If you are new to investing, you are in the right place.

In this series, equily co-founder Helen Lawton outlines some basic principles she followed when she began her investment journey.

My aim with this series of short articles is to share my own personal insights and set out some guiding principles I have followed on my investment path.

Buying Individual Equities

As of 2019, there were just over 43,000 publicly listed companies in the world: https://www.statista.com/statistics/1259025/global-listed-companies/  These publicly listed companies – equities – are classified by country and by sector. The relevant country is the location where the company has its main stock market listing and usually its headquarters. The two main index providers in the world, the MSCI and FTSE Russell, provide (among other things) equity, fixed income (bonds), and real estate indices. There are currently 47 countries in the MSCI All Country World Index, of which 23 are classified as developed and 24 as emerging. As well as a country and regional classification, every listed company in the world has an industry classification. The MSCI has 11 industry sectors, these are: Energy, Materials, Industrials, Consumer Discretionary, Consumer Staples, Healthcare, Financials, Information Technology, Communication Services, Utilities and Real Estate.

A benefit of holding individual equities is that they do not have fund management charges. But it is costly to buy individual equities, and you would need to buy many individual equities from all around the world to be diversified. It is better to allocate the equity portion of your portfolio to equity funds rather than individual equities – the latter are much better suited to institutional investors with large pots.

Equity Funds

There are many types of equity funds available, both passively and actively managed. Some funds focus on a very specific type of equity (e.g. companies in the UK’s FTSE 100 index or global small cap companies or themes such as cyber security) and others follow very broad indices such as the MSCI all-country world index.

Buying Individual Bonds

A benefit of holding individual bonds is that they do not have fund management charges, whereas bond funds do. Also, if an investor intends to hold an individual bond to maturity, they need not worry about the market price volatility of the bond between its issue and maturity. However, the investor should pay attention to the creditworthiness of the issuer – will the issuer repay the principal in full at maturity? In the case of bonds issued by Western governments, that answer should always be “yes”.

It is relatively easy to buy individual government bonds. In the UK, note that interest on UK gilts is paid gross but liable for income tax (making them attractive to non-taxpayers). But profits from selling UK gilts are free from UK Capital Gains Tax. UK gilts are available to buy on retail investment platforms, and in small values such as £100. UK gilts can also be held in UK tax-efficient wrappers such as ISAs and SIPPs.

It is relatively difficult for retail investors to buy and sell corporate bonds – the corporate bond market is highly fragmented compared to the equity market, and minimum order sizes are large. Bonds are thinly traded over numerous trading venues, many of which are inaccessible to retail investors and smaller institutions.

Bond Funds

It is however, very simple and easy to invest in bonds via funds. A bond fund is a portfolio of individual bonds and over time the fund will replace bonds as they mature in order to maintain the stated maturity range of the bonds in the fund. The benefit of investing in a bond fund is diversification: the ability to easily invest in many bonds with different risk/return profiles, while negating the risk of a material loss due to the default of any individual bond. If you intend to hold the bond fund for longer than its stated maturity range, you will ultimately profit from any rise in interest rates and overcome any loss in market value.

There are many types of bond fund available, both passively and actively managed (the former can be known as strategic bond funds). Some bond funds focus on a very specific type of bond (e.g. high yield bonds issued by US companies, or long-dated UK government bonds) and others contain a diversified range of bonds from around the world. Note however that “global aggregate bond funds” that passively track a global bond index tend to exclude some types of bond such as inflation-linked bonds, high yield, and emerging market bonds.

Currency Hedging

There is often a choice between currency hedged and non-currency hedged funds, and this exists across the range of asset classes. Currency hedging offers financial protection against losses arising from changing exchange rates when investing in a foreign currency e.g. a UK investor buying the S&P 500 index will make a loss if the US dollar falls against the British pound, even if the S&P 500 index remains unchanged. A fund manager can eliminate this exchange rate exposure via derivatives trading. Note however, that currency hedging also eliminates any potential profit from currency exposure. Currency returns have been fairly random historically, so there is no guarantee that the protection offered by currency hedging will always turn out to be the best strategy. Also, currency hedged funds usually have higher costs, both explicit (in terms of higher management fees than unhedged alternatives) and implicit (the invisible costs that occur through the operations of the fund manager). Hedging also reduces the diversification benefits of having a portfolio of assets spread over multiple currencies, because a currency-hedged portfolio makes these assets more correlated with one another.

