Investment Company

Many investment companies have broadly the same structures as unit trusts. There are closed and open-ended investment companies, have managers who make investment decisions for the funds, issue and redeem shares with investors, can be single or multi-manager companies, have different classes of shares and will have a depository and a custodian.

As these funds are set up as companies under company law there is no trust to manage. The assets of the fund are owned by the investment company and the investors own shares in the company that give them various rights to participate similar to shareholders in any company.

Responsibility for the performance of the company lie with the board of directors. The depository will monitor the investment company, just like the trustee in a unit trust.

Unit trusts and investment funds are collective investment schemes whereby investors' money is pooled and managed as one amount by the investment/fund manager with each investor having a share in the assets in the portfolio.

Funds that are authorized by the regulator can be sold to the general public; those that are not authorized can be sold only to certain types of investor, usually the ones that can prove either market knowledge and expertise or certain levels of wealth or both.

Authorized funds must comply not only with the trust deed if there is one but also with the terms given in the prospectus and the prospectus must be available to the investor before they purchase shares or units.

Funds are established in either onshore or offshore jurisdictions. The main reason for this is the tax and regulatory environment and the target investor base. Offshore funds are neither "tax free" nor "unregulated". However, the rate of tax applied to the funds' activities may be more attractive in an offshore locality and likewise there may be a less onerous regulatory environment applying to the activities of the fund. Therefore, offshore funds are often "unauthorized" for sale to the general public and can only be sold to what is often referred to as "qualifying investors".

Offshore locations where funds are registered include:

• Jersey
• Guernsey
• Isle of Man
• Bermuda
• Cayman
• Bahamas
• British Virgin Isles

Portfolio Investment

Funds are established with investment objectives in mind.
This is reflected in the title of funds, for example UK Small Caps would indicate that the fund invests in small capitalized UK-based companies. A Global Income Fund would suggest that the fund invests in assets that will generate income, dividends, interest, etc. Some funds are mixed so that they are designed to deliver both capital growth and income.

The manager therefore has the guideline for what the fund is investing in, however there are further guidelines and objectives. The fund will have a target for the return it will deliver to the investor. Often this is in simplistic terms a percentage return; for instance a fund may have a target of growth or income return of 10% per annum. This is sometimes set against a benchmark so, for instance, the fund might be expected to return X% more than an index such as the FTSE 100 or the S&P 500.

Fund managers may also operate within a benchmark allocation of what is called 'asset classes and targets'.
For example:
                     Asset Class           Asset Allocation          Benchmark
                     Equities                          60%                  FT All share
                     Bonds                            30%                  FT Gilt index
                     Cash                              10%                  Merrill Lynch Index

The above portfolio, the asset allocation split across equities, bonds and cash. If the fund has received a subscription of say USD100,000 the manager will invest USD60,000 in acceptable equities, USD30,000 in acceptable bonds and USD10,000 in acceptable cash instruments. The selection of the actual instruments and securities is down to the manager and the target is to at least equal the indices shown.

Markets and Investments

Fund managers must have somewhere to invest the money contributed to the fund by the investors. In most cases the money is invested through the capital markets in either the purchase of equity (shares) in companies listed on stock exchanges or new issues (public offerings) of shares on stock exchanges, debt instruments like fixed income bonds, floating rate notes, etc. issued by governments, companies and other government agencies or local authorities like local or county councils, etc. and in cash or what is called "near cash" instruments like treasury bills.

The precise instruments that are used depend on the types of fund and what it is permitted to use. For example any fund allowed to invest in government bonds could invest in the bonds issued by the governments of the G7 countries like US, UK, France, Germany, Japan, etc. However retail funds may be restricted and not permitted to take the risk of investing in the bonds of emerging markets although the income return is higher there is a greater risk of the fund losing its money if the issuer defaults on a payment or redemption of the bond.

Likewise a hedge fund which can assume far greater risk than an authorized unit trust can "gear" or "leverage" the portfolio's exposure by using products like derivatives where they can acquire a much greater exposure for the money invested than a unit trust can by investing the same amount in shares.

Structure of funds

Investment funds are generally structured as either "open-ended" or "closed". These terms refer to the shares or units in the fund that investors can hold. Shares are issued by investment companies and units by funds set up as trusts, hence the term "units trusts". A closed fund has a finite number of shares or units in existence whereas an open-ended fund creates or cancels shares/units as investors look to purchase or sell their holding. The size in terms of the humber of investors and the holding they have of an open-ended fund can therefore increase or decrease depending on the attractiveness of the fund to investors. Unite trust was created under trust law rather than company law. Thus the assets of the fund are held on behalf of the investors by a trustee.

