How successful can an investment company get?

Funds as an investment: you should know that

Annette de los Santos, March 9th, 2021

In 1772 there was a big stock market crash: After several London banks went bankrupt, not only prices in England fell in a chain reaction, but also on the stock exchanges in Scotland and the Netherlands.

The Dutch merchant Abraham van Ketwich, who had lost a lot of money in the crash, drew his own conclusions from the crisis. He saw a gap in the market for a product with which private investors with limited resources had the opportunity to diversify their risk broadly and thus to be better armed against the next stock market crash.

In 1774 he therefore launched a financial product that invested in a wide variety of bonds (including bonds or annuities) in Europe and the Dutch colonies - the birth of the modern mutual fund. The fund, named after the Dutch Republic's motto “Unity makes you strong”, was a success, and the average return of 4.0% was also impressive.

Funds as financial investments are still relatively popular with private investors, including in Germany. Today, German investors can choose between more than 8,000 funds choose. The following article examines why this is the case and which opportunities and risks should be considered when investing in funds.

What are funds?

An investment fund is a special fund managed by a capital management company (investment company). This fund can be invested in stocks, government bonds, real estate, currencies and commodities. There are also money market funds that invest in money market instruments and bank balances.

Funds in the sense understood here are so-called investment funds and not index funds (ETFs, i.e. exchange-traded funds). Unlike index funds, mutual funds are run by fund managers actively managed (managed).

aim It is this actively managed investment fund, through clever investment and targeted asset shifting to be better than the market. For equity investments, for example, this means investing in German securities and outperforming the DAX, i.e. achieving higher returns.

As the fund assets legally Special fund that does not fall into the insolvency estate of the capital management company does not exist for the investors Issuer risk. The investment companies must deposit the investment capital of the investors with independent custodian banks.

What types of funds are there?

Funds can basically be classified according to the management and the distribution categorize investor funds. One differentiates accordingly open and closed Funds, as well distributing and accumulating Funds. The individual types of funds are briefly presented below.

Overview: types of funds
Open fundsOpen funds can be a unlimited amount from investor funds. Shares in open funds are bought through banks and financial institutions, the investment company itself or through the stock exchange. The sale (or return) of fund units, on the other hand, is usually only possible to the investment company.

The shares can already be approved low prices acquire. The investment horizon can be short, medium or long term, since open funds usually do not have an end of term. However, there are also time-limited, so-called term funds.

Closed fundsClosed funds are used to create a limited amount of capital for large projects to recruit. Once all fund units have been sold, the fund will be closed and no further units will be issued.

The costs are relatively high with a front-end load (agio) of 15% to 20%. The same applies to the minimum investment amount, which is usually € 5,000.

The investment horizon is usually long-term and can be between ten and 30 years.

Distributing FundsIn the case of distributing funds, the net income generated annually is passed on to the shareholders poured outafter the final withholding tax (25% plus 5.5% solidarity surcharge and, if applicable, church tax) has been withheld. This payout will too dividend called and means a passive cash flow for the investor.
Accumulating Funds

In the case of an accumulating fund, the income generated is reinvested and not distributed to the investor. Investors thus benefit from the so-called compound interest effect. The reinvestment of the profits takes place after deduction of the running costs and a possible profit sharing of the investment company.

Why open funds are more popular with investors than closed funds

Closed-end funds usually invest in commercial real estate and occasionally also in residential real estate. There are also closed media and film funds, aircraft funds, forest funds, ship investments, infrastructure funds and company investments (venture capital funds and private equity funds) that are designed as closed funds.

Disadvantages of closed funds

It is true that closed funds in Germany were comprehensively regulated by the Capital Investment Code in 2013; the investment is still considered to be particularly risky. On the one hand, this is due to the mostly opaque business models that are behind the individual funds and that are difficult for private investors to assess. On the other hand, the long-term capital commitment (usually more than 10 years) deprives investors of any flexibility.

