Investment fund

Investment fund is a pooled investment vehicle that collects capital from multiple investors and invests it collectively in securities, real estate, commodities, or other assets according to a defined strategy (Bodie Z., Kane A., Marcus A.J. 2018, p.92)^[1]. Instead of buying individual stocks or bonds directly, investors purchase shares or units in funds that hold diversified portfolios. A single $10,000 investment in a fund might buy exposure to hundreds of companies—diversification that would be impractical for small investors to achieve independently.

The fund industry manages staggering sums. Global assets under management exceeded $120 trillion by 2023. In the United States alone, mutual funds and ETFs hold over $30 trillion—more than the annual GDP of any country except the U.S. and China. These vehicles have democratized investing, giving ordinary savers access to professional management and broad diversification that once belonged only to the wealthy.

Types of investment funds

The investment fund universe encompasses diverse structures:

Mutual funds

Structure. Mutual funds pool investor money into portfolios managed by professional investment managers. Investors buy shares at net asset value (NAV) calculated daily after market close. Redemptions occur at NAV, making these "open-end" funds—they create new shares when investors buy and redeem shares when investors sell^[2].

Regulation. In the United States, the Investment Company Act of 1940 governs mutual funds. Strict rules mandate diversification, limit leverage, require daily liquidity, and enforce disclosure requirements. Similar regulations exist in other jurisdictions.

Categories. Mutual funds span the investment spectrum:

• Equity funds invest in stocks—growth, value, large-cap, small-cap, international
• Bond funds hold fixed income—government, corporate, municipal, high-yield
• Money market funds invest in short-term, high-quality debt
• Balanced funds combine stocks and bonds
• Index funds passively track benchmarks

Costs. Expense ratios cover management, administration, and distribution. Average equity fund expense ratios have fallen from over 1% to approximately 0.50% due to competition from passive funds. Some funds charge loads—sales commissions paid at purchase (front-end) or sale (back-end).

Exchange-traded funds

Structure. ETFs trade on exchanges like stocks, allowing intraday buying and selling at market prices. Authorized participants create and redeem shares in large blocks, keeping market prices close to NAV through arbitrage^[3].

Advantages. ETFs typically offer lower expense ratios than comparable mutual funds, greater tax efficiency through creation/redemption mechanics, and trading flexibility. Investors can use limit orders, stop losses, and even short selling.

Growth. ETF assets have grown explosively—from under $500 billion in 2005 to over $10 trillion by 2023. The shift from active to passive management has disproportionately benefited ETFs.

Varieties. ETFs now cover virtually every asset class and strategy—broad market indexes, sectors, countries, commodities, currencies, and increasingly active strategies.

Hedge funds

Structure. Private investment pools for sophisticated investors, typically structured as limited partnerships. General partners manage investments; limited partners provide capital with limited liability^[4].

Investor restrictions. U.S. regulations limit hedge fund investment to accredited investors (high net worth or income thresholds) and qualified purchasers. Minimum investments often range from $1 million to $25 million.

Strategies. Hedge funds employ diverse approaches:

• Long/short equity—buying undervalued stocks, shorting overvalued ones
• Global macro—trading currencies, rates, and commodities based on economic views
• Event-driven—merger arbitrage, distressed securities, special situations
• Quantitative—algorithmic strategies based on statistical models
• Multi-strategy—combining multiple approaches

Fee structure. The traditional "2 and 20" model charges 2% annual management fee plus 20% of profits. High-water marks ensure performance fees only apply to gains above previous peaks. Pressure has compressed fees—many funds now charge "1.5 and 15" or less.

Private equity funds

Structure. Closed-end funds that invest in private companies or take public companies private. Investors commit capital that is called over time and returned as investments exit^[5].

Strategies. Buyout funds acquire companies using leverage. Venture capital funds invest in early-stage companies. Growth equity funds invest in expanding companies without using significant leverage. Fund-of-funds invest in other private equity funds.

Timeline. Private equity funds typically have 10-year lifespans—investment periods of 4-5 years followed by harvesting periods. Interim liquidity is limited.

Closed-end funds

Structure. Issue fixed numbers of shares through IPOs. Shares then trade on exchanges at prices that may differ from NAV—sometimes at premiums, often at discounts.

