Fund units

What are investment funds?

Some people prefer a single flavor, others want a cocktail – because it’s harder not to like something that combines multiple tastes. That’s exactly how investment funds work – diversified portfolios that offer broad exposure through a single investment. It’s like the difference between investing in solar panels and investing in the energy market as a whole.

Funds can be open-ended (ETFs or mutual funds) or closed-ended. ETFs are traded on at least one exchange, with the trading price determined by market supply and demand. Mutual funds can be converted into cash only through redemption by the issuing fund. Closed-ended funds can fall into either category. Fund units are the instruments that grant ownership over a portion of an investment fund’s assets.

Why would you choose them? We’ll give you one word – diversification.

Sounds good. How much does it cost?

Price of fund units

It depends. The price at which you can buy or sell fund units depends on the type of fund, but a first reference point is the NAV, published only after verification and approval by the fund’s custodian/depository (a bank or a specially authorized broker).

Alright. We’ve talked about fund units and investment funds, but what are they exactly, in more detail? ETFs, mutual funds, closed-ended funds… everything may seem a bit confusing, but don’t worry – let’s clarify.

Let’s start with ETFs.

Let’s say recent years have convinced you that the pharmaceutical industry… or perhaps the defense sector… could be a good investment. But you’re not sure you want to allocate all your resources to the company researching penicillin 2.0 – you want a broader horizon. Perfect. That’s where ETFs come in.

These investment funds are ideal for those who want exposure to the overall market or to a specific sector, such as biotechnology, agriculture, and so on. Depending on your risk appetite, you’ll allocate different proportions of your capital to bonds, shares, and commodities.

ETF may sound intimidating, like any acronym, but Exchange Traded Fund literally means “fund traded on the stock exchange”, and the concept has existed since the 1990s. As you might expect, ETFs are traded on at least one exchange, and their price depends on market supply and demand.

Initially, there were only passive ETFs, aiming to closely replicate the performance of a stock or bond index.

Over time, the concept expanded to include ETFs that track commodity prices such as oil or gold. More recently, actively managed ETFs have emerged, where the tracked index is actually an actively managed portfolio, with asset weights decided by an investment management company rather than by market capitalization or another strict objective criterion.

Market supply and demand determine the exchange trading price of ETF units. To prevent price deviations from the tracked index, every ETF must have at least one market maker and a creation-redemption mechanism directly linked to the fund. Only market makers (and sometimes institutional investors) can access this mechanism to adjust the total number of ETF units to market demand.

The quotes provided by market makers are aligned with the ETF’s indicative NAV (iNAV), updated at least every minute.

If you follow the motto that fortune favors the bold and you seek returns higher than major stock indices, you may consider actively managed investment funds – typically mutual funds or closed-ended funds. These involve an investment management company or a team of portfolio managers who decide how and where the fund’s capital is invested.

The upside of choosing a mutual fund? They can include multiple asset classes: bonds, shares, commodities, as well as real estate, works of art, and more.

The downside of actively managed funds is that very few managers are able to consistently outperform major market indices over the long term. This means that for an investor with a time horizon of more than ten years, a combination of ETFs may be a more efficient solution.

Have you invested in a mutual fund and want to convert your units into cash? This can only be done through redemption by the issuing fund. Every business day, funds are required to publish a value for issuing and redeeming fund units – usually the fund’s NAV, potentially adjusted by an issuance or redemption fee.

In the EU, these operations are carried out at the NAV of the day the request is submitted. In other words, you won’t know the exact price at which the investment is entered or liquidated.

In general, mutual funds are actively managed and invest mainly in shares and bonds (including government bonds), alongside investments in other funds and money market instruments such as bank deposits.

There are also so-called “index funds” that aim to closely replicate the performance of a stock index, but they are not listed on an exchange.

Closed-ended funds can be either listed or unlisted. The term “closed-ended” is somewhat misleading, as these funds periodically open windows to accept new investors or redeem fund units, but these windows are not daily and can sometimes occur only after years.

As you may have guessed, closed-ended funds are less liquid than other types, but they are more versatile in terms of asset classes, including bonds (including government bonds), shares, commodities, as well as alternative assets such as real estate, works of art, stamps, and more – assets that are typically associated with closed-ended funds. Famous hedge funds fall into this category.

For closed-ended funds listed on at least one exchange, the trading price depends on market supply and demand. Combined with the lack of a mechanism to balance supply and demand other than price, this often leads to closed-ended funds trading either at a discount, or at a premium relative to the most recent NAV, sometimes by significant margins.

Periodically, new fund units may be issued or redeemed directly with the fund through a process similar to capital increases or decreases at listed companies.

For unlisted closed-ended funds, issuance and redemption are carried out directly with the fund at the most recent available NAV, similar to mutual funds, but only periodically – usually at intervals equal to or greater than one month.

We know this was a lot to process, and it’s perfectly fine if it feels overwhelming. Let’s summarize.

If you want exposure to a sector rather than to a single company, choose fund units and an investment fund.

If you want maximum transparency, supply-demand balancing mechanisms, and a long investment horizon, choose ETFs.

If you want the chance to outperform market benchmarks through active management and you accept not knowing the exact liquidation price, mutual funds may be suitable.

If your plan is to invest in the most diversified portfolios and you are comfortable with trading price fluctuations, you may find opportunities in closed-ended funds.

That’s about it. We bet you can now better explain to your friends what’s really going on in movies featuring hedge fund managers.

Variable (from low to high, depending on portfolio assets)

A money market fund or one investing in government securities will generally have low risk. Funds that invest in shares and bonds may have moderate risk, while funds using leverage or focusing on highly volatile niches will carry higher risk.

As with all spot market instruments, an important thing to remember is that you cannot lose more than the amount invested. Additionally, investing in a collection of assets reduces investment risk, depending on how well diversification is implemented.