What is a “Pooled Investment”?
As the name suggests, “pooled investments” are a mixture of funds from multiple sources such as individual or institutional investors, which combined together benefit from economies of scale and cost optimization.
This type of investment provides investors with a larger opportunity set, as collectively they have enhanced purchasing power relative to small individual purchases. In addition, they are also very efficient from a transaction costs perspective and depending on the mandate can offer additional diversification benefits.
Some of the most popular types of pooled investments include mutual funds, investment trusts, exchange-traded funds (or ETFs), pension funds, hedge funds, and endowments.
Key Learning Points
- Pooled investments are aggregated funds gathered from multiple investors that create a giant portfolio, most often managed by a team of professionals.
- The biggest benefit of gaining exposure to pooled investments is the economies of scale – that broadens significantly the investment opportunity set and optimizes cost efficiency.
- As they are structured as a collective investment, pooled investments also provide portfolio diversification benefits.
- Mutual funds, ETFs, investment trusts, and pension funds are among the most common types of pooled investments.
How Pooled Investments Work?
The main philosophy behind pooled investments is that they allow a group of investors to be treated as a single account holder, which on the other hand enables them to make larger purchases at a more efficient cost. For example, mutual funds are one of the most popular types of a pooled investment, in which a large number of investors put their money together to create a sizeable portfolio.
In pooled investments, the money is managed by a professional portfolio manager or a team of professionals. They are paid a fee to monitor performance and risk, make adjustments where required, and also make sure that the fund is liquid enough to face large redemption requests from its investors.
By gaining exposure to a mutual fund, investors benefit from economies of scale – an aggregated amount from a large number of investors could buy a larger number of securities than an individual purchase, therefore, the potential opportunity set is broader. Mutual funds also limit the risk of a single security underperforming through portfolio diversification, as often they hold a larger number of securities.
What Are the Disadvantages?
Restricted control over the portfolio and investment decisions is the biggest disadvantage of pooled investments. In the case of investment clubs or partnerships, usually all members need to come up with a collectively made decision, which sometimes could take longer and have a negative impact on the portfolio, especially during market turbulence.
On the other hand, investing in a professionally managed vehicle means no input into the decision-making process – instead, a fund manager is making those decisions on behalf of investors. Although that may be a good and efficient solution, since fund managers can have greater knowledge and market experience, shareholders are charged a fee for that service.
Pooled investments are designed as collectives and, while offering good diversification benefits, stronger downside protection means limited upside too – investing in single securities could potentially deliver higher returns but at the expense of higher risk and vice versa.