Pooled funds

Imagine having the power to tap into investment strategies that require a substantial capital, all the while maintaining the flexibility to start with an affordable sum. This is the concept of pooled funds––financial instruments that have transformed the way everyday investors approach wealth creation. In the landscape of investment opportunities, pooled funds stand out for their financial synergy. As you navigate the world of wealth management, you'll find that these collective investment vehicles offer a blend of accessibility, diversification, and professional oversight.

This article tells you more about what pooled funds are, their types, and how to invest.

• Table of contents

• What are pooled funds?
• Pooled funds example
• Types of pooled funds
• The working of pooled funds
• Why are pooled funds important?
• Advantages of pooled funds
• Risks of pooled funds

What are pooled funds?

Pooled funds represent a collaborative approach to investing, where your capital is combined with that of other investors to create a larger, more potent investment pool. This collective pot of money is then managed by professional fund managers who use their expertise to invest in a diverse range of securities on behalf of all participants.

Think of pooled funds as a financial potluck where each investor brings a portion of the capital to the table. The combined resources allow for a feast of investment opportunities that might be out of reach for individual investors acting alone. This pooling of resources enables you to gain exposure to a wide array of assets, from stocks and bonds to real estate and commodities, all within a single investment vehicle.

There are various types of pooled funds – some requiring a high minimum investment and oriented towards HNI investors, some with low barriers to entry, such as mutual funds.

Also Read: What are hedge funds

Pooled funds example

To grasp the concept of pooled funds, let's consider a practical example. Imagine a group of 1,000 investors, each contributing Rs. 10,000 to a pooled fund. This creates a substantial investment pool of Rs. 1 crore. The fund manager, armed with this collective capital, can now make strategic investments that would be impractical or impossible for individual investors.

Also, this level of diversification and access to various asset classes would be challenging to achieve with a Rs. 10,000 investment on your own. But the pooled fund structure makes it possible for you to participate in a professionally managed, well-diversified portfolio regardless of your individual means.

Thirdly, the involvement of a professional fund manager allows you to participate in the financial markets and benefit from nuanced trading and investing strategies even if you don’t have the time, knowledge or inclination to do so independently.

Types of pooled funds

1. Mutual Funds
   • Professionally managed investment funds that pool money from multiple investors.
   • Invest in stocks, bonds, money market instruments, or other assets.
   • Can be actively or passively managed (e.g., index funds).
   • Investors buy and sell shares at the Net Asset Value (NAV).
2. Exchange-Traded Funds (ETFs)
   • Similar to mutual funds but traded on stock exchanges like individual stocks.
   • Usually passively managed, tracking an index, commodity, or sector.
   • Lower fees than actively managed mutual funds.
   • Investors can trade throughout the day at market prices.
3. Hedge funds
   • Private, pooled funds for high-net-worth individuals or institutional investors.
   • Use aggressive strategies like leverage, derivatives, and short selling.
   • Typically have high fees (2% management + 20% performance fee).
   • Less regulated than mutual funds and ETFs.
4. Pension funds
   • Pooled investments set aside for retirement benefits.
   • Managed by pension plan administrators or investment firms.
   • Invest in a diversified mix of stocks, bonds, real estate, and private equity.
5. Real Estate Investment Trusts (REITs)
   • Pooled investment funds focusing on real estate assets.
   • Investors earn income from rental income or capital appreciation.
   • Publicly traded REITs act like stocks, while private REITs are less liquid.
6. Private equity funds
   • Investment pools that acquire and manage private companies.
   • Usually structured as limited partnerships.
   • Invest in startups, leveraged buyouts (LBOs), or distressed assets.
   • High risk, high return potential, and require a long-term investment horizons.
7. Venture Capital (VC) Funds
   • A type of private equity fund focusing on early-stage startups.
   • Invest in high-growth potential companies.
   • Typically structured as limited partnerships.
   • High-risk but with potential for massive returns.

