An investment fund can invest in a variety of financial assets. As a rule, these assets include shares, bonds or money market instruments (short-term debt instruments).
Some investment funds also invest in specialised instruments such as derivatives as part of their asset allocation. Other types of fund (not including undertakings for collective investment in transferable securities, or “UCITS”, the main type of fund explained on this website) may invest directly in real estate.
The performance goal of a fund is reflected in the types of assets it holds. Funds investing in shares generally offer higher potential returns, but sometimes also higher risks, than pure bond funds. Mixed funds (also known as “balanced funds) invest in a combination of shares and fixed-income securities (e.g. bonds, money market instruments). The individual components are weighted according to the fund manager’s view of the market situation and the economic outlook. Traditionally, the financial assets in which UCITS may invest are divided into three categories:
Money markets instruments are a type of short-term debt instrument used by governments, banks and commercial companies to finance working capital.
Investors often use money market funds as an alternative to bank deposits, because units or shares of money market funds can be bought or resold on a short-term basis and they frequently offer higher returns than bank interest rates. Like bonds, money market instruments also provide a fixed rate of interest and the original investment is repaid at the end of the term. Money market funds invest in money market instruments from a variety of issuers in order to achieve a broad diversification of their investments.
Bonds, often known as “fixed income securities”, are issued by companies, banks or government authorities as a form of debt certificate.
They are repayable at the end of a certain period, usually several years, and generally pay a fixed rate of interest. In some cases the annual interest, or “coupon”, varies during the lifetime of the bond. Another type, known as “zero-coupon bonds”, do not pay annual interest; instead the final redemption amount received by the investor is higher than the initial price they paid for the bond. So-called “floating-rate notes” pay a variable coupon, corresponding to a fixed spread above a benchmark interest rate (for example the LIBOR, the rate at which banks borrow from each other in the London market), which may move up and down depending on market conditions.
Bonds are often assessed by an independent rating agency according to the level of the issuer’s default risk. Bond investments are suited for investors who wish to receive a steady income. Moreover, unless the company or organisation that issued the bond runs into difficulties meeting payments, the principal amount is repaid in full at maturity.
Many government bonds entail virtually no interest rate or redemption risk. Bonds issued by many reputable companies are also considered to be very safe. Most of them pay a higher interest rate than government bonds because they also entail a higher risk that the issuer may become unable to meet interest payments or repay the original principal amount. Generally bonds offer greater price stability than shares, although their price can rise or fall according to changes in interest rates.
When a private company decides to be listed on a stock exchange, the ownership rights to the company are converted into shares that can be bought and sold on that stock exchange.
A share represents a portion of the ownership of a public listed company, and collectively a company’s shares are known as its equity capital. The individual or institution that owns the share is known as the shareholder, and can receive income from its shares. Such income is called a “dividend”. Whether or not a dividend is paid out and, if one is, the amount that is paid out depends on the profits earned by the company as well as its financial situation and corporate planning.
The price of a share depends on supply and demand, which in turn are influenced by many factors such as the profitability of the company, its long-term business prospects or the general sentiment of consumers and investors. Share prices will often fluctuate, sometimes for no apparent reason, and finding the right time to buy and sell shares is critical to the success of your investment.
Shares can be traded on wide range of financial markets, including regulated markets such as stock exchanges or, especially in the case of smaller companies, unregulated off-exchange markets. Shares can also be traded between institutional investors such as banks in private deals known as “over-the-counter” (OTC) trades.