Fundamental Fund Management

Fundamentals of fund managementThe term fund management has that all too common financial jargon sound to it.

Not too dissimilar to financial management.

In fact, even for those in the industry is it a pretty confusing term because fund management can refer to at least two very distinct financial disciplines.

Usually either:

The management of a particular collective investment with a very specific mandate. For example, an Asia Pacific equity fund would need a fund manager who had the ultimate say on which company shares went into the fund, and which ones were left out. Should the fund buy more Singtel shares, or maybe increase its holding in Telstra?

More commonly fund management could refer to something similar to portfolio management or investment management. In this role fund management would mean looking at all the various investment options available, choosing those which are suitable for their clients, and then managing this asset allocation in order to build a diversified portfolio.

The rationale for this type of fund management is based on the idea that different assets (stocks, bonds, property, gold etc), behave differently in different stages of the economic cycle, and also have different tendencies in terms of the returns and the risk involved.

Fund Management Rationale Example

A bond is a ‘fixed interest’ instrument, and is generally regarded as a fairly low risk investment. The return you get from buying a bond from, say, the Australian government is usually ‘fixed’ at outset. Let’s say 6% per year. This might be a good return if you can only get 3% from leaving your money with Commonwealth bank.

But what if interest rates go up to 7%?

You’d then be getting less from your bond than you would from the bank, but if you tried to sell that bond, who would want it? The price of the bond will therefore decline if interest rates go up. Fund management needs to account for this tendency for assets to behave in a particular way.

So, bonds might not be great investments when interest rates are rising; i.e. when there is inflation. The same is often true for property because investors tend to borrow to buy; property prices are very sensitive to changes in interest (borrowing) rates. However, some investments have a tendency to do well when inflation (and interest rates) is on the rise. Gold – and some other commodities – have a historical record of returning well when there’s inflation. I.e. they keep their value when cash in the bank might be being eroded.

Of course there is no certainty that what worked well in the past will work again in the future, however, there is a general consensus that holding different ‘assets’ will reduce the risk of a particular set of circumstances having a major impact on your wealth and financial security. This is where a good fund manager can help, by trying to alter the balance of assets in anticipation of changes in the economic environment.

The actual weighting of these assets within a portfolio is largely a function of your goals as an investor.

The Fund Management Process

An essential part of the fund management process in ensuring that the chosen investments match your investment profile. For those with a longer period between investing and actually using the money, the more aggressive a fund management specialist will suggest your portfolio should be.

Therefore, more emphasis may be put on equities and commodities, less in bonds and cash. Conversely those will only a short time until they use the money, losses in the portfolio cannot usually be tolerated, and therefore, safer investments should be used.

At the end of the day, unless you can devote the time needed for the fund management process, you’re far better off leaving it to a financial services professional, and the best way to do this is by taking advantage of a financial planning consultation.