by WWM | Sep 5, 2018 | Exchange Traded Funds
One perceived advantage of exchange traded funds (ETFs) over open-end mutual funds is their greater trading flexibility.
Many investors believe that there are also advantages in respect of ETF costs. Specifically, expense ratios, transaction costs, and tax efficiency. As with trading flexibility, the potential advantages will vary between investors depending on their investing tactics. I will lay out the reality and you can decide if there is a benefit for you.
We will cover annual expense ratios below, with transaction costs and tax efficiency next week.
ETFs tend to have lower expense ratios than open-end index mutual funds that track the same benchmarks.
That is a fact.
But, like most things, there is a little more to it than that.
Expenses Can Differ Between Funds
The difference between index fund expenses can vary to some degree. And when you include actively managed funds in a specific category, the differences can be substantial.
Consider the Standard & Poor’s (S&P) 500 index. The S&P 500 is considered a Large-Cap Blend investment style.
Per Morningstar data as at September 4, 2018, the average expense ratio for funds in this category, which includes both actively managed and index funds, is 0.99%. That is a lot of return paid back to the fund each and every year.
Being an average calculation, we will find both higher and lower expense ratios in this category.
For example, the no load Fidelity® Total Market Index F (FFSMX) has an annual expense ratio of 0.02%. On the other side, the no load American Century Core Equity Plus R (ACPWX) has an expense ratio of 2.35%. Quite the range!
One would hope that the higher cost funds outperform the lower cost ones. But that is not often the case. In the example above, over the last 5 years the Fidelity fund achieved an annual return of 14.22%. The higher cost American Century only averaged 11.38% per annum. And that is not cherry picking data.
Higher cost does not usually translate into better results. In fact, annual expense ratios are usually a drag on net returns. That is, higher cost funds do not outperform. Investing in low cost products tends to be the better route.
ETF Expenses Should Be Lower
Now if we compare these specific funds to certain S&P 500 ETFs, we see even lower costs with the ETFs.
That said, over the last few years, mutual funds have really tightened the costs on their index funds. Primarily in response to investor cash flowing out of mutual funds and into the less expensive ETFs. We saw that in out example above with Fidelity. As well, behemoths like Vanguard and iShares also offer very low cost mutual funds.
You will also find higher cost ETFs as their fund companies branch into actively managed ETFs. As well, more niche asset classes that cost more to administer.
But, if we consider plain-vanilla S&P 500 index ETFs, on average they will be less costly than mutual funds. For example, Vanguard S&P 500 ETF (VOO) and iShares Core S&P 500 ETF (IVV) each charge only 0.04% per annum.
Keys to Remember
From this, I suggest you take away five points.
One, there is a significant variation in expense ratios between open-end mutual funds in any given investment category. This is true for both actively managed funds and index funds. Make sure you do some comparison shopping before investing. Giving up 1.0% or more in return due to expenses is not a prudent way to accumulate wealth.
Two, there is some variation between the expense ratios of even the lower cost open-end index mutual funds. It may not be substantial, but still compare between index mutual funds.
Three, while ETFs currently have lower expenses than index funds, the gap has narrowed greatly in recent years. Do not automatically assume that you will save more money with an ETF over an open-end index fund. Depending on your investment tactics, you may not.
Four, expense ratios may vary between ETFs. While a top ETF should have lower costs than a top mutual fund, not every ETF may beat every index fund on cost. Make certain you choose wisely when selecting ETFs.
Five, cost minimization is crucial. But do not confuse that with getting value for your money. While an ETF may have the lowest expense ratios, there may be other factors that make open-end index funds preferable for your needs. Transaction costs are one such factor. We will review these, plus tax efficiency, next post.
by WWM | Aug 30, 2018 | Exchange Traded Funds
Some investors perceive advantages in utilizing exchange traded funds (ETFs) versus open-end index mutual funds.
Depending on the investor, some of these may be more important than others.
Or possibly these potential benefits may actually not entice an investors to choose ETFs over open-end index mutual funds. I write, you decide.
Today we will consider potential ETF trading advantages.
Active or Speculative Trading
Active traders like ETFs over open-end funds.
ETFs are traded intraday so traders can each buy and sell the same ETF multiple times in a single day if they so wish.
With an open-end fund, traders may only buy or sell fund shares after the share’s closing net-asset value (NAV) is calculated. For most funds, that is once daily, but not for all funds.
If you want to potentially day trade indices on various asset classes, ETFs are preferable.