In 2015, Stiftung Warentest examined over 1,000 closed-end funds from a wide variety of areas and came to the conclusion that (based on the money invested) only 6% of the funds examined were able to meet their profit forecast. Due to the miserable balance sheet of media funds - only two out of 27 were successful - these have now almost completely disappeared from the market.

Even with closed real estate funds, which are considered safer compared to ship or media investments, only about 14% of the funds were able to meet or exceed the forecast profit. Most of the closed-end real estate funds (57%) even led to the loss of investment funds.

An example from the recent past are closed real estate funds in the new federal statesthat were launched in the 1990s and were often bought by newcomers or inexperienced investors. When the expectations regarding the rentability of the properties were not met, many investors suffered major losses.

In addition to the regular defaults in closed funds, there are reports of fraud as well as the loss of tax advantages and increased liability risks. The funds have therefore rightly fallen into disrepute among the public not recommended for private investors.

Advantages of open funds

In contrast to closed-end funds, open-ended investment funds are a suitable financial instrument for private investors and stock market beginners. Open funds have these five main advantages:

  • You can invest in large, also international securities or real estate portfolios with small amounts of money.
  • There are funds for every investment strategy, region, sector and other criteria, for example ethical, religious or ecological aspects.
  • Funds give investors easy access to international capital markets and, depending on the type of fund, they can invest in a diversified way.
  • Investors can invest in funds via a savings plan. In this way you can avoid entering at the "wrong" time and use the cost-average effect.
  • Open funds are liquid because the units can be sold on the stock exchange at any time

The risks of open-ended investment funds are very dependent on the underlying values. Pension funds that invest in government and corporate bonds are relatively low-risk. Real estate funds and equity funds, on the other hand, offer investors higher returns, but are also riskier.

Open-ended mutual fund categories

In addition to the type of investment (stocks, bonds, real estate, etc.), a distinction can be made between the following types of funds.

Overview: types of funds
Fund of fundsWith a fund of funds, you buy the shares of a fund, which in turn is in other funds invested. This can be both bond and equity funds.

The aim of the fund manager is to achieve the highest possible return with low fluctuations in value (volatility) through a clever mix of fund units with different strategies.

However, fall for investors double the cost because they bear the running costs of both the fund and the fund of funds.

Mixed fundsMixed funds usually invest in Stocks and bonds, Occasionally, other investment categories are added to a small extent. Some mixed funds have a fixed mix ratio, others can invest up to 100% in either stocks or bonds in order to react flexibly to market developments and to achieve the best possible return.

Given the now extremely low interest rates on the bond market, they are mixed funds not recommended in the current market environment, as they have clearly lost their attractiveness. This also applies to Pension funds to an increased extent, which for a long time were considered a safe investment for old-age provision.

Further differentiation criteria for open-ended investment funds are:

  • Geographical Spread of investments according to markets (e.g. USA, Europe, Asia, emerging markets, international)
  • Industry orientation (e.g. consumer goods, healthcare, automotive, commodity funds)
  • Special strategies other than purely return-oriented aspects, for example ethical or religious (such as "Islamic funds") as well as ecological (e.g. sustainable investments).
  • Investment horizon, that means short, medium or long term. Money market funds are well suited to investing short-term surplus liquidity, whereas open-ended real estate funds are more interesting for long-term investors.
  • target group: Private (public funds) or institutional investors (e.g. banks, insurance companies or family offices) who are reserved to invest in special funds.
  • Risk structure, e.g. short-term return-oriented, long-term value-oriented etc. Sub-categories of the risk classification are e.g. guarantee funds and (umbrella) hedge funds.

The fund market is very dynamic and new special forms are constantly being developed. An example are Retirement fundswhich must contain at least 51% shares and shares in open-ended real estate funds.

Disadvantages of open-ended mutual funds

In the case of open-ended investment funds, investors do not have any issuer risk with regard to the investment company due to the qualification of the fund assets as special assets. The risk of fluctuations in value up to considerable Depreciation still exists, of course.

