Funds Articles

Cheat Sheet / Updated 02-22-2024

Mutual funds have been around for decades and despite other types of investments finding their way into investor portfolios, these securities are still king in Canada. Despite their still sky-high fees, mutual funds offer investors an easy way to buy into a diversified basket of stocks and bonds, which is really all you need for growing your wealth. Here are a few key points to keep in mind when considering these investments.

Article / Updated 08-31-2023

When, in November 2004, State Street Global Advisors introduced the first gold ETF, it was a truly revolutionary moment. You buy a share just as you would buy a share of any other security, and each share gives you an ownership interest in one-tenth of an ounce of gold held by the fund. Yes, the gold is actually held in various bank vaults. You can even see pictures of one such vault filled to near capacity (very cool!) at SPDR Gold Shares website. If you are going to buy gold, this is far and away the easiest and most sensible way to do it. You currently have several ETF options for buying gold. Two that would work just fine include the original from State Street — the SPDR Gold Shares (GLD) — and a second from iShares introduced months later — the iShares Gold Trust (IAU). Both funds are essentially the same. Flip a coin (gold or other), but then go with the iShares fund, simply because it costs less: 0.25 percent versus 0.40 percent. Strange as it seems, the Internal Revenue Service considers gold to be a collectible for tax purposes. A share of a gold ETF is considered the same as, say, a gold Turkish coin from 1923 (don’t ask). So what, you ask? As it happens, the long-term capital gains tax rate on collectibles is 28 percent and not the more favorable 15 percent afforded to capital gains on stocks. Holding the ETF should be no problem from a tax standpoint (gold certainly won’t pay dividends), but when you sell, you could get hit hard on any gains. Gold ETFs, therefore, are best kept in tax-advantaged accounts, such as your IRA. (This strategy won’t serve you well if gold prices tumble and you sell. Then, you’d rather have held the ETF in a taxable account so you could write off the capital loss.)

Article / Updated 08-23-2023

If you want to invest your money in companies that are smaller than small, you can invest in ETFs based on micro caps. These companies are larger than the corner delicatessen, but sometimes not by much. In general, micro caps are publicly held companies with less than $300 million in outstanding stock. Micro caps, as you can imagine, are volatile little suckers, but as a group they offer impressive long-term performance. In terms of diversification, micro caps — in conservative quantity — could be a nice addition to your portfolio, though not a necessity. Take note that micro cap funds, even index ETFs, tend to charge considerably more in management fees than you’ll pay for most funds. Micros move at a modestly different pace from other equity asset classes. The theory is that because micro caps are heavy borrowers, their performance is more tied to interest rates than the performance of larger cap stocks. (Lower interest rates would be good for these stocks; higher interest rates would not.) Micro caps also tend to be more tied to the vicissitudes of the U.S. economy and less to the world economy than, say, the fortunes of General Electric or McDonald’s. Given the high risk of owning any individual micro cap stock, it makes sense to work micro caps into your portfolio in fund form, despite the management fees, rather than trying to pick individual companies. To date, a handful of micro cap ETFs have been introduced. They differ from one another to a much greater extent than do the larger cap ETFs.

Cheat Sheet / Updated 01-06-2023

Hedge funds use pooled funds to focus on high-risk, high-return investments, often with a focus on shorting — so you can earn profit even when stocks fall.

Article / Updated 08-17-2022

Buying and selling an exchange-traded fund (ETF) is just like buying and selling a stock; there really is no difference. Although you can trade in all sorts of ways, the vast majority of trades fall into these categories: Market order: This is as simple as it gets. You place an order with your broker or online to buy, say, 100 shares of a certain ETF. Your order goes to the stock exchange, and you get the best available price. Limit order: More exact than a market order, you place an order to buy, say, 100 shares of an ETF at $23 a share. That is the maximum price you will pay. If no sellers are willing to sell at $23 a share, your order will not go through. If you place a limit order to sell at $23, you’ll get your sale if someone is willing to pay that price. If not, there will be no sale. You can specify whether an order is good for the day or until canceled (if you don’t mind waiting to see if the market moves in your favor). Stop-loss (or stop) order: Designed to protect you should the price of your ETF or stock take a tumble, a stop-loss order automatically becomes a market order if and when the price falls below a certain point (say, 10 percent below the current price). Stop-loss orders are used to limit investors’ exposure to a falling market, but they can (and often do) backfire, especially in very turbulent markets. Proceed with caution. Short sale: You sell shares of an ETF that you have borrowed from the broker. If the price of the ETF then falls, you can buy replacement shares at a lower price and pocket the difference. If, however, the price rises, you are stuck holding a security that is worth less than its market price, so you pay the difference, which can sometimes be huge. For more information on different kinds of trading options, see the U.S. Securities and Exchange Commission discussion.

