Investing in managed funds is an easy way for you to become an investor without the hassle of managing that investment. But not all funds are created equal so you need to be comfortable with what your fund is doing with your money.
How do managed funds work?
Managed funds are when you invest a specified amount and your money is pooled with other investor’s money. These ‘units’, once pooled together,are then invested as a group.Any profit is then paid to the investors based on the percentage that each investor has contributed to the fund. For example, if your $5,000 investment makes up 0.005% of the total fund, you will get 0.005% of the profits paid out. KiwiSaver is a good example of managed funds. Your KiwiSaver contributions are merged with other KiwiSaver investor’s contributions and invested as a group. (Note: you don’t have to have a KiwiSaver account to invest in managed funds).
Who looks after the funds?
A fund manager is put in charge of the pooled money. It’s their job to manage the funds, invest it in the way that the fund is intended to be, and to make as much money as possible.
What do managed funds invest in?
Each fund has its own rules about what the fund manager can invest in. Some funds invest in only one type of asset (such as property), while others spread the risk across different types of assets (for example, bonds, shares and property). Funds may also invest in NZ or foreign assets.
Virtually all KiwiSaver funds have a portion of their funds invested in shares. As the over-riding objective of most KiwiSaver fund managers is to make money, there is a high probability that your fund has some investmentin industriesthat may not align with your values and principles. E.g. weapons,gambling, tobacco, environmentally damaging industries, companies that use child labour etc. Your money could be funding wars, climate change and a range of other less-than-saintly causes.
Putting your money into funds aligned with your principles comes under a lot of different names. It can be called socially responsible investment, green investment, ethical investment, sustainable investment, or even religious investment.
Although ‘responsible funds’ take into account social or environmental objectives, each fund has a different approach to selecting what it will invest in.Perhaps the most important concept to grasp before choosing the right fund for you is the difference between negative and positive screening.
Screening investment opportunities
Fund managers may use either “negative” or “positive” screening when choosing the underlying investments in ‘responsible’ funds.
Negative screening is the most common method, and it involves avoiding companies or industries that are considered to be harmful to society or the environment. ‘Sin’ shares include shares in companies involved in gambling, alcohol, weapons, nuclear power, fossil fuel exploration, adult entertainment, and research into and the production of genetically modified (GMO) crops.
Managed funds that negatively screen simply avoid investing in these types of industries.
Positively screened managed funds go one step further and invest in companies and industries that aim to have a positive social or environmental impact.
In addition to screening (negative or positive) proactive fund managers will also consider environmental, social and governance factors in choosing their funds. Many go on to engage with the companies they invest in, and if necessary put pressure on them to behave as good corporate citizens. They do this by starting discussions with the companies, filing resolutions to be voted on at annual general meetings, educating the public, and attracting media attention.
How do you know what your money is being invested in?
If responsible investing is important to you, then you need to check where your money is going.
If your managed fund is a KiwiSaver fund, then this is easy. A range of schemes are available that have standards in place to filter out unethical investments. Check with your provider to see if they offer this.
If you are going directly through a fund manager or broker, you can ask for their disclosure statement. Do some research though – names that can look innocuous may not represent what they actually invest in.
Is responsible investing safer?
As with any investment, there is always a risk that the fund will lose money, no matter what type of fund you invest in. This could be through mismanagement, poor planning, or a catastrophic financial issue such as the global financial crisis. Choosing a fund manager who has a good track record will help to negate this risk.
The risk profile of your chosen fund is a better indicator of how safe your investment is likely to be than whether the fund invests in ‘responsible investments’.Funds which are invested in growth investments will always carry a greater risk of loss than balanced or conservative. Just because your chosen fund is ‘responsible’ does not mean it’s conservative. You need to ensure that the fund you invest in matches your appetite for risk.
Will it cost more to invest in ‘ethical’ managed funds?
Traditionally, investors assess their results with one simple criteria – financial return. The goal of the investment is to make money, pure and simple. But does socially responsible investing produce lower returns?
It depends! Research has found that when returns are adjusted for risk, index-style investors (i.e. those who invest in passively managed funds) give up very little by investing in socially responsible funds. However, if you invest in actively managed funds (i.e. those funds which take greater risks and seek to ‘beat the market’ in term of returns), restricting your investment to only responsible funds could cost you up to 3.5% of returns a year. Over time that adds up to a lot.
The reason for this is that there are far fewer socially responsible funds than ordinary funds available to invest in. As an investor’s criteria for choosing funds get narrower and more restricted, there is a growing chance that the best performance will be delivered by non-socially responsible funds. So the investor who prefers active managers with a great track record, but still wants to focus on a narrow segment, may sacrifice a lot of performance by limiting themselves to socially responsible funds.
What about fees?
All managed funds have costs and the fees charged to look after your money may eat away at any income you make.
A typical managed fund account will be charged a member fee, usually charged monthly, that covers the administration. An administration fee contributes to the overall administration of the scheme. A trustee/ supervisors fee pays for overseeing all the funds. A management fee pays the fund manager for making the decisions on who, how and when funds will be invested. A performance fee (if any)is a bonus paid to the fund manager if they achieve a better-than-expected return.
In January 2018, KiwiSaver schemes charged $40 million in fees! While management fees are to be expected as these fund managers are skilled and require payment for their time, there may be instances – like a low-growth fund – where the level of fees charged may not be working for you.
The KiwiSaver performance report gives you the ability to check how much you are being charged for management fees, compare with other providers, and make a switch if you want. As you will see, some funds do have higher fees if they are being actively managed – and therefore produce higher returns. Responsible fundsmay also have higher costs due to the extra effort required to examine investments, but the difference is generally small.
No matter what type of fund you invest in, you need to assess if you are getting value for money. Some funds may be paying higher than average results, in which case a high fee may be justified.
Choosing a fund
As you can see, investing in the right fund (or funds) for you requires some careful thought. There is no one “best” fund because your personal requirements and expectations are very different from other investors. That is why it pays to seek advice from an authorised financial adviser before making any decisions and commitments. A good adviser will be able to help you find funds and investment opportunities that align with your goals, values and risk profile.
If you have already invested in a managed fund and have concerns about what your funds are up to, talk to your authorised financial adviser.