The Essential Guide to Investing in Managed Funds

A managed fund pools members' money in a portfolio of asset classes, such as shares, property, fixed interest and cash, locally and abroad. This diversification enables an individual investor to spread the risk much further than could, say, by buying a handful of shares or an investment property. The funds, which are constantly monitored by professional managers, also give investors access to large asset classes for a relatively small outlay, such as commercial property...

Investors buy units, which in the case of "open" funds, can be bought and sold like shares. The units are valued on a weekly basis by calculating the net asset value less debt and operating costs and divided by the number of units issued, which can be limited as in the case of "closed" funds. Some funds are "listed" and trade on the stock exchange, but in this guide we deal mainly with "unlisted" funds...

Managed funds are many and varied, but there are two major types: active and passive. An active fund buys and sells investments to generate the highest possible returns. A passive fund might be constructed to mirror a certain market, such as an index fund which tracks the ASX 200, and are usually cheaper to buy into. But you also can select the asset class, market, sector and region or a combination of those. There are even funds that invest in managed funds. Most importantly, you get to choose your level of risk, from conservative to aggressive or somewhere in between...

Active funds fall into two general types: growth and value. Growth funds look for assets that are likely to outstrip the gains over time against a benchmark, such as the ASX 200. Value managers look for assets that are undervalued by the market, for whatever reason, but have strong potential returns. In recent times, a third type - ethical funds, which may apply environmental and corporate governance standards to companies in which they invest - have grown in stature...

Before you decide to which type of managed fund to in vest in you need to carefully consider your risk profile, your investment horizon, your existing investments and your financial goals. How much risk you are comfortable with? How you long do you want to invest for? Answering these questions will have a major bearing on the type of fund you should choose...

You can usually join a fund for as little as $1000, and can set up a regular savings plan with $100 monthly contributions. There can also be entry and exit fees as well as a yearly management fee to cover operational costs, which is known as the management expense ratio MER. The MER on a passive fund, which usually have no entry or exit fees, can be as low as 1 per cent. For active funds, the MER ranges from 0.5 to 2.5 per cent in addition to a 5 per cent entry or exit fee. Above that, "absolute return" funds, which aim to deliver the highest possible returns above a set benchmark, can charge up to 20 per cent on the amount they exceed their target by...

You can save on fees by investing through discount brokers, who will may the entry fee and possibly refund some of your MER. However, they will not give advice but you may pay for advice on a fee for service basis. Investors with more funds at their disposal, say $25,000, may be able to access a wholesale fund, which won't charge entry or exit fees and usually has an MER of about 1 per cent...

Platforms, also called wraps or master trusts, are used by financial planners to directly control your investment for an additional fee. They can provide access to a large range of funds, including wholesale funds, and allow you to easily add to and withdraw from or change your investment. A big attraction is the consolidate reporting whereby investors get one statement no matter how many the funds they invest in, which makes life a lot easier at tax time...

Past performance is a useful though flawed tool for choosing a managed fund. Many people invest in last year's winner, only to see it underperform the following year. So you need to look beyond the one-year performance for consistency over a long period. The rolling average return is the best tool for comparing managers. The top-performing funds are regularly published in The Sydney Morning Herald and The Age, and on the Morningstar website...

The tax liabilities on the distributions you receive from a managed fund include income from dividends and from the sale of assets - i.e. capital gains. The split of this income will determine how you are taxed...

You can invest in managed funds either directly through a fund manager, an adviser (usually through a wrap), or through a platform you can access directly or through a discount broker. Once you do buy, note that that you should be able to switch between funds run by the same manager, and may get a number of free switches a year...