Managed funds: pooled investing, explained

Strip away the branding and a managed fund is a simple machine — many investors' money pooled together, professionally invested. Moneysmart's managed funds and ETFs section pitches it in one sentence: if you have money to invest and want to pay a professional to make the investment decisions for you, a managed fund might be for you. Its what is a managed fund page supplies the mechanics: money from many investors is pooled and invested to match the fund's investment strategy, a fund manager makes the day-to-day investment decisions, and a responsible entity — the fund's legal operator — manages the fund itself. And it's explicit about the part people miss: you don't own the underlying investments directly. You own a stake in the fund, held as units — the same page notes a managed fund may also be called a unit trust, a mutual fund or a managed investment scheme.

There are thousands of managed funds in Australia, and Moneysmart's choosing a managed fund guide says they differ in three basic ways: what they invest in, what fees they charge, and how they manage risk. It sorts them by the job you'd hire them for. Growth funds invest in assets like shares, aiming for higher long-term returns with a higher risk of the value going up and down along the way. Income funds tend to hold bonds, credit and cash, with varying degrees of risk and return. Balanced or diversified funds mix growth and income across a range of assets; cash and bank-bill funds aim to protect your money and keep it quickly available; and sector or theme funds specialise — property, technology, ethical investing. None of them is risk-free: the what-is page is blunt that the value of your investment can fall and you may get back less than you invested. It adds a detail that surprises people — if you have superannuation, you likely already invest in managed funds.

Money comes back to you along two channels, and Moneysmart's what-is page names both: the value of the fund — and with it, your stake — can go up or down, and some funds also pay you income, called distributions. Moneysmart's worked example on the choosing page, Daniel, shows why the mix between the two matters. A retiree who wants a regular monthly income, he compares a share fund that aims for long-term growth and pays small distributions with a diversified income fund that pays distributions monthly — and picks the income fund, not because it's "better", but because monthly payments match his goal. That's the guide's larger point: the same fund will not suit every investor; your goal, timeframe and comfort with risk should pick the fund.

How do you judge a machine you've paid to invest for you? Moneysmart's answer is to measure it against an index — a published yardstick for a whole market, such as the S&P/ASX 200 for the Australian sharemarket — and against similar funds, to see how it performs versus its competitors. Past returns are not a reliable guide to future returns, the guide is careful to say, but performance over five to ten years shows whether a fund has done the job it was designed for. Its caution is specific: be wary of a fund that hasn't kept pace with its benchmark or its peers over the long term, even if last year's return was strong.

That benchmark question splits fund management into two philosophies, and Moneysmart's what-is page describes both. Active funds employ fund managers to make ongoing investment decisions — some trying to beat the market's return, others aiming for steady income or shielding investors from losses. Passive funds — also called index funds — try to match a market index rather than beat it; there's less day-to-day decision-making, so fees are usually lower than active management fees. You can see the same split in the fee list: the performance fee described on the choosing page — a charge that may apply if the fund does better than its benchmark — belongs to the active world, where beating the market is the promise being sold. Whichever philosophy a fund follows, the long-term-returns test applies, and the fees section below matters more, not less, when the promise is bigger.

Then there's the cousin you'll meet on every comparison page. Moneysmart's what-is page notes that some managed funds are listed on exchanges like the ASX — the exchange traded fund (ETF) among them. The machinery inside is the same pooled-money machine; the door is different. A traditional managed fund is unlisted, and Moneysmart's worked example Mia shows the unlisted route end to end: not confident picking individual shares, she reads a fund's PDS to check how it invests, the fees and the risk, sees that a managed fund could give her a diversified mix that lowers her risk, and buys units directly with the manager. A listed fund's units are bought and sold on the exchange instead, like any share, whenever the market is open. The pooled-investing logic is shared; how you get in and out is not — and the exchange-traded side has its own page, ETFs.

Managed funds charge fees for managing your money — and Moneysmart's list of what to look for is longer than most people expect. There can be an establishment fee to open the investment and a contribution fee when you add money. The big one is management fees and costs — the ongoing charge for running the fund, taken year after year. Some funds add a performance fee, which may apply if the fund does better than its benchmark. And beyond the named fees, funds can deduct costs straight out of your returns — transaction costs and borrowing costs — plus charges for withdrawals, changing investment options or leaving the fund altogether.

The line worth memorising from Moneysmart's guide is this one: small differences in fees can make a big difference to your investment performance over time. The reason is compounding. An ongoing fee is a percentage of your balance taken every year — in good years and, more painfully, in bad ones — and every dollar it takes is a dollar that stops earning for the rest of your timeframe. The true cost of a fee isn't the fee itself; it's the growth that dollar would have produced over the decades it no longer works for you. A fee that looks like a rounding error on one year's statement can, over a long investment, quietly become one of the largest costs in your financial life.

The defence is unglamorous: read the fees section of the Product Disclosure Statement (PDS) — the fund's own disclosure document, covered properly in the next section — before any money moves, and compare funds on fees the way you'd compare them on returns. Moneysmart suggests seeing the effect for yourself with its managed funds fee calculator, linked from the choosing a managed fund guide; the comparer below runs the same what-does-the-fee-cost-me question on your own numbers. And remember the pairing from the last section: a fund charging premium fees while trailing its benchmark over the long term is exactly the pattern Moneysmart says deserves caution.

Getting in starts with a document, not an application form. Moneysmart's compare-funds checklist — what the fund invests in, whether its mix suits your goal, the investment timeframe it suggests, the minimum investment amount, how easy it is to get your money out, the fees, the risks, and how to complain if there's a problem — comes with the note that most of this information is in the fund's PDS, and the instruction is blunt: read the PDS for each fund before you invest. Alongside it sits the target market determination (TMD) — a statement every managed fund must publish explaining who the fund is designed for. Use it as a quick check against your goals, timeframe, risk tolerance and how likely you are to need the money back at short notice; if you're not in the target market, the fund may not suit you.

Applying to an unlisted fund means dealing with the fund itself: meet its minimum investment amount, send the application, and the fund issues you units — from there your balance moves with the pool. One trap Moneysmart flags for larger balances: if you're classed as a wholesale client — which includes a "sophisticated investor", a classification generally based on your income and assets — you can be sold financial products without a regulated disclosure document at all: no prospectus, no PDS, no TMD. Its advice is to always ask to see disclosure documents if you have any uncertainty about how an investment works. The label sounds like a compliment; what it removes is your paperwork.

Getting out is where a managed fund differs most from a bank account, and where the PDS earns its reading time. Some funds let you withdraw fairly easily; others only allow withdrawals at certain times, or after a set period. And Moneysmart is explicit that funds can restrict, delay or stop withdrawals in some circumstances — which is why "what if I need quick access to this money?" is one of the first questions its guide tells you to ask yourself. Before investing, check the PDS for when you can withdraw, how long a withdrawal may take, whether a withdrawal fee applies, and whether the fund can restrict withdrawals. This is liquidity risk by its proper name — on Moneysmart's risk list as the chance you may not be able to get your money out as quickly as expected. Its bottom line applies here more than anywhere: managed funds are not an appropriate investment for everyone, and its may-not-suit-you list includes needing your money back at short notice and not wanting to pay ongoing fees.