While most readers are not day-traders, at times it is beneficial to be able to buy or sell during the trading day. For example, perhaps the market is falling significantly. You might be able to sell your ETF shares in the morning, thereby receiving a higher sales price than if you had to wait until the end of the day as with an open-end fund.
Note that I differentiate between active traders (or day traders) and investors. I have nothing against those that want to trade often. But I consider this to be speculation, not investing (in the true sense of the terms). Further, it takes substantial time and effort to be a day trader and is best left to those with the expertise, investment tools, and extreme risk tolerance. Finally, the more one trades, the more transaction costs and possiblly taxes are generated. I would not recommend highly active trading for individuals seeking long-term wealth accumulation.
(Probably) Improved Liquidity
Having the ability to trade ETFs continuously during exchange hours usually makes ETFs quite liquid as compared to open-end funds that typically only allow purchases and redemptions once daily, after the closing NAV has been calculated.
For long-term investors, usually this is not a major issue. Long-term investors have lengthy time horizons and daily price fluctuations are not significant concerns. If you can trade once daily, I think that is adequate for most investors.
I would caution though that some mutual funds may not be valued daily. Rather, they may only be valued weekly or even at longer intervals. The longer the time frame between being allowed to buy or sell shares, the greater liquidity risk becomes a factor. If the fund you are considering only allows trades once a week or once a month, I suggest you consider ETFs as an alternative.
While ETFs tend to be more liquid than open-end funds, there is a caveat. Like common shares, to be able to buy or sell ETFs requires a counterparty. When you are selling, you need a buyer. If the ETF you are considering has a limited number of shares outstanding or is not listed on a major exchange, these may indicate that the ETF has liquidity issues.
On the flip side, assuming your mutual fund company remains solvent, you have a ready partner with which to buy and sell your mutual fund at NAV. With ETFs, you are subject to market forces which may cause liquidity (and pricing) issues.
Most popular ETFs will not normally have liquidity issues. If concerned, you can assess an ETF’s liquidity (or any exchange traded investment) yourself.
Check the average trading volume over daily and weekly ranges. If you intend to purchase 10,000 shares and the ETF only trades an average of 1,000 daily, it might be difficult to sell all your shares at prevailing market prices.
Further, review the bid-ask spreads for these ETFs. Spreads for liquid investments should be very close to each other. That means that investors do not have to budge greatly from their initial positions to close the transaction. But say you want to sell 10,000 shares at the last sale price of $10 per share. You post your ask price and wait for the sale to occur. Unfortunately, no buyers want to pay $10 for your shares. In fact, the closest bid is for 5,000 shares at $6. Either the interested buyer needs to increase his bid by 67% or you need to reduce your asking price by 40% or you both need to meet somewhere in the middle to do the deal.
Counterparty risk may also be a consideration against buying an open-end mutual fund. With most ETFs there is an adequate number of shares outstanding with a wide variety of investors present to buy and sell. However, with an open-end mutual fund you are buying and redeeming shares directly with the fund company. Should the fund company become insolvent, investors in funds of that company may have difficulties redeeming their shares.
So, before investing in an open-end mutual fund, I suggest you ensure that the fund company is in strong financial shape.
Trading Flexibility
ETFs offer greater trading flexibility than open-end mutual funds.
We already discussed above the increased possible frequency of ETF trades. But there are other potential advantages in trading ETFs.
As you trade an ETF exactly like a stock, you can enter a variety of trading orders. Besides buying or selling at the current market price, investors may engage in other tactics, including limit or stop-loss orders.
Open-end mutual funds are only purchased or sold at the fund’s per share closing NAV. You cannot put in orders at different values.
You can also short ETFs in many jurisdictions. That is, you “borrow” shares of the ETF and sell them in anticipation that they will fall in value. If the ETF price does decrease, you buy the shares back on the open market, give back the “borrowed” shares to the lender, and pocket the profit on the difference. Of course, if the price does not fall, then you will face margin calls and possibly steep losses when you close the short position.
You cannot short open-end mutual funds as you are buying and selling them directly from the fund company.
I think that being able to enter non-market orders is advantageous, especially when rebalancing one’s portfolio. That said, if you are investing for a lengthy period chances are that buying or selling based on NAV will not impact on your returns.
As for shorting, or using margin accounts in general, I do not think they are necessary to create a strong portfolio.
Next, a few more areas where ETFs are considered preferable over open-end mutual funds.
by WWM | Aug 22, 2018 | Exchange Traded Funds
Another popular way to passively invest is through exchange traded funds.