However, it is common for investors to choose currency-hedged funds for the bond portion of their portfolio, leaving the equity portion of their portfolio unhedged. This is because currency hedging reduces the expected riskiness of bond investments (because currency movements tend to be more volatile than bond returns, and bonds are the part of the portfolio where the least risk is sought) but currency hedging does not reduce the expected riskiness of equity investments, because equity returns tend to be more volatile than currency movements anyway.

Types of Fund: Open-Ended Funds vs Closed-Ended Funds

It is important to understand the types of funds and their varying structures.

Open-Ended Funds

An open-ended fund is a type of collective investment fund where investors’ money is pooled together and invested collectively on their behalf. These types of funds are also known as mutual funds. An open-ended fund can expand without limit – if investors wish to purchase more of the fund, the fund manager will issue more units by purchasing more of the fund’s constituents from the market. The assets under management (AUM) of the fund manager will grow. Similarly, the fund manager can cancel units of the fund if investors wish to sell.

Exchange-traded funds (ETFs) are a type of open-ended investment fund that are listed and traded on a recognised stock exchange. They typically track the performance of an index and trade very close to their net asset value (NAV).

There are also open-ended funds that do not trade live on a stock exchange – typically, these funds set a time once a day for investors to buy/sell from the fund manager. These types of funds include Unit Trusts, Open Ended Investment Companies (OEICs) and ICVCs (Investment Company with Variable Capital).

Closed-Ended Funds

Investment trusts are closed-ended funds. They are not constituted as trusts in the legal sense of the word, they are established as Public Limited Companies (PLCs). On their launch, they only issue a fixed number of shares for investment via an Initial Public Offering (IPO). Investors are not entitled to redeem their shares on demand with the investment trust manager, they must trade amongst themselves on the secondary market through a recognised stock exchange (similar to trading individual company shares).

Unlike most other types of investment fund, investment trusts can borrow money, which can be invested alongside the capital injected by purchasers of the trust’s shares. This facility provides an investment trust with leverage, known as gearing. Needless to say, the investment trust manager needs to be confident they can generate a higher return than the cost of borrowing the money. Gearing increases the volatility of the fund – the rise or fall in the value of the assets will be magnified.

Another feature of investment trusts is the ability of their share price to trade at a premium or discount to the trust’s underlying net asset value (NAV, the value of underlying assets after any liabilities). This occurs because the share price depends on (i) the performance of the underlying assets owned by the investment trust and (ii) supply and demand for the shares of the investment trust in the stock market. The share price paid will rarely be exactly the same as the NAV – at any particular point in time, the shares could be trading at a discount (where investor demand is low) or at a premium (where investor demand is high) to their NAV. This is not commonly a feature of open-ended funds.

A particular type of investment trust that invests solely in real estate is known as a Real Estate Investment Trust (REIT). REITs invest directly in commercial real estate to earn rental income and management fees. Some also invest in real estate debt (mortgages and mortgage-backed securities). Many real estate companies are incorporated as REITs to take advantage of their special tax status. A company with REIT incorporation is allowed to deduct its dividends from taxable income.

Finally, any type of fund will be either accumulating or distributing:

Accumulation Fund (Acc)

A fund where dividends in the underlying investments are retained within the fund and not paid out to investors, resulting in the fund’s price increasing.

Distributing Fund (Dist)

A fund where dividends in the underlying investments are paid out to investors as cash payments on a regular schedule (often quarterly or semi-annually).

Please note, when investing, your capital is at risk, and returns are uncertain. The information in these blog posts does not constitute financial advice and should not be considered as such.