Cheat Sheet / Updated 02-24-2022

When I invest my own money, I've long used the best mutual funds. To make the most of your money when investing in funds, you should be sure that you have your overall finances in order. You should also understand what works and doesn’t work and what will maximize your chances for success and minimize your chances of problems in funds. The following will guide you well in your journey.

Article / Updated 12-22-2021

In the investment world, "I run a hedge fund" has the same meaning as "I'm a consultant" in the rest of the business world. In general, a hedge fund is a private partnership that operates with little to no regulation from the U.S. Securities and Exchange Commission (SEC). A hedge fund uses a range of investment techniques and invests in a wide array of assets to generate a higher return for a given level of risk than what's expected of normal investments. In many cases, hedge funds are managed to generate a consistent level of return, regardless of what the market does. To understand what a hedge fund is, it helps to know what hedging is. Hedging means reducing risk, which is what many hedge funds are designed to do. Although risk is usually a function of return (the higher the risk, the higher the return), a hedge fund manager has ways to reduce risk without cutting into investment income. A hedge fund manager can look for ways to get rid of some risks while taking on others with an expected good return. For example, a fund manager can take stock market risk out of the fund's portfolio by selling stock index futures. Or (s)he can increase her return from a relatively low-risk investment by borrowing money, known as leveraging. Keep in mind, however, that risk remains, no matter the hedge fund strategy. The challenge for the hedge fund manager is to eliminate some risk while gaining return on investments — not a simple task, which is why hedge fund managers get paid handsomely if they succeed. Characteristics of hedge funds A hedge fund differs from so-called “real money” — traditional investment accounts like mutual funds, pensions, and endowments — because it has more freedom to pursue different investment strategies. In some cases, these unique strategies can lead to huge gains while the traditional market measures languish. The amount of potential return makes hedge funds more than worthwhile in the minds of many accredited and qualified investors. Here, are some of the basic characteristics of hedge funds. Hedge funds are illiquid One key characteristic of hedge funds is that they’re illiquid. Most hedge fund managers limit how often investors can take their money out; a fund may lock in investors for two years or more. In other words, investing in a hedge fund is a long-term proposition because the money you invest may be locked up for years. Hedge funds have little to no regulatory oversight Hedge funds don’t have to register with the U.S. Securities and Exchange Commission (SEC). Most funds and their managers also aren’t required to register with the Financial Industry Regulatory Authority or the Commodity Futures Trading Commission, the major self-regulatory bodies in the investment business. However, many funds register with these bodies anyway, choosing to give investors peace of mind and many protections otherwise not afforded to them (not including protection from losing money, of course). Whether registered or not, hedge funds can’t commit fraud, engage in insider trading, or otherwise violate the laws of the land. Hedges use aggressive investment strategies In order to post a higher return for a given level of risk than otherwise expected, a hedge fund manager does things differently than a traditional money manager. This fact is where a hedge fund’s relative lack of regulatory oversight becomes important: A hedge fund manager has a broad array of investment techniques at his disposal that aren’t feasible for a tightly regulated investor, such as short selling and leveraging. Managers receive bonuses for fund performance Another factor that distinguishes a hedge fund from a mutual fund, individual account, or other type of investment portfolio is the fund manager’s compensation in the form of a performance fee. (SEC regulations forbid mutual funds, for example, from charging performance fees.) Many hedge funds are structured under the so-called 2 and 20 arrangement, meaning that the fund manager receives an annual fee equal to 2 percent of the assets in the fund and an additional bonus equal to 20 percent of the year’s profits. You may find that the percentages differ from the 2 and 20 formula when you start investigating prospective funds, but the management fee plus bonus structure rarely changes. Hedge funds use biased performance data What gets investors excited about hedge funds is that the funds seem to have fabulous performances at every turn, no matter what the market does. But the great numbers you see in the papers can be misleading because hedge fund managers don’t have to report performance numbers to anyone other than their fund investors. Those that do report their numbers to different analytical, consulting, and index firms do so voluntarily, and they’re often the ones most likely to have good performance numbers to report. Add to that the fact that hedge fund managers can easily close shop when things aren’t going well; after it shuts down it doesn’t report its data anymore (if it ever did), and poorly performing funds are most likely to close. What all this means is that measures of hedge fund performance have a bias toward good numbers. Hedges are secretive about performance and strategies Some hedge funds are very secretive, and for good reason: If other players in the market know how a fund is making its money, they’ll try to use the same techniques, and the unique opportunity for the front-running hedge fund may disappear. Hedge funds aren’t required to report their performance, disclose their holdings, or take questions from shareholders.

