The structure of a mutual fund offers many benefits to a broad spectrum of investors, even the most sophisticated. Unlike a hedge fund, for example, the structure of a mutual fund is highly transparent and governed by law to protect investors.

There is a perception that mutual funds are meant for investors of modest means, while ‘sophisticated’ —read, wealthy—investors build portfolios of individual securities à la Warren Buffett. Mutual funds have been rightly criticized for their high cost, particularly in Canada where management fees are among the highest in the world. However, the structure of a mutual fund offers many benefits to a broad spectrum of investors, even the most sophisticated. The trick is to find funds from amongst the thousands available to Canadian investors that offer these benefits at a low cost—and they do exist.

So, a quick recap on the structure and function of a mutual fund and the powerful advantages this structure provides to investors. At its most basic level, a mutual fund is a company that pools the capital of like-minded individual investors who share similar investment goals. Each unit held by an investor represents proportionate ownership of the fund’s holdings and the income generated by these holdings. Unlike a hedge fund, for example, the structure of a mutual fund is highly transparent and governed by law to protect investors. There are regulations which require a certain level of liquidity, that mutual fund units be redeemable at any time, that protect against conflict of interest, that ensure fairness in the pricing of fund units, disclosure requirements, and so on.

The specific characteristics of each mutual fund reflect the investment and business decisions of its professional management. With a view to achieving specified investment objectives, a professional manager invests the pool of money in a diversified basket of securities which share certain features. The individual investor reaps the benefits of holding a position in a large number of companies (in global markets) at a modest cost, relative to the overall trading costs involved in buying all the individual securities contained in the fund.

The benefits are substantial:

  • Cost: Because of the reduction in trading costs, investors have the ability to participate in a broad range of investments, including some that might otherwise be available only to institutional or sophisticated investors.
  • Professional management of underlying securities: Access to the professional knowledge and expertise required to research, select, monitor and trade securities is expensive, but the structure of a mutual fund makes it affordable as this cost is distributed across all unit holders in the fund. Investors can choose a fund which uses an investment style most suited to their needs and objectives. For example, if you choose a value fund, you will have part ownership in a diversified basket of securities which share a set of features representative of value stocks: that is, stocks that have a low market value relative to their book value. It is very difficult to purchase individual securities with any given level of knowledge on foreign stock exchanges. Access to a specialized fund to buy stocks or bonds in global developed markets or in emerging markets is of tremendous value to a domestic investor.
  • Diversification: Because a fund holds a broad portfolio of investments in many companies, it spreads risk. The failure of one company held by the fund has little impact because it represents only a small portion of the fund’s overall investment. With mutual funds you can diversify your holdings across asset classes—stocks, bonds, money market instruments, or some combination of these investments— invest in funds that track an index, or even in a fund of funds. Funds offer diversification by style dimensions: small cap versus large or value versus growth stocks. They are also a way of gaining access to global markets and tapping into emerging markets, allowing diversification by country and region.

The bottom line tends to be cost for benefits received. The right mutual fund can offer significant benefits that you could never expect with individual security ownership. If you can have access to all of these benefits at a low cost (maybe lower than individual security ownership) why would you ever consider trying to access direct ownership of individual securities. The marketplace has changed over the years and mutual funds can offer a highly competitive arrangement for high net worth investors which sophisticated needs.

Before you invest your hard-earned money in a mutual fund, do your homework. Ideally, work with a trusted advisor. Read the prospectus, look carefully at fees and other costs, look for excessive portfolio turnover which would incur trading costs and tax consequences. As John Bogle, the founder of Vanguard, pointed out in his much praised book, Common Sense on Mutual Funds, you have to pay attention to four dimensions: reward, risk, cost and time. His advice: “Don’t select funds as if they were simply individual common stocks, to be discarded and replaced as they face the inevitable ebb and flow of performance. Select a fund with the same thoughtful consideration you would give to appointing a trustee for your assets and establishing a lifetime relationship.”

Daryn Form is a Senior Financial Advisor with Assante Capital Management Ltd. providing wealth management services to principals of family-owned and privately held companies. Assante Capital Management Ltd. is a member of the Canadian Investor Protection Fund and is registered with the Investment Industry Regulatory Organization of Canada.  The information mentioned in this article is for general information only. Please contact him to discuss your particular circumstances prior to acting on the information above.  The opinions expressed are those of the author and not necessarily those of Assante Capital Management Ltd.  Rates are not guaranteed and are subject to change at any time without notice.