Today we will discuss exchange traded funds and how they differ from similar investments.
Exchange Traded Funds
Exchange traded funds (ETFs) share traits with a few investments. But there are also significant differences.
ETFs are funds that invest in a collection of securities or derivatives. ETFs may be passive, in that they attempt to replicate the performance of a benchmark index. As well, there are an ever increasing volume of actively managed ETFs. Almost exactly like mutual funds.
Certain ETFs pursue targeted investment strategies. For example, leveraged or inverse ETFs. For now, we shall avoid discussion of the more exotic varieties of ETF.
ETFs have a fixed number of shares outstanding.
These shares trade on authorized exchanges and can be bought or sold continuously during open exchange hours. ETF shares trade directly between investors who buy and sell through their accounts in a brokerage house.
As trades are conducted via broker, commissions are paid when ETFs are bought or sold. However, no sales loads are charged on any ETF acquisitions or dispositions. As well, brokerage firms may waive transaction costs on some ETFs.
The price of the ETF shares is determined by investor supply and demand in the open market. No closing net-asset values are calculated for ETFs. Instead, ETF share prices fluctuate throughout each trading day based on trading activity. That said, ETFs normally trade close to their net asset values.
Compare with:
Open-End Index Mutual Funds
Open-end index mutual funds are also structured to replicate a benchmark index. In performance, gross returns should be similar to an ETF with the same benchmark index.
Open-end funds do not have a fixed number of shares or units. As new investors subscribe for shares (or units) of the mutual fund, new shares are created to reflect the addition of capital.
Open-end mutual fund shares are purchased and redeemed directly through the mutual fund company, not from other investors on an exchange.
Investors buy and sell open-end mutual funds at the fund’s closing net-asset value. Investor supply and demand has no impact on the price of the fund’s shares.
While ETFs may be traded at any time the exchange is open, open-end mutual funds only trade upon calculation of the net-asset value. For most funds, this is daily, but it can be less frequent. So open-end funds may be less liquid than ETFs.
When buying or selling open-end funds, investors may be charged a sales fee or load. Further, if one trades via their brokerage account, the trades may be subject to a broker’s commission as well. ETFs do not have any loads, only commissions on trades.
Common Shares
A company’s common shares trade on authorized exchanges or over-the-counter any time the exchange is open. A share’s price is determined by investor supply and demand for the company’s fixed number of outstanding shares. Net-asset value is irrelevant to the share price.
Shares are bought and sold through one’s brokerage account and traded directly with other investors. There are no loads, but the broker will charge a commission on any trades made.
While an ETF trades exactly like a stock, the obvious difference is the asset itself.
Whereas the ETF is a diversified portfolio of investments that seeks to replicate an index, shares are single, non-diversified investments. Depending on the company’s correlation to different indices, the shares may or may not move in tandem with a specific index.
Closed-End Investment Funds
Closed-end investment funds (CEFs) also have a fixed number of shares and trade on exchange throughout the business day. And the price of CEF shares is also determined by investor supply and demand.
There are index CEFs that replicate benchmark indices.
No loads are paid, but brokerage commissions are charged.
CEFs are essentially the same thing as an ETF. However, technically, they are not ETFs.
Okay, there are some similarities and differences between ETFs and open and closed-end index funds. Big deal.
The key question is, what is the attraction of ETFs to investors?
We will look at that next.
by WWM | Dec 13, 2017 | Exchange Traded Funds, Investment Strategies, Mutual Funds
Investors often pursue investment strategies based on market capitalization.
Additionally, equities may be viewed through the prism of being either value or growth stocks.
Today we look at value investing.
What exactly is value investing? What are its advantages and potential pitfalls. Should you value invest?
Value Stocks
Stocks in this category are seen as value buys.
That is, the stock is considered undervalued based on quantitative and qualitative analysis.
The objective is to identify companies that trade below their intrinsic (i.e., “true”) value. Then purchase shares and wait patiently for the rest of the world to see what they have missed.
Companies in this category tend to be: established companies that have fallen out of favour and been beaten down in price due to poor performance, bad news, lawsuits, management changes, etc.; smaller companies that are not extensively followed by analysts and the investing public; mature companies that have minimal upside for internal growth, so they pay out their earnings in dividends rather than reinvest in the company’s operations.