Cheat Sheet / Updated 10-01-2021

An exchange-traded fund (ETF) is something of a cross between an index mutual fund and a stock. It’s like a mutual fund but has some key differences you’ll want to be sure you understand. Here, you discover how to get some ETFs into your portfolio, how to choose smart ETFs, and how ETFs differ from mutual funds.

Article / Updated 03-26-2016

Hedge funds are designed to reduce an investment risk (called hedging) while maintaining a good return on investment. You can sort hedge funds into two basic categories: absolute-return funds and directional funds. The following sections look at the differences between the two. Hedge funds are small, private partnerships, and hedge fund managers can use a wide range of strategies to meet their risk and return goals. For these reasons, we can't recommend any funds or fund families to you, and we can't tell you that any one strategy will be appropriate for any one type of investment. That's the downside of being a sophisticated, accredited investor: You have to do a lot of work on your own! Absolute-return funds Sometimes called a "non-directional fund," an absolute-return fund is designed to generate a steady return no matter what the market is doing. An absolute-return fund has another moniker: a pure-alpha fund. In theory, the fund manager tries to remove all market risk in order to create a fund that doesn't vary with market performance. If the manager removes all the market risk, the fund's performance comes entirely from the manager's skill, which in academic terms is called alpha. An absolute-return strategy is most appropriate for a conservative investor who wants low risk and is willing to give up some return in exchange. Some people say that absolute-return funds generate a bond-like return because, like bonds, absolute-return funds have relatively steady but relatively low returns. The return target on an absolute-return fund is usually higher than the long-term rate of return on bonds, though. A typical absolute-return fund target is 8 to 10 percent, which is above the long-term rate of return on bonds and below the long-term rate of return on stocks. Directional funds Directional funds are hedge funds that don't hedge — at least not fully. Managers of directional funds maintain some exposure to the market, but they try to get higher-than-expected returns for the amount of risk that they take. Because directional funds maintain some exposure to the stock market, they're sometimes called beta funds and are said to have a stock-like return. A fund's returns may not be steady from year to year, but they're likely to be higher over the long run than the returns on an absolute-return fund. A directional fund's return may be disproportionately larger than its risk, but the risk is still there. These funds can also swing wildly, giving a big return some years and plummeting big in others. Longer-term investors may not mind as long as the upward trend is positive.

Article / Updated 03-26-2016

Hedge funds are expensive, for a variety of reasons. If a fund manager figures out a way to get an increased return for a given level of risk, he deserves to be paid for the value he creates. One reason hedge funds have become so popular is that money managers want to keep the money that they earn instead of getting bonuses only after they meet big corporate overhead. Face it — a good trader would rather keep his gains than share them with an overpaid CEO who doesn’t know a teenie from a tick. Almost all hedge fund managers receive two types of fees: management fees and performance fees. More than anything else, this business model, not the investment style, distinguishes hedge funds from other types of investments. A management fee is a fee that the fund manager receives each year for running the money in the fund. Usually set at 1 percent to 2 percent of assets in a fund, the management fee covers certain operating expenses, salaries for the fund manager and staff, and other costs of doing business. The fund pays other expenses in addition to the management fee, such as trading commissions and interest. For example, say a hedge fund has $100,000,000 in assets. It charges a 2-percent management fee, which is $2,000,000. The fund has an additional $1,750,000 in trading expenses and interest. The fund investors have to pay fees from the assets whether the fund makes money or bombs. Most hedge funds take a percentage of the profits as a performance fee — also called the incentive fee or sometimes the carry. The industry standard is 20 percent, although some funds take a bigger cut and some take less. You need to read the offering documents you receive from a fund to find out what the fund charges and whether the fund’s potential performance justifies the fee. If the fund loses money, the fund manager gets no performance fee. In most funds, the fund managers can’t collect performance fees after losing years until the funds’ assets return to their previous high levels, sometimes called the high-water marks.