4.1 Introduction

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If you were thinking about investing your wealth, you could do it directly with the help of an investment advisor or indirectly through an investment fund. This depends on the time and effort you are willing to put into your investment analysis.

 

4.2 Investment advisor

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If investing was a passion of yours and you were willing to put time and effort into it, it is suggested an advisor instead of doing it alone.

 

It is strongly recommended to be followed by one or more professionals ready to be consulted before making an investment choice.

 

4.3 Investment fund

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Otherwise, if investing was just the way to keep safe and growing your wealth in the long run, buying a share in an investment fund is suggested. An investment fund manager will take care of everything. Investment funds were defined in the previous chapter at 3.7 paragraph (hedge funds vs. mutual funds, hedge funds are managed by hedge fund managers, while asset managers manage mutual funds).

 

The only disadvantage of investment funds is that most of them require a minimum initial investment that not everyone can reach using their savings.

 

As in any investment, some due diligence has to be applied before giving away the money, as explained in this chapter.

 

4.3.1 Trust

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If well trusted, an investment fund manager is most likely going to satisfy her/his investors. Choosing an investment fund manager is like marrying someone. Before doing so, you really want to trust her/him.

 

There are two types of trust you have to look for in a manager:

 

1. Do you trust their ‘loyalty’?

2. Do you trust their ‘smartness’?

 

You need both types of trust, especially the first one, which is why it is ranked first. Smartness without loyalty is the worst combination, her/his smartness is going to fool you instead of work for you.

 

The two types of trust are the theory, but in practice, to assure both types of trust, you are going to do some due diligence in order to screen your potential partners (investment fund managers). Specifically, you are going to make sure that the next three conditions will satisfy you:

 

1. Pay incentive structure

2. Curriculum

3. Past performance

 

The pay incentive structure and curriculum will verify the level of loyalty. Past performance will verify the level of smartness.

 

4.3.2 Pay incentive structure

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You want a pay incentive structure that makes your investment fund manager (personally) profit when the fund makes money, and at the same time, you want a pay incentive structure that makes your investment fund manager (personally) lose when the fund loses.

 

Having your investment fund manager personally exposed to the investment fund performance makes her/him loyal. This is why you should always check first if the manager had a good amount of her/his wealth invested in the fund. The more of her/his overall wealth, the better.

 

As you can see, the pay incentive structure is the key point in the screening: a bad pay incentive structure makes the manager act against your interest, a good pay incentive structure makes the manager act in your interest.

 

4.3.3 Curriculum

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The second thing to analyze in order to prove loyalty is the manager’s curriculum. With curriculum, I simply mean her/his past.

 

Before giving your money to an investment fund manager, you want to know the past of that person. Like a detective, you will do your research on your potential investment fund manager to drag up all the dirt you can find, then you decide if she/he would be loyal enough to manage your money.

 

4.3.4 Past performance

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Last but not least, you want to see the past performance of a potential investment fund manager before giving her/him the money. Here I want to underly the fact that past performance is extremely important, but it is overvalued, pay incentive structure and curriculum are more important, trust over smartness.

 

4.4 ETF vs Investment fund

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ETFs are popular because they charge cheap fees and because they are well diversified. The ETF on the Standard & Poor’s index and the ETF on the Dow Jones index are the most known.

 

Some famous figures have been publicly talking well about ETFs, especially the previous ETFs on the American market, which made them popular also among ‘normal’ people - with ‘normal’ I mean non-professionals or people that are not passioned about finance. This popularity might threaten the risk of a bubble.

 

By buying an ETF on an index, an investor is indirectly buying a very small fraction of each company listed on that index, pushing the prices of an entire market up.

 

But before buying an ETF, like with any other investment, an investor should do her/his research before. A good ETF is an ETF that has good fundamentals: a growing economic sector if it was an ETF on a sector or a good law structure that incentivizes economic growth if it was an ETF a country index.

Not counting the fact that an ETF, like any other financial instrument, has to be undervalued before being bought, and it has to be bought with good timing, which involves more research.

So, it is not that easy. Like with MBSs, just because they are diversified, it does not necessarily mean that they are safe.

 

In case of a general market collapse, when all the stocks listed on an index go down, an ETF on that index cannot protect its investors by definition, while an investment fund manager can protect her/his investors if she/he foresaw it.

A smart investment fund manager would buy derivatives before a market collapse.

Some investment fund managers might also short the index if they felt very confident about the collapse, but it is not recommended. Shorting is a bad game because it has an upper floor but not a bottom floor. With a bad chosen short, an investment fund manager can lose more than what she/he invested.