Or perhaps entire industries or sectors are depressed. Look at real estate markets in the US and Canada over the last decade. At times, significant bear markets in some regions. Oil and gas is another industry that took a hit in the past few years. Nothing wrong with the companies per se, they just happened to be in a market with low oil prices.
In essence, you are attempting to buy assets that are “on-sale” due to specific circumstances. As the circumstances alleviate, the share price reverts back to its “true” price.
In theory, this is an excellent way to invest. In any other investment you make (house, art, coins, etc.) you always try to find acquisitions being sold at a discount to market value. Better to purchase your home in a down market than to buy the same property when demand is high.
Benjamin Graham and David Dodd are considered the fathers of this investment style. Warren Buffett uses this approach in a slightly modified form. Hard to argue with those investors.
I quite like value investing. But it is not an easy process.
Given the amount of publicly available data, the number of analytical tools one can use to screen stocks, and the sheer volume of investors searching for the next great value stock, it is not simple to find a hidden gem all on your own.
If you lack the time or expertise to do your own in-depth analysis, value equity funds are a good way to invest. Many are professionally managed, albeit often at a relatively high management fee. And by purchasing a number of companies that meet the value criteria, funds spread out the risk of the individual stocks.
Quantitative and Qualitative Analysis
In analyzing companies under a value approach, analysts examine an investment’s fundamentals.
Please refer to my post on Quantitative and Qualitative Analysis for details.
Quantitative analysis is not difficult. Find the data, plug it into the appropriate equation, and you have your result.
Common fundamentals include: price/earnings; price/book; dividend yields. Analysts usually arrive at similar numbers.
The difficulty lies in interpreting those results.
Qualitative Analysis
In value investing, the proper qualitative analysis is what separates value from junk. This is critical, because based on the quantitative data, terrible investments often look like value opportunities.
A low price/earnings ratio may suggest value. Or it may indicate a company heading for difficulties. The same is true for companies with high dividend yields. The exact same ratio in two different companies may indicate the complete opposite future potential.
When we cover the common fundamentals later, we will go through examples.
Qualitative analysis assesses an asset’s systematic and nonsystematic risk factors to make sense of the quantitative results. Risks involving: general economic conditions; management; operations; industry; competitors; customers and suppliers; credit and financial; tax and regulatory; legal.
Intrinsic Value
By conducting both quantitative and qualitative analysis, you attempt to determine a stock’s intrinsic value.
But what is this true value?
And that is the problem with value investing.
What exactly is a stock’s intrinsic value?
As I stated above, most analysts will arrive at similar quantitative results. Then they use quantitative analysis to adjust the data to reflect what they believe is the asset’s “correct” value.
Based on your analysis, you will arrive at one number. Other investors, using the same publicly available data, will arrive at different valuations. Some will be higher, some lower.
No matter how good the analysis, many investors will be incorrect.
And no matter how poor the analysis, some investors will get lucky.
Further, unforeseen events may render even the perfect analysis irrelevant.
Consider the September 11, 2001 terrorist attacks in the US.
On September 10, certain assumptions were made in respect of investments. Interest rates, government spending, oil prices, consumer demand, company revenues, to list a few variables.
On September 11, many factors changed completely. Share prices across the board fell. The US government launched a long and costly war. And so on.
In the space of 24 hours, many assumptions that investors relied on materially changed. And those changes impacted valuation calculations.
In November, 2016, it was widely expected that Hillary Clinton would win the US presidency. That win would usher in her world views and policies. When Donald Trump won, that required a significant shift in thinking. Forecasts and estimates based on assumptions made in late October required adjustments. Adjustments that impacted fundamental analysis.
Considering that just before the election, pollsters showed Clinton with a 95% probability of winning, it is hard to fault analysts for assuming she would win. But she lost and all analysis became erroneous to some degree.
Determining the “real” value for a company is difficult, if not impossible. As the world and company specific factors change, so too does its future value. Without a crystal ball, very hard to get it right.
As well, what you consider an asset’s true value will be different than others. Think of buying or selling a house or used car. Pretty much anything. The value you assign to something is likely different than other parties may believe.
Should You Value Invest?
While it may be impossible to accurately predict a company’s intrinsic value, should you ignore value investing?
Not at all.
Studies often show that value investing outperforms growth strategies.
I do not agree with this as a general statement as other data shows mixed results. But there are some who believe value investing is the only way to go.
I do believe that investors following any investment strategy (e.g., growth, balanced, Japanese equities) must follow the tenets of a value strategy. After all, when you get to the heart of value investing, it is simply common sense.
Find companies that are undervalued relative to what you believe is their true worth.
