense (equity funds, bond funds, real estate funds, commodity funds, etc. or a mixture). Then the next narrowing down takes place: does the investor - for example in the equity fund category - want to focus on Swiss equities, perhaps on the China market, perhaps only on pharmaceutical equities, etc.? The evaluation process continues in this way until the specific fund selection is up for discussion.
Here, the rule of thumb is then, "No fund is without alternative!" Do people tend to prefer funds from a major bank, do their preferences lie more with cantonal bank funds, or do they primarily focus on the track record of the individual fund investment? In practice, these questions are likely to be answered by the investment advisor and fund professional. The final selection is not easy in the "jungle of countless funds", but it is not so "match-decisive" as is often assumed. Sometimes one equity fund comes out on top, sometimes another...
Clear question, clear answer: "Yes, very good!" As mentioned, a long investment horizon generally applies to fund investments. And a long investment horizon significantly increases the chances of long-term returns. Not least because the regular accumulation of pension assets (e.g. savings3) means that investments can also be made on a regular basis, i.e. at different cost prices ... so you hardly always buy at the highest prices, which generally results in a favourable average.
If you are younger, you can increase the risks somewhat, i.e. invest more in promising equity funds. If you are a few years away from retirement, it is advisable to gradually adjust towards a somewhat more conservative fund selection; however, this statement also depends on the total assets saved and other retirement and pension planning criteria. In any case, do not neglect to seek qualified pension advice at an early stage and in the event of changed circumstances (e.g. inheritance, lottery winnings, etc.) in the meantime! You should not shy away from the costs of such advice.
Savings plans outside of pension provision are also very suitable for the continuous accumulation of assets through fund investments.
Every investment stands and falls with its performance, including funds (incl. ETFs). For an investment fund with a quality rating of "good", the performance over a longer period should be at least in the range of the annual benchmark (comparative index), and in the best case above it. It should be noted that performance refers to net income, i.e. after deduction of costs (total expense ratio, or TER for short). For the "last-instance" performance, the investor must then take into account the respective bank fees.
However, if the fund has not yet been in existence for several years, because it is new and in the process of being established, there are no corresponding comparative values for performance. Nevertheless, one may be convinced of the quality of the fund and invest in it after careful consideration; however, regular and precise performance monitoring is probably indispensable.
Opinions always differ somewhat on the amount of the total TER. However, the general opinion is that the TER should not be much higher than 1%. Anything significantly higher, of course, reduces the "very best" performance!