Characteristics. Permanent capital allows managers to invest in illiquid assets without redemption concerns. But persistent discounts frustrate investors who cannot access full NAV.

Fund operations

Investment funds share common operational elements:

Portfolio management

Active management. Portfolio managers select investments based on research and judgment, attempting to outperform benchmarks. The track record of active management beating passive alternatives over long periods is poor—spurring massive flows to index funds.

Passive management. Index funds replicate benchmark composition, minimizing costs and tracking error. Full replication holds all index constituents; sampling holds representative subsets^[6].

Smart beta. Rules-based strategies that weight securities by factors other than market capitalization—value, momentum, quality, low volatility. These strategies fall between traditional active and passive approaches.

Valuation

Net asset value. For open-end funds, NAV equals total portfolio value minus liabilities, divided by shares outstanding. Calculated daily for mutual funds, continuously approximated for ETFs.

Fair value pricing. When markets are closed or securities are illiquid, funds must estimate fair values. International funds holding Asian or European securities may adjust prices if events occur after foreign market closes but before U.S. NAV calculation.

Administration

Custodians. Banks or trust companies hold fund assets, ensuring safekeeping and preventing misappropriation.

Transfer agents. Process purchases, redemptions, and maintain shareholder records.

Auditors. Independent accountants verify financial statements and NAV calculations.

Investor considerations

Selecting funds requires evaluating multiple factors:

Performance

Historical returns. Past performance doesn't guarantee future results, but extreme underperformance may indicate problems. Compare returns to appropriate benchmarks over meaningful periods.

Risk-adjusted metrics. Sharpe ratio, Sortino ratio, and alpha measure return relative to risk taken. High returns achieved through excessive risk may not persist^[7].

Consistency. Returns achieved steadily differ from volatile paths to the same endpoint. Some investors prefer lower but more consistent returns.

Costs

Expense ratios. Annual operating costs as percentage of assets. Higher expenses directly reduce returns. A 1% expense advantage compounds significantly over decades.

Trading costs. Active funds incur brokerage commissions and market impact costs not captured in expense ratios. Portfolio turnover indicates trading intensity.

Tax efficiency. Capital gains distributions trigger tax consequences. ETFs and tax-managed funds minimize distributions; high-turnover active funds may generate substantial taxable gains.

Manager factors

Tenure and team. Who manages the fund, and how long have they done so? A star manager's departure may change a fund fundamentally.

Strategy capacity. Some strategies work only at limited scale. Asset growth beyond capacity constraints forces style drift or performance degradation^[8].

Firm stability. Organizational issues—ownership changes, regulatory problems, key departures—can affect fund management.

Regulatory framework

Investment funds face substantial regulation:

Securities regulation. Fund shares are securities subject to registration, prospectus requirements, and antifraud provisions.

Investment company regulation. The 1940 Act and similar laws in other jurisdictions govern fund structure, operations, and investor protection.

Disclosure requirements. Prospectuses describe strategies, risks, fees, and performance. Regular shareholder reports detail holdings and returns.

Fiduciary duties. Fund managers owe duties of care and loyalty to investors. Conflicts of interest must be managed and disclosed.

Investment fund — recommended articles

Portfolio management — Asset management — Financial markets — Risk management

References

• Bodie Z., Kane A., Marcus A.J. (2018), Investments, 11th Edition, McGraw-Hill.
• Investment Company Institute (2023), Investment Company Fact Book, ICI.
• SEC (2023), Investor Bulletin: Mutual Funds, Securities and Exchange Commission.
• Morningstar (2023), Fund Research and Data, Morningstar, Inc.

Footnotes

1. ↑ Bodie Z., Kane A., Marcus A.J. (2018), Investments, p.92
2. ↑ Investment Company Institute (2023), Fact Book, Chapter 2
3. ↑ SEC (2023), Investor Bulletin on ETFs
4. ↑ Bodie Z., Kane A., Marcus A.J. (2018), Investments, pp.892-912
5. ↑ Investment Company Institute (2023), Fact Book, Chapter 7
6. ↑ Morningstar (2023), Fund Research Methodology
7. ↑ Bodie Z., Kane A., Marcus A.J. (2018), Investments, pp.134-156
8. ↑ Investment Company Institute (2023), Fact Book, Chapter 4

Author: Sławomir Wawak