The working of pooled funds

The mechanics of pooled funds are designed to be straightforward yet effective. Here's a step-by-step breakdown of how pooled funds operate.

• Fund creation: A fund management company establishes a pooled fund with a specific investment objective and strategy.
• Investor contributions: You and other investors purchase units of the fund, contributing to the collective pool of capital.
• Professional management: The fund manager invests the pooled money according to the fund's stated objectives, which could range from potential capital growth to income generation or a combination of both.
• Diversification: Your money is spread across various investments, reducing the risk associated with putting all your eggs in one basket.
• Valuation: The fund's market value is calculated regularly, often daily, reflecting the current market value of its holdings.
• Returns: Any gains or losses are reflected in the market value of your investment. You may also receive distributions in the form of dividends or interest, depending on the fund's structure and performance.
• Liquidity: The level of liquidity depends on the type of pooled fund, but many do allow redemptions and additional investments at any time.
• Reporting: The fund management company provides regular updates on the fund's performance and holdings, enhancing transparency.

Why are pooled funds important?

Pooled funds, especially those that require low minimum investments such as mutual funds and ETFs, have helped make investing accessible to a larger number of individuals.

• Accessibility: Pooled funds break down barriers to entry, allowing you to invest in markets and assets that might otherwise be out of reach due to high minimum investment requirements or complex trading processes.
• Professional expertise: You benefit from the knowledge and experience of professional fund managers who dedicate their time to researching and selecting investments.
• Risk management: Through diversification, pooled funds help mitigate the impact of poor performance in any single investment, potentially smoothing out returns over time.
• Cost-efficiency: By sharing expenses across a large investor base, pooled funds can often achieve lower transaction costs and management fees compared to individual investing.
• Time-saving: For busy professionals or those new to investing, pooled funds offer a hands-off approach to growing wealth without the need for constant monitoring and decision-making.

Advantages of pooled funds

• Diversification: Perhaps the most significant benefit, diversification helps spread risk across multiple investments, potentially reducing the impact of poor performance in any single holding.
• Professional management: You gain access to experienced fund managers who make informed investment decisions based on extensive research and market analysis.
• Economies of scale: The large size of pooled funds can lead to lower transaction costs and better pricing on investments, which can translate to improved returns for you.
• Liquidity: Most pooled funds offer daily liquidity, allowing you to buy or sell units with relative ease.
• Accessibility: With low minimum investment requirements, pooled funds make it possible for you to invest in a wide range of assets that might otherwise be out of reach.
• Regulatory oversight: Pooled funds are typically subject to regulatory supervision, which can help safeguard investor rights and interests.

Also Read: What is the power of compounding in mutual funds?

Risks of pooled funds

1. Limited customisation: Pooled funds follow a predetermined investment strategy that may not perfectly align with your specific financial goals or risk tolerance. You can't tailor the fund's holdings to your individual preferences.
2. Lack of ownership control: As an investor in a pooled fund, you don't have direct ownership of the underlying securities. This means you can't exercise shareholder rights, such as voting on corporate matters.
3. Potential style drift: Over time, fund managers may deviate from their stated investment strategy, a phenomenon known as style drift, which can alter the fund's risk-return profile.

FAQs:

What is the meaning of pooled funds?

Pooled funds are investment vehicles that combine capital from multiple investors into a single portfolio. This collective approach allows for greater diversification and professional management of assets.

What is the difference between a mutual fund and a pooled fund?

Mutual funds are a type of pooled fund. However, they are typically more heavily regulated than other pooled funds such as hedge funds and other alternate investment funds. In terms of accessibility, mutual funds are generally available to many retail investors because of their low barriers to entry, while some pooled funds may be restricted to institutional investors or high-net-worth individuals.

Are pooled funds risky?

Like all investments, pooled funds carry some level of risk, but the risk level can vary significantly depending on the fund's investment strategy and the assets it holds. Pooled funds typically offer built-in diversification, which can help mitigate some types of risk.