A person can invest their savings directly, either in fixed income, in equity securities or in money market instruments, making investment decisions by himself and thus acquiring a high degree of independence.
However, when investing directly by oneself, a series of barriers arise that discourage this activity, such as, for example, costs and limitations in terms of information, dedication, amounts to invest, operating expenses, difficulties to diversify, as well as to correctly assess the risks that are taken, etc.
That is why investment through collective investment undertakings makes it possible to mitigate or even eliminate some of the aforementioned barriers, since with a single investment in an investment fund, the barriers related to the scarcity or inaccuracy of information can be eliminated, the dedication that an investment requires, the difficulties to achieve the optimal diversification, etc., since the investment fund managers will take care of it. However, there are some barriers that cannot be totally eliminated —although they can be mitigated— through investment in an investment fund, such as problems derived from an incorrect assessment of the risk taken with investments.
Collective investment undertakings are those whose purpose is to raise funds from the public to manage and invest them in goods, rights, securities or other financial or non-financial instruments, provided that the investor’s yield is established based on the collective results generated.
Collective investment undertakings of a financial nature, depending on their legal form, can be classified in two different ways, which are the following:
- Investment funds: They are separate assets, without legal personality, formed by the contributions of investors. As they lack legal personality, they require for their representation, management and administration of the services of two types of specialized entities, which are a management company and a custodian.
- Investment companies with variable capital: They have their own legal personality, as they are incorporated as public limited companies and, therefore, they are governed by their General Shareholders’ Meeting and their Board of Directors.
Investment companies can be self-managed, with their own resources and management staff, or they can entrust the management to a management company of collective investment undertakings. The latter is the most common. In any case, they require the services of a custodian, which manages and keeps safe the securities in their investment portfolio. Investors in these firms acquire shares of the company and become its shareholders.
On the other hand, CIUs have a series of competitive advantages compared to other investment instruments, which has meant that in recent decades they have experienced an unprecedented expansion, especially among retail investors, but also among large investors. Among these advantages, the following should be noted:
- Professional management: CIUs have professional investment management, generally provided by a specialized company, which must have sufficient human and technical resources for monitoring, purchasing, valuation and accounting of financial assets. The fact of being subject to the supervision of the administrative authorities of each country guarantees this professionalism.
- Many investment alternatives: Any demand for investment, of any type of asset, whether fixed income, equity securities and from any geographical area, can be made through investment funds. The existence of standard classifications facilitates the choice of the CIU that adapts to the needs of each investor, guaranteeing that the investor is fully aware of where they are investing.
- Possibility of access with relatively moderate amounts: Due to its characteristics, market returns can be made regardless of the amount invested. The return of each unitholder is determined in accordance with the collective performance, regardless of the contribution made to the pooled money.
- Diversification: Investing through collective investment undertakings allows diversification and investment in many assets and markets from small amounts, which would be impossible for an individual investor to do.
- Legal certainty: Although it varies a lot from one country to another, the certainty of these undertakings is explained by the submission to the administrative bodies in charge of supervising the securities markets in each country, the obligation to be subject to external audits and the role of risk control and of internal regulatory compliance of the management company and the custodian.
Furthermore, in certain economies, investors have an additional protection factor due to the existence of investment guarantee funds, whose function is to compensate, at least partially, investors in cases of insolvency of investment firms.
- Liquidity: Investment funds, in general, enjoy high liquidity, being possible to buy or sell units on a daily basis and to liquidate the position in a few days, except in the case of investment funds with special characteristics, such as hedge funds, in which restrictions are expressly established, with monthly or even annual liquidity windows.
- Reduced costs: Investments through collective investment undertakings reduce the operating costs of intermediation, deposit, etc., since by having greater assets, they can resort to professional markets and get better conditions than a private investor gets.
- Information: Investment fund management companies and distributors are obliged to offer detailed information about the evolution of their assets and investments made prior to purchasing and, subsequently, for the duration of the investment. The prospectuses of the CIUs usually contain complete information about them.
- Tax advantages: Collective investment undertakings usually have a very favourable tax treatment compared to direct investment. The main advantage consists of a deferral of taxation until the moment of getting the profits obtained (sale of the shares)
On the other hand, the assets of the investment funds is constituted with the contributions of the unitholders and is divided into units, of equal value and characteristics. To invest in a CIU, investors have to subscribe (or buy) units or shares, as appropriate to the legal form of the undertaking; if they want to divest (totally or partially), it will be necessary for them to sale (redeem) their units or shares. Even if it is not the most usual, there are also CIUs that pay dividends to their investors.
Units, unlike shares, have no par value, but are allocated daily a net asset value per unit, identical for subscriptions and redemptions, which is equivalent to the listed value of the shares. The net asset value per unit is determined by dividing the total net asset value of the fund’s assets, after deducting the expenses attributable to it, by the total number of units issued. The net asset value per unit is calculated as a market value, that is, every fund investment (securities and assets) are valued as if they had to be fully sold. This implies that the net asset value per unit of the investment fund units includes daily every change that occurs in the prices of the different assets that make up the fund’s portfolio.
