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An Overview of Investment Funds

By Kathleen Wang What are investment funds?


Investment funds are collective funds where investors supply capital (money) that is used to purchase securities. An investment fund draws on the inherent advantages of working as part of a group, such as a broader selection of investment opportunities, greater management expertise, and lower investment fees, in order to reduce the risks of investment.


Assets held by a fund typically include company shares or bonds, or, less commonly, real property, commodities (such as precious metals), and derivatives.


Types of investment funds


Investment funds can either be close-ended or open-ended. A close-ended fund has a fixed number of shares sold at the outset; once investors acquire the shares, they may not redeem it on demand, and the shares are only realised on the winding up of the fund or when traded between other investors. An open-ended fund, by contrast, can issue an unlimited number of shares and sells directly to the investors. The price of the shares will vary proportionately to the net asset value of the fund.


Additionally (in the UK), funds are either regulated or unregulated. A regulated fund is one that is authorised by a regulator (usually the Financial Conduct Authority (FCA)), and is for retail sale to consumers. An unregulated fund is not authorised (though the fund manager usually is) and cannot be generally promoted for retail in the UK.


Types of regulated funds include:


Investment company with variable capital (ICVC) – an ICVC is, essentially, an open-ended investment company available to the general public. The ICVC manager creates shares when money is invested and must redeem them at the request of the shareholder. An ICVC can also be an umbrella fund, holding sub-funds with their own investment goals.


Authorised unit trusts (AUT) – these trusts are authorised by the FCA. An AUT consists of a trustee, who holds investment assets on trust for the shareholders, and is usually a well-known bank. The trustee can then employ a separate management company to advise on investment decisions.

European long-term investment funds (ELTIFS) – An ELTIF is an investment framework allowing investors to put capital into companies and projects that need long-term capital. Uniquely, an ELTIF is required to invest at least 70% of its capital in ‘eligible investments’ as governed by the ELTIF regulations, and which include equity (shares) and debt instruments issued by a qualified portfolio undertaking (the criteria for who is a ‘qualified portfolio undertaking’ is also governed by the ELTIF regulations). Shares in an ELTIF can be redeemed at the closing of the fund, the date of which must be disclosed to investors.


Authorised contractual schemes (ACS) – An ACS may take one of two forms, namely a co-ownership scheme or a limited partnership scheme. Under a co-ownership scheme, the investors have interest in the assets of the scheme, although the assets are held by a depositary. This is essentially a contract between each shareholder, the ACS manager, and the depositary. An ACS can also be structured as a limited partnership (see below).


Types of unregulated funds in the UK include:


Investment trusts – a company formed for the purposes of investing in other companies. Responsibility for investment under an investment trust rests with the board of directors, although this role may be delegated to investment management companies. Investment trusts are close-ended funds.


Limited partnerships – a limited partnership acquires and manages investments that are owned collectively by the partners as partnership assets. The unique feature of a limited partnership is its flexibility; the general partner usually has unlimited liability for the fund, but the remainder of the partners enjoy limited liability so long as they do not participate in the management of the partnership’s business. The general manager is usually the investment manager. A limited partnership can be either open or close-ended.


Unauthorised unit trusts – an investment vehicle where trustees hold the investment assets on trust for shareholders. The trustees are legally obliged to apply the asset to the benefit of the shareholders, and are usually advised by a fund manager. As the name implies, unauthorised unit trusts are not authorised by UK regulations.


Benefits and risks of investment funds


The main benefits of an investment fund include:


A professionally managed fund – the collective nature of the fund means that, importantly, investors have access to a professionally managed fund, along with its resources, experience, and expertise. These resources are helpful in deciding, inter alia, which assets to buy/sell, and when to do so.


Diversification – due to the collective nature and size of investment funds, investors may have access to a more diversified fund than they could individually, thereby lowering investment risk. Funds can provide this diversification by holding individual groups of assets independent of individual performance.


The main risks of an investment fund include:


Liquidity risk – the risk that assets cannot be realised at a particular point in time. Investment funds incorporate two levels of liquidity risk. The first relates to the investment manager's ability to buy or sell assets for the fund at a certain point; the second level of risk arises in the investor’s ability to buy and sell assets in the fund itself. This is especially the case in close-ended funds.



Manager risk – this is the risk associated with the manager of the investment fund; as the manager is responsible for investment decisions, this may pose a significant risk. Fund management in the UK is regulated by the Financial Services and Market Act 2000 (FSMA) and other various FCA rules.


Case studies


EU Sustainable Finance Disclosure Regulation (SFDR) to come into force 2021 (Nov 2020) – the EU is set to implement new sustainable finance regulations in March 2021, and may require investment funds to abide by new pre-contractual disclosure requirements on sustainability. In addition, firms may be required to disclose their approach on sustainability risk and adverse impacts on sustainability of their investment decisions.


Germany finance ministry to introduce new law to boost investment fund operations (Dec 2020) – The German Ministry of Finance has proposed a new draft law to promote investment funds in the country. Among others, the bill would introduce new investment vehicles such as open infrastructure investment funds (allowing investors to invest in infrastructure projects in the private sector) and close-ended special funds.

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