Then buy their shares.
At its basis, it is that simple.
And even if you follow a growth strategy you need to adhere to these principles.
Apple, Amazon, Facebook, and Google may be considered growth stocks. But even so, you want to buy the one(s) with the best potential. Not the ones that may be overpriced.
Implementing a value investing program requires investing skill. It also takes time and luck to do well picking individual value stocks. It is difficult, but not impossible. As the success of Warren Buffet and others can attest to.
Many investment companies offer value funds. I suggest initially using them if you wish to follow a value strategy.
As you develop experience and confidence in your analysis, then consider trading individual stocks.
by WWM | Nov 15, 2017 | Exchange Traded Funds, Mutual Funds
To date, we have reviewed the major asset classes: cash and cash equivalent; fixed income; equity or common shares. There are a variety of lesser asset classes, as well as sub-classes within each class. We will cover some of these in time.
You can invest in assets of each class individually or via collective investment schemes. In the latter, many investors aggregate their money in a single investment vehicle. These collective schemes are generally called investment funds.
In theory, aggregation allows some or all of the following benefits for individual investors: a simple way to create and maintain an investment portfolio; better portfolio diversification through asset classes and time; access to investments that cannot be bought by small investors; improved liquidity; fund management by investment professionals; economies of scales on expenses that reduce costs allocated to any one investor; consolidation of tax information.
Because of these potential benefits, most investor portfolios should be comprised primarily of investment funds.
Today we will review four types of investment funds.
Closed-End Investment Fund (CEF)
This fund is established as a corporation with a limited number of shares initially issued to investors via an Initial Public Offering (IPO). The proceeds are then invested according to the objectives and fund policies as stated in the prospectus.
Occasionally CEFs have subsequent public offerings. But normally there are no other issues after the IPO.
The CEF is listed on a stock exchange. Share acquisitions or dispositions by investors takes place in this secondary market. Transactions occur during normal trading hours of the exchange.
Shares are not redeemed by the company. An exception would be if the CEF decides to either reorganize and redeems a portion of shares or liquidates the company itself.
Share value is determined in two ways.
Net Asset Value
Share price is based primarily on the net asset value (NAV) of the investment fund. The NAV is the value of the fund’s investment portfolio (its only assets) less any liabilities that exist. To calculate the NAV per share, divide the net assets of the fund by the number of outstanding shares.
For example, Omega Investment Fund has an investment portfolio with a market value of $100 million, short term liabilities of $1 million, and 9 million shares outstanding. The NAV of Omega’s shares is $11 per share.
The key to NAV is the market value of the investment portfolio. The portfolio is made up of common shares, bonds, money market instruments, etc. As these asset valuations fluctuate daily, a fund’s NAV will also change daily.
In our example, Omega’s NAV is $11 per share. If this was a real company and I checked the actual share price, I would expect to see it somewhere around $11 per share.
Somewhere, that is, but not exactly.
Premium or Discount
The second component of a CEF’s share price is based on investor supply and demand.
Investors who want the stock must buy it on the secondary market. The greater the number of investors who want the CEF, the more competition for available shares. Stronger demand than supply will increase the share price above the NAV.
The difference between the NAV and market price of the shares is known as the “premium”.
Other CEFs may trade below the NAV. This is because more shareholders wish to sell (supply) than there are new investors wanting to buy (demand). In this case, shares trade at a “discount” to NAV.
Why Trade at Premium or Discount?
Why are there premiums and discounts for mere investment portfolios?
Investors look at securities within a CEF portfolio and believe these investments will increase or decrease. Based on perceptions about future returns on the portfolio, investors will be bullish (optimistic) or bearish (pessimistic). The more bullish, the greater the demand and the greater the premium. The more bearish, the opposite.
Secondly, investors look at fund management. If management is seen as strong, investors believe that management will find new investments that will bring superior returns versus other funds. This will also create a premium.
Consider Warren Buffett. If Mr. Buffett managed a CEF, I expect there would be a nice premium on the share price. And with Berkshire Hathaway (a conglomerate, not a CEF), there is usually a healthy premium to the share price.
Note that these are the same principles that drive the share price of operating companies.
Open-End Investment Fund (Mutual Fund)
Mutual funds, as the formal name indicates, are open-end funds.
Like closed-end funds, a new mutual fund issues shares (or units) to investors and invests the proceeds according to the fund’s stated objectives. However, a mutual fund continuously sells new shares to the public. The issue price of the shares is equal to the NAV of the fund.
