Investment Funds
Investment funds, also known as collective investment schemes or managed funds, are vehicles where people put their money in order for a fund manager to manage them according to fundís investment philosophy. Among those probably the most popular are mutual funds. Recently however, a growing popularity started to gain opportunities funds.
Opportunity Funds
An opportunity fund belongs to a wide family of collective investment schemes. Its style of investment is however quite different in many ways than other investment funds. Opportunities funds most likely apply the following investment strategies: distressed, market timing, arbitrage, and event-driven. Opportunity fund's investment philosophy seems to be suitable to the global present market environment.
Opportunity fund gives individuals income opportunities by allowing to access investment opportunities that otherwise would not be available to them. They tend to be managed by highly experienced and skilled individuals who during their lifetime researched and benefited from investment opportunities using their own private resources.
The higher the value of Assets under Management (AUM), the higher is the range of investment opportunities as well as its purchasing and bargaining powers. The later ones ensure lower transaction costs and thus higher profits for investors. In order to achieve desired level of AUM that makes fundís operations profitable, a minimum investment level is usually determined.
Main differences between opportunity funds and mutual funds
Funds are often distinguished by asset-based categories, such as equity, bonds, property, etc. Also, very often funds are divided by their geographic markets or themes (such as technology, healthcare, socially responsible funds, etc.). Some funds among these broad categories might invest in companies that are considered to be growth or value stock with large, mid or small market capitalization value.
Opportunity funds tend not to concentrate on one specific market segment or theme, but rather invest in opportunities that exist across different asset classes. Some of the opportunistic funds may decide to target specific geographical regions only (e.g. Europe) in order to avoid currency risk and cost.
"Opportunities" are assets that at particular time can be bought at an attractive discount to their inner value. The discount could be triggered by many factors, such as distressed situation of the seller or general macroeconomic conditions. It could also happen that a particular asset is sold at a reduced price due to its defaults. The reason for discount is not always clear and straightforward, and, as a result, outcome of the investment is often uncertain. Consequently, an opportunities fund is perceived as bearing a significant amount of risk.
Opportunity fund is an actively managed investment vehicle, meaning that fund's manager employs dynamic portfolio strategies by buying/selling investments according to market conditions. It highly differs from passive portfolio management when fund's manager believes he will not be able to outperform the market, and thus decides to invest in indices that mirror market's performance.
In terms of legal structure, opportunity funds are structured in a manner similar to other investment vehicles. They might be created under company law, by legal trust or by statute. An opportunity fund tends to have a fund manager, who supervises investment decisions, custodian bank, who keeps custody of assets in fund's portfolio, and a fund administrator, whose main tasks are keeping shareholder register and calculating net asset value.
Opportunity fund can also have one of the main three schemes that vary in terms of accessibility by investors. They can be opened to general public, limited to only certain type of investors or highly exclusive. Moreover, they can also offer different types of shares with different privileges and sell them through different intermediaries, which in the end influence their price. They can be open-ended or a closed-ended, and use leverage in order to increase its investment capabilities.
Fees charged by an opportunity fund
Types of fees charged by an opportunity fund are the same as charged by other funds. However, due to its nature, as well as expected profits and amount of work performed, they tend to be higher than in case of traditional mutual fund or other lower risk fund, such as traditional equity or bond fund.
Types of fees might include management fee (covers basic operations costs) and performance fees that goes to fund manager (depends on the return made by the fund, might be determined also using high water mark or hurdle rate), an exit/entrance fee that typically are directed to the investment fund, commissions paid to intermediaries or salespeople and any other expenses associated with investment process.
All fees are typically related to the Assets under Management (AUM). The management fee tends to be in a range of 1.5% to 2.5% of AUM per annum and the performance fee between 15% and 25% of the profits achieved. If the performance fee is on the higher end, it is then typically subject to high water mark in order to ensure fair approach towards investors. The entrance fee is likely to be higher than the exit fee and might be equal of up to 8% of the assets introduced to the fund by a new investor. The exit fee is charged when the investor decides to withdraw his funds with profit earned from an opportunities fund before the advised investment period.
Performance measurement of an opportunity fund
In order to compare a fund's performance, fund managers tend to choose a benchmark against which the investment fund's results are compared. This benchmark tends to be an index or combination of indices.
Due to the fact that an opportunity fund is typically absolute return fund, it is very difficult to find comparable benchmark. Also an estimation of fund's alpha and beta is not very reliable indicator of a fund's performance. Alpha is a measure of fund's performance when return of comparable benchmark is equal to zero and thus demonstrates value added solely by the fund's manager skills. The higher alpha, the more skillful manager is believed to be. Beta, on the other hand, is the factor representing sensitivity to market changes. It is a similar measure to R-squared, which shows correlation between a benchmark and a fund and, at the same time, reveals whether fund's manager just closely tracks the market or is his performance achieved by active management.
Types of risks present at an opportunity fund
Depending on nature of investments made, the type of 'investment' risk will vary. As in case of any other investment fund, opportunity fund bears - among others - capital risk, market risk, currency risk, liquidity risk, operational and reputation risks.
Capital risk means that money invested might be lost if the investment strategy fails. Uncontrollable market factors that could contribute to deterioration of portfolios value constitute market risk. Currency risk applies to a fund that tends to invest in countries with different currencies that do not have a fixed exchange rate between them. If investment made cannot be easily sold for a fair value, we talk about liquidity risk. Operational risk is connected with failure in creation of safe and conflict-less working environment.
Advantage over other investment funds, mainly mutual fund, equity fund and bond fund
The advantage of investment into opportunity fund is their low (or lack of) correlation with different asset classes and the fact that they can perform well in a difficult market environment, which cannot be said about any other investment fund.
Opportunity fund is a good diversification factor since, as mentioned previously, it tends to invest in diverse asset classes wherever an income opportunities exists. In this manner, capital risk is lowered and spread out. By investing across diverse market sectors and often also countries, systematic risk is reduced.
Why to invest in an opportunities fund?
Deterioration of fundamentals of the economy in numerous countries around the word created unprecedented investment opportunities for entities that are in possession of liquidity. There are many distressed sellers that are ready to sell their precious assets at significant discount to their inner value.
In general there is little anticipation of fast economic recovery and individuals anticipations are not optimistic as there is still a great uncertainty about timing of a recovery and its sustainability given current levels of public deficit and growing unemployment rates. This is a perfect time to invest in an opportunity fund rather than traditional mutual fund or any other equity or bond fund, as it provides the highest income opportunity.
Who should invest in an opportunities fund?
Opportunity funds tend to be opened for professional investors who are able to judge risk involved, assess it against its risk-return profile, and make an independent investment decision. This category may include private Investors, pension funds, and institutional investors.
Those investors should have medium to long term investment time-frame. In order to bring the highest profits possible fund managers are willing to accept investors with an investment horizon of five years and more.