This was shown not least by the financial crisis of 2007/2008, which followed the bursting of a real estate bubble in the United States. In the wake of the financial crisis, numerous open-ended real estate funds such as Morgan Stanley P2 Value and Degi Global Business not only suffered massive losses in value - they were even wound up completely, with immense losses for investors.

Price losses of this magnitude are particularly painful for investors if the fund units have a particularly low value at the time of sale. That is why funds are not suitable as a secure retirement provision.

Tip: Retirement provision should always have several pillars, i.e. cover different asset classes (e.g. savings accounts, stocks, bonds, funds, real estate).

Also not to be neglected are those costscreated by open funds. Although these are below the fees of closed funds - due to the active management, however, they are still significantly higher than e.g. index funds.

What costs should the investor expect?

The usual costs of the funds are:

  • administrative expenses between 1.5% and 2.5% per year.
  • Transaction costs incurred when the fund company switches custody accounts.
  • Possibly. success dependent compensation (English performance fee) for fund management (up to 20%).
  • Custodian Feeswith which the fund is deposited.
  • Trading fees when buying shares on the stock exchange.
  • Discount (Redemption fee): These costs are charged by some fund companies to cover the costs of redeeming the units and may amount to several percentage points.

The representative key figure for comparing the fees of the fund companies (excluding premium) is the Total Expense Ratio (TER).

Tip: Passively managed ETFs are an inexpensive alternative.

What you should consider before buying fund units

Although a fund saves you a lot of effort (ongoing investment decisions, constant monitoring of market developments and, if necessary, reallocation of your money), it is all the more important Fund search and the Choosing the right fund. There are three steps you should take to heart.

1 | Define the investment horizon, strategy and investment area

The Investment horizon of the fund company should be compatible with your own so that you have the liquidity you need when you need it. If you need your money in the short term, you should also invest rather low-risk in order to be able to sit out any fluctuations in value.

Closely related to this is the Investment strategy. For a value-oriented fund that invests in strong standard stocks, a longer holding period is generally required in order to generate the desired return. They are in contrast to risk- and return-oriented funds, which are geared towards short-term profit maximization.

You should also get one Overview of the markets, that is, provide industries and regions before deciding on a fund. The fund strategy and structure can be found in Investment prospectus, which you should read carefully before you decide. Pay special attention to the investment conditions to avoid unpleasant surprises.

Same goes for that Annual reports of the fund company. Semi-annual reports are also published in some cases. You should always read these, even if you already own fund units. It is important to obtain information independently of the provider, bank and glossy catalogs.

2 | Consult rating agencies and key figures critically

Funds are from the big ones Rating agencies (e.g. Moody’s, Fitch, Standard & Poor’s) are rated according to their performance (value development of the fund over a specific, past period) in recent years. The volatility in the past is also given there.

However, the system of rating agencies has structural problems. The central point here is that the agencies are paid by the issuers of the financial products. This creates a conflict of interest: the agencies have an incentive to rate the products too well. The problem was particularly evident in the 2000s, when the rating agencies over-rated mortgage-backed securities on a large scale and thus caused the global financial crisis from 2007 onwards. The ratings of the rating agencies should therefore be treated with caution.

Then it makes sense to do the following, relevant key figures. to match the funds in question with one another.

Fund key figures
performanceGive the Development of the fund price in the past. As a rule, management fees are included, but not the front-end load.
alphaAlpha indicates how the fund is performing in Relation to a comparable market (Benchmark) beats. If it exceeds the benchmark, alpha is positive.
betaBeta indicates how close the fund price is to the benchmark developed. If the value is above one, the fund value has risen or fallen more than the selected benchmark. So, large beta funds are particularly volatile.
Fund volumeCompare that too Fund volume. It should be of a considerable size in order to ensure sufficient security and fungibility (tradability).