Role of Trustee

The trustee monitors the activites of the investment or fund manager to make certain that the investments are in line with the trust deed. The trustee owns the assets of the fund, not the fund manager and if there are more buyers than sellers of the units in the fund it is the trustee who will, on request by the fund manager, create more units, or the reverse if there are more sellers than buyers.

Trust Deed

The trust deed sets out the terms under which the trust is established and specifies the investment objectives, products and markets permitted, constraints on investments and the amount of risk the fund manager can establish in the portfolio.

Fund Manager

The fund manager is the firm and/or person making the investment decisions. Many large unit trusts are managed by investment companies. Employees working for the company as fund managers deal with particular funds and make decisions based on:

• the trust deed
• the fund management company's view of markets and products
• the asset allocation profile of the fund
• selecting individual assets to be held in the portfolio
• adjusting the assets to reflect market conditions and changes

The fund management company will be responsible for marketing and sales of units in the trusts for which it acts as investment/fund manager for and makes its money by charging fees to investors. These fees are based on an initial fee paid when the units are first purchased and management fees related to the function of the manager in making investment decisions and running the fund.

Some funds are what is called "multi-manager" funds and this can involve more than one management firm being responsible for managing parts of the portfolio. For example manager A may manage equities and manager B fixed income investments within the fund. Equally there could be two managers from different firms managing the equity part of the portfolio on a percentage basis, i.e. fund manager A manages 60% and manager B manages 40%.

Custodian

The trustee may appoint a custodian to hold the assets of the fund in safekeeping and to deal with the settlement of transactions undertaken by the manager.

Fundamentals of Fund Administration

Many funds have decided to focus their role as investment managers and have decided to outsource their work, especially those operational work. In particular hedge funds, their roles like custody and administration tend to be handled by specialist organisations, prime brokers and fund administrators. These roles are important as in reducing almost completely the need for the "fund manager", in this sense the sponsor/owner, to be involved in anything but investment decision-making; and the setting up of new hedge funds is made staggering easy. This may go some way in explaining the significant growth in these funds in recent years.

However, fund administration has evolved from a relatively humble beginning where the primary role was that of calculating the value of the assets in the fund so that a price for the investors wanting to buy or sell shares or units in the fund could be established. Today a fund administrator may have roles related to everything from setting up the fund to risk management and compliance roles. The administrator is very much monitoring the fund to ensure that the actions of the investment manager are in line with the objectives of the fund, the regulatory environment applicable to the fund, the tax situation affecting the fund and the client service role between the fund and its investors.

As a result some of the functions previously carried out by specialist firms have been absorbed into the fund administration role, particularly within the largest fund administrators. Transfer agency/fund registrar services for instance are provided as part of fund administration services by some companies. However specialists can and do survive, providing bespoke services to their clients.

In some ways the fund administration business has evolved in similar way to custody services. Consolidation, expanding range of services, competition, increased costs and investment have all impacted on the business.

This expansion of funds and the role of the fund administrator is not without its problems. Some financial centres like Dublin have witnessed huge growth within a short time frame. This can obviously lead to strains on the infrastructure and the community not only in small offshore locations but also in larger locals like Dublin and Luxembourg . Shortage of experienced personnel is an inevitable consequence of the development of fund administration services in a developing financial centre. This is made more critical by the need for skill sets in more and more diverse products and strategies, particularly in the hedge fund arena. Another factor is that the large organisations can move their entire operations function dealing with the administration of funds and other operations-based functions to these localities putting even greater pressure on the recruitment environment.

We can add increased workflow to the list of evolution of the fund administrator's role. Many of the funds that appoint external administrators have been small funds like private funds, hedge funds, etc and many of them were closed funds. These funds by nature had, relative to retail mutual funds, far fewer requirements in terms of reporting, etc. As a result many would calculate the NAV of the fund perhaps monthly, some even less frequently. Today many of the hedge funds are seeking to be included in funds of hedge funds and these in turn are attractive vehicle of other funds to invest in. As a result the NAV needs to be calculated daily if the wide appeal is to be maintained. Given the types of products these funds might be investing in, the relatively straight-foward NAV calculation by the administrator becomes, when needed on a daily basis, somewhat of a nightmare.

If we also consider the greater sophistication in the use of products and strategies and therefore the need for product and market knowledge then the whole administration process, not just valuations, becomes a much more demanding function.

Reporting to investors and the manager, fund set-up, monitoring compliance and managing risk have all become more and more high profile issues and the fund administrator has had to respond by developing and providing the kind of support and services that the managers require.

One thing is for sure, the changes will continue; and so, as long as wealth continues to be created, will the growth in the number of funds. Each one will need an administrator!