What is a fund?


Funds, ETFs and REITs for expat investors

Funds come in many different shapes and sizes; mutual funds, index funds, Smart-beta, leveraged funds, passive or active funds, and even hedge funds. What they all have in common is that they are collective investment vehicles, that pool together money from many different sources. They then use it to invest in multiple companies, according to the investment objectives that the fund was set up with.

Some funds may choose to invest in companies from a certain sector – clean energy, biotech or banking for example. Others may wish to focus on a particular geographic area – a region or even a country. Some specialise in small companies or start-ups that have the potential to grow quickly. Others track much broader indices and invest in shares from all over the world. These are usually known as all-world funds or global funds.

Do funds only invest in shares?

No, funds can invest in all sorts of assets. Bond funds are an example of funds that invest in assets other than shares. Others might invest in commodities. Real estate and even unlisted companies are all investable using funds. Private equity funds specialise in investing in companies that aren’t available on the open stock market. 

Multi-asset funds are investment vehicles that diversify across all different investment sectors. They aim to not pick the best performing sector in the future, but rather to assume that the future is largely unknowable and therefore it makes sense to not focus overly in one particular area but to spread investments around and help protect against the downside.

How are funds priced?

Funds, and specifically OEICs (open-ended investment companies) are priced once a day, usually at noon on the stock market where they are listed. That pricing is based on the net asset value (NAV) per share at that time and is published by the fund managers. The sum of all the assets that the fund owns is added up and then divided by the number of shares or units in existence. 

The number of shares (units) in a mutual fund can be increased or decreased by the fund managers, according to demand. Mutual funds have a single price that they are bought or sold at, and the only cost to be considered is the trading commission. They are priced once a day, usually at noon on the local stock exchange, and then the actual trades happen after the market closes that day. As investors are dealing directly with the fund, they all receive the same price, that has been quoted that day.

Investors in ETFs trade on the secondary or ‘open market’ and the price of the fund can vary continuously through the trading day.

Are investment trusts the same as funds?

No. Investment trusts are closed-ended funds, whose number of shares in existence is fixed. They trade much more like a normal company on the stock market, with the price fluctuating according to demand from the market. Although investment trusts publish their NAV, the trust will usually trade at a premium or a discount to the NAV. If the market price is above the NAV, that is trading at a premium, and vice versa.

What funds are best for an expat?

The best type of fund for most expat DIY investors is called an ETF, or Exchange Traded Fund. It is not that one type of fund is better than another, they merely are constructed and traded in different ways. The best fund to use is one that is accessible to you, that meets your investment goals, and that is cheap. (ETFs are mainly what I use to build my portfolio.)

The reason that expat investors often end up using ETFs is that the offshore brokerages that we use, often don’t give access to mutual funds (OEICs). So we use the next closest thing, which is an ETF. The brokerages are often set up more with active trading in mind, and having investors occasionally buying funds is not what they are really interested in. They make their commissions by traders buying and selling stocks. As ETFs trade on the same markets as stocks, investors using these platforms are able to access them.

ETFs are not necessarily cheaper than mutual funds. Often all-world ETFs have expense ratios around 0.2%. Vanguard’s admiralty share class of its total stock market fund VTSAX has an astonishingly low annual fee of 0.04%! This is the mutual fund that tracks the total US stock market. However, since expats are usually unable to access the mutual fund versions of these funds, we make do with what we can get our hands on. 

Expat investors should also take heart that the industry average annual fee is about 0.58%, and we are paying well under that. In the expat financial environment, ongoing fees in mutual funds that are sold by advisors are often well above 1%. If all you do is avoid these high fees, you will drastically improve your chances of building wealth successfully.

What is an ETF?

An ETF (Exchange Traded Fund) is a type of financial security that contains within it a number of other securities, such as stocks. It works in a very similar way to an OEIC or mutual fund, only it trades like any other stock, on the open stock market. Its price is variable in the same way that any stock price is and is driven by the demand for the underlying stocks. This is different to a mutual fund, which is only priced once a day, and is traded after the markets close at a fixed price. 

An ETF has to be bought or sold in units of at least 1 share. The shares, as with any share, are indivisible. A mutual fund can create or destroy ‘units’ as required, so an investor can buy or sell a fixed amount of currency, rather than a fixed number of shares.

How do you buy an ETF?

You can buy an ETF in the same way as you would buy any stock on a stockbroking platform.

  1. Identify the correct ticker.
  2. Confirm that it is trading on the correct exchange and in the correct currency.
  3. Select the number of shares that you want to buy.
  4. Check the predicted total cost of the trade, to avoid gross errors and to check that you have sufficient funds.
  5. Select the trade type, market or limit.
  6. Hit ‘Buy’.
  7. Verify the trade has completed correctly.

What ETF should I buy as an expat?

This all depends on your personal situation and investment goals. However, for global expat investors, I would usually suggest a global index tracking fund like VWRD or IWRD. For bonds, it is more down to a question of should you stick in your own currency or diversify all around the world, and the answer is less obvious. However, Vanguard and iShares are two good starting points to try and identify funds that suit your needs.

Should I invest in a real estate fund or REIT?

Investing in property is not simple. Putting money into just one property concentrates your risks into that one location. Would it not be better to diversify the risks of the sector by using a property fund?

Investing in an open-ended fund that specialises in any type of property carries with it some risks. The same could be said for funds that invest in any unlisted or illiquid companies. These are companies that are hard to buy and sell quickly. The reason for this is that if a large number of investors decide to withdraw money from the fund at the same time, in order to release that money, the fund may have to sell some of its assets. 

If the fund contains shares in large, easily tradable (aka ‘liquid’) companies, that shouldn’t be a problem, but if the investments are illiquid, then selling them could take much longer. It is possible that the fund then runs out of cash to pay back investors, and trading could be suspended. Investors may be unable to access their money until the managers have sold off assets to raise the required cash. Given that these are now effectively distressed sales, they may well not be able to sell them for as much as they thought they were worth, either. 

If you need any more convincing of this, have a look at the rather sorry Woodford ‘Patient Capital’ fund, or the M&G Property Portfolio.

A much better solution, if you wanted to invest in property through a collective investment vehicle, is by using a REIT (Real Estate Investment Trust).

Are REITs better than real estate funds?

Yes. By a long way. As investment trusts can trade at a premium or discount to their NAV, REITs (Real Estate Investment Trusts) are much more flexible vehicles for investing in property. They don’t suffer from the same problems of liquidity as mutual funds or OEICs do. 

If demand for a particular REIT is depressed, and the market sentiment is against it, then the trust may well trade at a price below its quoted NAV (Net Asset Value). But that does not mean that the fund has to sell assets to release the cash to pay investors back. As investors sell shares in the trust, they are simply bought or sold on the open market, to other investors. The price just fluctuates according to market forces. 

Investment trusts also have the advantage of being able to use leverage. Leverage is when you borrow and use someone else’s money to increase the effective size of your own investments. The most common example of this is using a mortgage to buy a property. It must be remembered that leverage is always a double-edged sword, amplifying both gains and losses. However, when it comes to investing in property, the investments are backed by physical assets. It is generally considered, therefore, that there is less risk than there might be in other asset classes, when using a sensible amount of leverage, to improve investment returns.

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