There should be no premium or discount associated with the share/unit price.
Open-end funds are not traded on stock exchanges. Investors purchase shares directly from the fund. With no secondary market, the fund itself must buy back any shares investors wish to sell. This is known as “redemption of shares”.
For most funds, the NAV is calculated. Investors purchase or redeem shares at the close of day NAV.
A few funds do not allow purchases or redemptions on a daily basis. Investors may only have the option of buying or selling on a weekly, monthly, or quarterly basis. This can create liquidity problems for investors. Be certain you know the frequency of possible transactions before investing in any funds.
Over time, an open-end fund may become a “closed fund”. Do not confuse a “closed-end fund” with a “closed fund”.
A closed fund is an open-end fund that has been shut to new investors. Closure may be permanent or for a temporary period. While the fund may not accept new investors, often existing investors can still acquire additional shares.
The most common reason for a fund to close is that its assets under management has become too large for the fund to properly invest under its stated objectives and strategies.
Exchange Traded Fund (ETF)
An ETF is like a closed-end fund in that it trades on a stock exchange and does not issue new shares to the public.
An ETF is a security that tracks, or performs against, a specific index or benchmark. There are many different ETFs that cover a wide variety of areas. Many ETFs simply passively follow their benchmarks as closely as possible.
An ETF may track a: country (iShares MSCI Brazil Index); region (Vanguard Emerging Markets Stock ETF); stock exchange (SPDR for the Standard & Poors 500 Index); industry sector (United States Oil); commodity (SPDR Gold Shares).
Some ETFs are actively managed as they attempt to outperform their benchmarks. For example, the PowerShares Actively Managed Low Duration ETF.
ETFs trade like shares and there is no NAV calculation.
In attempting to replicate an index or benchmark, there are a few different methods employed. ETFs may hold the index fully in its proper proportion. This may be accomplished for smaller indices such as the Dow Jones 30.
ETFs may use representative sampling techniques to replicate performance with less than 100% of the index components.
ETFs may also utilize derivatives such as options, futures, and swaps, to try and mirror an index’s performance or synthetically create portfolios.
With passive index ETFs, how the fund replicates its benchmark and its tracking error are important considerations.
Hedge Fund
A hedge fund can be a variety of investment creatures. Some more scary than others.
In general, a hedge fund is a pooled structure of investments that uses a wide variety of strategies to achieve its stated investment objectives.
Sounds much like a CEF or mutual fund.
The main difference between hedge funds and other funds is the level of regulation.
Hedge funds are intended for (supposedly) sophisticated investors who understand the world of investments. Especially the concept of investment risk.
In many jurisdictions, there are rules governing who is and is not a sophisticated investor. Usually this is linked to the investor’s net worth, annual earnings, investment experience, etc.
As hedge fund investors are supposed to be experienced and knowledgeable, hedge funds invest in a wide variety of investments and utilize strategies and tactics not usually found in mutual funds. For example, hedge funds may take short positions, invest in derivatives, and utilize leverage.
A common perception of hedge funds is that they are out of control investment vehicles, engaging in high risk (hopefully high reward) activities.
Some hedge funds are indeed very risky. But other hedge funds use derivatives, short sales, etc. to reduce portfolio risk. In fact, the term “hedge” is used for activities that attempt to decrease investment risk in an asset or portfolio.
If you ever get to the point where you want to invest in a hedge fund, make sure you read the prospectus or offering documents very carefully. Know the level of risk that the fund will accept in their investment plans.
Another consideration with hedge funds is the cost.
Hedge funds tend to be extremely actively managed, so the management expense ratio is usually high relative to other funds types. Not always, some open and closed-ended funds also require extensive management, but usually.
And it is not uncommon to find “performance fees” (also called “incentive fees”) paid to fund managers for returns in excess of agreed upon hurdle rates (e.g., benchmark or minimum return). These can be extremely generous, so know in advance what you might be paying to the fund managers for their efforts.
Strangely, while I have seen many performance fees in hedge funds for superior returns, I have yet to come across any funds that offer refunds for underperformance. Funny how it always works that way.
I believe management expense ratios and other fund costs should be the key consideration when selecting any type of fund. As a result, we will spend some time a little later on this topic.
That should give you a quick sense for investment funds. What they are and how they differ from one another.
I am a big proponent of mutual funds and ETFs. Especially for smaller investors, the potential benefits are often very worthwhile. We will consider these two investment funds in greater detail over time.