What a fund promises Every fund makes its promise in writing: what it will try to do, what it will hold, and what it measures itself against. Reading that promise tells you more than any advert. Here is one, made up but laid out like the real thing. Tap a marked line: each says what it lets the manager do with your money, and what it never may.
Read with Red Start’s founderTap a line; it is decoded beside the paper
Prospectus, extract Practice document Page 4 of 48
Larch European Leaders Fund Class A, accumulating · a UCITS fund · made up for this lesson
Investment objective The fund aims to grow your money over the long term, over periods of at least five years.1
Investment policy It invests at least 90% in shares of large companies listed in Europe, and may keep up to 10% in cash and money market funds. It does not borrow to invest.2
Benchmark The fund is actively managed and compares its return with a European large-company share index, which it aims to beat.3 The manager chooses the shares and is not bound by the index’s weights.
How far it differs from the index Each month the factsheet reports the fund’s tracking error and its active share against the index.4
Charges This paper is made up for Red Start Education and describes no real fund. Past performance does not predict future returns.
Line 1 · The objective
What the fund is trying to do “The fund aims to grow your money over the long term, over periods of at least five years.”
This is the promise itself, set out in the prospectus: the fund’s objective, here to grow over the long term. It names a goal and a time. It does not name a result.
It lets the manager Aim for growth over five years or more Have bad single years on the way Read it slowly Read the time first. A fund that aims for five years can have a bad year and still keep its promise.
Check it yourself Find the objective in your own fund’s prospectus. Write its goal and its time in one line each.
Line 2 · What it may hold
The fence around your money “It invests at least 90% in shares of large companies listed in Europe, and may keep up to 10% in cash and money market funds. It does not borrow to invest.”
This is the mandate: what the fund may hold, and its limits. The manager may do anything inside it and nothing outside it.
It lets the manager Pick any large company listed in Europe Hold a few of them or a few hundred Keep up to 10% in cash It never may Buy shares listed outside Europe Buy companies with no listing Borrow to buy more Read it slowly Read every limit as a number: at least 90%, up to 10%, no borrowing. A limit with a number can be checked.
Check it yourself Open your own fund’s latest list of holdings: does every big holding fit inside its fence?
Line 3 · The benchmark
What it measures itself against “The fund is actively managed and compares its return with a European large-company share index, which it aims to beat.”
Most funds name an index they compare themselves with, such as a world or European share index. An index fund tries to match it as closely as it can. An active fund, like this one, tries to beat it, and charges more for the attempt.
It lets the manager Choose shares and weights unlike the index’s Trail the index for a while It never may Show its return without the index it named Read it slowly Active means paid to be different. The next line shows how different it really is.
Check it yourself Find the index your own fund names and set the two returns side by side.
Line 4 · How far it differs
Two numbers that show how active it is “Each month the factsheet reports the fund’s tracking error and its active share against the index.”
Tracking error measures how much the fund’s return wanders from the benchmark’s, year by year. Active share measures how much of what it holds differs from the index. A fund with low numbers on both is close to an index fund, whatever it calls itself.
It lets the manager Stray from the index as far as its fence allows It never may Stop reporting the two numbers it promised here The real case In 2016 Europe’s markets regulator, ESMA, looked at about 2,600 share funds and found that between 5% and 15% of them might be “closet trackers”: priced as active funds while holding almost the index. It was a first screen, not a verdict on any one fund, but it showed why the numbers matter more than the label.
Source: ESMA public statement ESMA/2016/165, 2 February 2016
Check it yourself Look for tracking error and active share in your own fund’s factsheet.
Line 5 · What it costs
The gap it has to beat “Ongoing charge, each year”
1.5% a year comes out of the fund whatever it earns. Say an index fund on the same market costs 0.2%. This fund has to beat its benchmark by the whole gap just to come level.
It lets the manager Take 1.5% a year, whether it beats the index or not It never may Charge an entry or performance fee this table does not show Over 20 years Say both funds earn 6% a year before costs. After 20 years, €10,000 has become about €30,900 in the index fund and €24,100 in the active one.
Read it slowly A small yearly number grows. Read a charge over the years you will hold the fund, not over one.
Check it yourself Find the ongoing charge in your own fund’s KID and set it beside an index fund on the same market.