We examine the various forms of investment funds and their operations
You can learn a lot about investment funds, which are a significant aspect of investing.
Investment funds are worth taking the time to understand, even though the variety of terms, acronyms, and fees can be daunting, particularly for novice investors. The best funds can contribute significantly to your portfolio.
The primary benefit of investing with funds as opposed to choosing individual stocks is that diversification is provided right away.
"Generally speaking, diversification is your friend and keeps one or two isolated issues from destroying your portfolio," says Ben Seager-Scott, chief investment officer at Forvis Mazars.
"Funds give you ready access to a spread of companies without being overly exposed to just a handful," he adds. He quotes renowned investor Harry Markowitz, who is said to have stated that "diversification is the only good thing about investing." This diversification is provided by funds, which negate the expense, management, and time commitments associated with creating your own portfolio from the ground up.
"If you have the time to comprehend and investigate every stock, listen to the earnings call, choose which winners to let run higher versus which to take profit on, which stocks to top-up after a fall or close out of, and so on," Seager-Scott says, "you could choose to manage a portfolio directly."
However, when you purchase a fund, a professionalwhether an index compiler or a fund manageris handling that for you.
The various kinds of investment funds.
There are so many different kinds of investment funds that it is nearly impossible to classify them all. The majority of the potential investment range is covered by three broad categories, though, which are particularly helpful for investors to understand. These include mutual funds, investment trusts, and exchange-traded funds (ETFs).
These three fund types are distinguished by two main differences: listed versus unlisted and open-versus closed-ended.
"Open-ended means clients can put money into the fund and take it out of the fund which makes the fund itself grow or shrink," Seager-Scott explains. In contrast, a closed-ended company raises all of its capital and issues all of its shares at the beginning.
"Listed means the shares are listed on the stock exchange so they can be traded on this secondary market throughout the day, while unlisted means you trade effectively directly with the fund group once a day (though it is still intermediated)," says Seager-Scott.
ETFs.
Listed, open-ended funds are known as exchange-traded funds (ETFs). You can purchase and sell them in a stocks and shares ISA in the same way that you might purchase shares in a publicly traded company, as the name implies.
Seager-Scott explains, "The benefit is that they can be bought and sold all day long and you can see live pricing while the market is open." "The drawbacks include the additional complexity that comes with the secondary market and the requirement to trade during market hours.
Even though an exchange-traded fund (ETF) is traded on a stock exchange, its price always reflects the net asset value (NAV) of its underlying assets. In order to guarantee that variations in the demand for the ETF's shares are consistently balanced against variations in its NAV, authorized partners have the ability to create or redeem new shares. This is what the term "open-ended" means.
Mutual funds.
In essence, open-ended, unlisted funds fall under this broad and occasionally ambiguous category.
Unit trusts, an older type of UK-domiciled fund, OEICs (which are UK-domiciled), and SICAVs (which are EU equivalents) are just a few of the many types, according to Seager-Scott.
Since mutual funds aren't listed on stock exchanges, this is the primary distinction between them and exchange-traded funds (ETFs). Once every day, units in the fund are purchased straight from the fund group through an investment platform.
Seager-Scott claims that although they are open-ended, it is crucial to understand that they can still close if necessary.
This may be because they grow too large and cease taking on new investors, in which case current investors will still be able to withdraw their own funds. However, there are instances when this occurs because the fund cannot fulfill redemption requests due to shares selling off too quickly. In that case, the fund is gated or closed, meaning that nobody can purchase or sell it. According to Seager-Scott, "this frequently causes a lot of concern."
Trusts for investments.
Closed-ended funds make up investment trusts. They are also technically listed businesses, which is why they are frequently called investment companies.
Being closed-ended means that all of their shares are created at the inception of the fund. Although the issuance of new shares is possible, it is far less frequent than the daily creation and redemption of shares that take place in open-ended funds. This is done to raise more money for investments rather than to control the fund's price.
The result is that, unlike open-ended funds, which are based on the value of their underlying assets, the price of an investment trust is entirely based on the demand for its shares, just like shares in a company. As a result, investment trusts may trade at a premium or a discount to their net asset value.
Though our explainer, Should investors worry about investment trust discounts? explores whether this is always the case, some investors view this as a drawback. In any case, there are a few significant benefits that investment trusts offer over open-ended funds.
To put it briefly, fund managers can pursue long-term investments with conviction because they never have to sell assets when investors withdraw their money thanks to the closed-ended model. As independent limited companies, they can also increase the returns on their investments by using leverage, or gearing.
Investment trusts can provide investors with a smoother dividend yield over time by reserving up to 15% of their returns from any given year and using that money to top up dividends in subsequent years.
Active and passive funds: what are they?
Investing funds can also be divided into passive and active categories. In short, a passive fund merely tracks an index (like the FTSE 100), whereas an active fund manager actively purchases and sells securities in an effort to produce market-beating returns.
Investment trusts are funds that are always in motion. In general, ETFs and mutual funds can be classified as either active or passive. Although ETFs are typically linked to passive investing, this is not required by the ETF structure, and active ETFs are becoming more and more important; last year, the assets managed by European active ETFs increased by nearly 70%.
Rahul Bhushan, managing director at ARK Investment Management, claims that competent portfolio management and research teams oversee active ETFs and make long-term investment choices. Companies in high-growth industries that the ARKs team believes will profit from technological innovation are the focus of their efforts, for instance.
"We believe active management can be a significant advantage in fast-moving sectors like AI, robotics, blockchain, energy storage, and multiomics," Bhushan continues.
What qualities should investors search for in an investment fund?
Your risk tolerance and how the fund reflects it should be your first priorities when selecting a fund to invest in.
As stated by Seager-Scott, "a common and sensible approach is to think about an asset allocation framework that matches your risk profile," which essentially means striking a balance between higher-risk and lower-risk bonds and stocks (shares in companies).
Similarly, youll want to think about what youre gaining exposure to when buying the fund. There are funds for both, as well as everything in between, depending on your preference for buying into a particular sector or exposure to global equities across all industries.
There will probably still be a number of options from various providers after you have decided what kind of fund you wish to purchase. Fee levels, as well as the funds underlying strategy, can help you decide which is your best option.
It's critical to comprehend fees because they can reduce your overall returns.
Generally speaking, active funds charge higher fees than passive funds because they require more labor to manage. Theoretically, this is offset by higher returns, but this isn't always the case. According to AJ Bell's most recent Manager versus Machine report, only 30% of active funds beat their passive counterparts over the ten years ending June 30, 2025.
Thus, it is crucial to examine the long-term annual returns of an active fund before purchasing it, ideally contrasting them with those of a passive fund or index within the same industry to make sure the manager is worth the additional costs. Naturally, past performance does not guarantee future outcomes, but a track record of superior performance is one sign of an experienced investment manager.
Before investing, investors should also confirm that they understand the fund manager's strategy (for an active fund) or the index's operation (for a passive fund).
When you're ready to begin choosing investment funds, take inspiration from our guide to six investment funds for beginners.
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