Do not make the mistake of relying solely on past performance, but include foreseeable or probable future market developments in your decision-making.

Fund courses can be found at various providers (e.g. onvista, fund web or fund data from the Federal Gazette). Fund comparisons can be carried out using the fund lists of reputable magazines (e.g. € uro, Stiftung Warentest) and various online tools. The News and Analytics from industry services such as FONDSprofessionell or fondsDISCOUNT.

3 | Pay attention to costs: "The cheap is always the expensive"

Last not least: Compare the costs of funds using the Total expense ratio (TER) and check whether the fund management receives a performance-related fee. Even if such payments reduce the return, they are not always to be assessed negatively. They can also have a positive effect as an incentive for the fund manager to achieve higher returns.Here, too, what ultimately counts is the overall picture that can be determined from the various key figures.

It is often the case that funds with a good rating and experienced and competent fund management are a bit more expensive. Act according to the principle "The cheap is always the expensive" and do not make your decision based only on the fund costs.

If the costs of the fund seem too high for you, choose a passively managed index fund (ETF) rather than a "cheap" mutual fund.

With online custodian banks, certain investment funds are often offered with 50% lower sales charges. If you want advice from a bank advisor at your house bank when investing in funds, you should question his advice critically, because he receives a commission for the successful fund brokerage of certain funds (e.g. those launched by your own group).

In addition, there is no issue surcharge if you buy the fund units directly on the stock exchange. Before making an investment decision, you should definitely check comparable funds from other providers to see whether they are cheaper and / or offer better performance.

What are the legal frameworks for funds?

In Germany, funds have been subject to the regulations of the Capital Investment Code (KAGB). Among other things, this regulates that funds launched in Germany must observe the principle of risk diversification. For equity funds, for example, this means that they must have at least 16 different stocks in their portfolio, none of which may amount to more than 10% of the fund's assets.

Funds launched in Germany are subject to Supervision of the Federal Financial Services Agency (BaFin). Legislators always endeavor to make the capital market and the financial products on offer transparent for investors.

Tax regulations

At investor level, investment income from investment funds in Germany is taxed with the flat rate tax.

The taxation of mutual funds at the fund level is in Investment Tax Act which was reformed in 2018. Since January 1, 2018, German dividends, rental income and capital gains from investment funds from property sales have been taxed directly by the fund company at 15%. In addition, there is the solidarity surcharge, making it a total of 15.825%.

In return, investors receive a so-called Partial exemption from the final withholding tax. This means a percentage of the income that no longer has to be taxed by the investor. The amount of the partial exemption depends on the respective fund category.

Fund categoryThe amount of partial exemption
Equity funds (the equity portion of the fund is at least 51%)30 %
Mixed fund (the equity component of the fund is at least 25%)15 %
Mixed funds (the share of shares is extremely low)0 %
Real estate funds60 %
Real estate funds with a foreign focus80 %

The reform also eliminates some tax-saving opportunities:

  • With the reform, the will also be eliminated Crediting of the withholding tax on the final withholding tax by the investor - Instead, the fund company now takes care of receiving the withholding tax reimbursement
  • There is also the Tax deferral for accumulating funds no more.
  • With the tax reform of 2018, the Grandfathering for fund sharesthat were acquired before 2009 no longer. This means that the profits from the sale of these shares must now also be taxed.

Fund in conclusion: No alternative asset class

An investment in closed funds is usually one for investors very risky investmentthat has not proven itself in the past and is rarely suitable for private investors. In comparison, are open funds an asset class with many advantages: even with small contributions you can invest in international securities with a good risk diversification. Investors should keep two main factors in mind when making an investment. On the one hand the costs of the funds and on the other hand likely market developments.

It is also helpful to keep the following information in mind: Only less than a quarter of the actively managed funds in Germany outperform its benchmark index. After deducting all costs, they often even perform worse than comparable alternatives.

That is why independent financial experts often give preference to investing in index funds (ETFs), which are significantly less expensive.

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