What is an Investment Fund and How Does it Work?

What is an Investment Fund and How Does it Work?

In this article we will explain the concept of an investment fund, and the main aspects to take into account in order to fully understand how it works. To understand what an investment fund is and how it works, we need to know the concepts that are closely related such as investments: net asset value, shares, management company or depositary, among other concepts are paramount.

What is an investment fund?

Investment funds, or also known as Collective Investment Institutions (CIS), are investment vehicles that include the contributions of various savers, and through which savers transfer to professional managers, the decision making on the investment of their assets. The investment is made jointly in the assets that the management team considers suitable to obtain the maximum possible return. Based on a previously defined investment strategy.

Therefore, an investment fund is made up of assets, which do not have legal personality, and which are divided into shares.

The fund can invest in a wide range of assets: bonds, stocks, derivatives, currencies, as well as in non-financial products such as real estate or raw materials. They can also invest in any geographical area. However, they must respect the marked investment philosophy.

All funds are born with a certain investment philosophy, which specifies the distribution of assets in the portfolio. The risk profile will determine the fund's exposure to equities (riskier) or bonds (more conservative). It must also be determined whether it will invest in a particular region, such as US, or in more countries. You can even invest globally.

Elements of an investment fund

To understand what an investment fund is and how it works, we need to know what the following concepts are:

Participate in an investment fund

Just as there are shareholders in a company, there are participants in an investment fund, who, through the contributions they make to the fund's joint assets, obtain a certain participation in it. Following the simile, the participants are owners of the fund in the same way that the shareholders are owners of a company, and in the proportion of the contributions they have made.

They can enter the fund at the time of its constitution or a posteriori, and they can leave it (obtaining the reimbursement of the investment) at any time.

Participants must know their risk profile well in order to make the best investment decisions. You can find out your risk profile using the Fondutest tool.

Investment fund shares

Units are the aliquots into which an investment fund is divided. The number of shares forming an investment fund is not a fixed value as is the case with the shares of a company, but depends on the purchases and sales of the shares. The purchase of shares is called a subscription and the sale of shares is called a redemption.

The price of an investment fund's participation on a certain date is called the net asset value. This is the value that will allow us to see how the fund evolves.

Technically, the net asset value is the sum of the assets that make up the fund, divided by the number of units in circulation. For example, if the units of the investment fund have a net asset value of $100 and you wish to invest $2,000, the investor will acquire 20 units. The net asset value is published daily, taking into account the closing stock market price.

The units are negotiable securities, but they are not normally traded on any stock market, but the units are sold and repurchased by the management company.

Investment fund management company

The management company is responsible for managing and administering the fund. It should be made clear that it is not the owner of the fund, the owners are always the participants. The management company decides where the fund's assets are invested, i.e. it determines the fund's investment policy.

Each investment fund is managed by a single manager, but a manager can manage more than one investment fund at a time. These companies directly charge a fee to the investment fund for the management and administration of the fund.

Management companies are required to submit information on their funds to the CNMV on a regular basis, and are responsible for keeping records of investment fund units.

Custodian of an investment fund

The function of the depositary is to guard and supervise the assets that make up the fund. This can be a bank, savings bank, securities company or credit cooperative that is registered with the CNMV. The depositary charges a commission to the investment fund as a deposit.

If the investment fund changes its depositary, the participants have the right to receive the totality of their investment without applying, if any, a redemption fee.

Operation of an investment fund

The operation of an investment fund is very simple. The participant puts his money into the fund and acquires shares. The management company integrates this money into the fund and invests it where it considers convenient (stocks, bonds, currencies...).

The patrimony of the investment fund is the money that forms it, whether or not it is invested in financial assets. On the other hand, the portfolio of an investment fund is the set of securities it owns.

When the investor acquires shares through the contributions he makes, he is buying a part of the fund, that is, he is forming a small portfolio equal to that of the fund.

A functioning investment fund may increase or decrease in size for two reasons. Firstly, due to the entry or exit of investors, and secondly due to variations in the market value of the assets that make up the fund.

The first reason will never affect the investment, the price of the units will simply vary according to subscriptions or redemptions. What does affect the investment and the results that the investor will obtain is the variation in the value of the assets.


Participants or investors are those people who invest their money. Their capital goes into the fund's common wealth and in return they receive shares in the fund in proportion to what they invest.

The funds are flexible, you can enter at the time of their creation or a posteriori. You can also withdraw totally or partially at any time.


Units are the equal parts into which the assets of an investment fund are divided, this number of units is not fixed, it depends on the purchase of units (subscription) or sale (redemption).

As a result, the value of the units also varies. The value on a particular day is called the net asset value of the investment fund. That's why units are negotiable securities, but they're not usually traded on any market. In this sense it is the management company itself that sells or repurchases the units.

Management company

The fund is administered and managed by the management company, which determines the investment policy to be followed. That is to say, where the patrimony of the fund formed by the contributions of the participants is going to be invested.

Each investment fund has a single management company, although this can manage different funds. The managers charge subscription and redemption fees (up to 5%) as well as performance fees, management fees, control of the depositary company, accounting and periodic reporting to the CNMV.

Taxation of investment funds

Investment funds are exempt from taxation until they are repaid. For individuals, capital gains obtained from the repayment of shares in investment funds are considered capital gains that will be integrated into the savings tax base in the personal income tax return, regardless of the period in which the gain was generated. At the time of repayment, an IRPF withholding tax will be applied to the capital gains obtained.

The main peculiarity of investment funds is that the sale of units will not be taxed when the amount obtained from them is transferred to another investment fund. In other words, a transfer can be made from one fund to another without being taxed. The number of transfers that can be made is unlimited, as is the length of stay.

To calculate the capital gain or loss, the expenses and commissions derived from the operation, such as subscription or redemption commissions, must be added to the purchase price (and subtracted from the sale price).

Gregory Weiss
Gregory Weiss July 25, 2020