What is a Fund?

An investment fund or simply a fund is a pool of money. Its owners are investors who have placed money into the fund. How does it work? Let us explain on the basis of an example.

Example: Let’s assume that you have 1,000 euros and your friend also has 1,000 euros. You decide to invest together and you open a special account to which you transfer in total 2,000 euros. Thereafter you will buy some securities for that or make a deposit. This is a simple fund. The rate of return of the fund depends on the rate of return of your investment and if it yields any profit you divide it in half, because your initial investments were equal.

Although the above example extremely simplified, in principle everything works the same way. Investors buy units (receive a piece of the fund), the assets are invested together and the rate of return is equal for everyone. The income of the fund depends only how the assets of the fund have been invested. The example above featured two investors and they decided together where they should invest their money. In reality, funds could have thousands of investors and making a decision together is out of question. For that purpose, investors hire a fund management company that invests the money and takes a certain fee for it.

In general the units of the funds are very liquid – they can be sold back at any time. The resale or redemption of the units is facilitated by the fund due to the fact that the fund purchases its own units back.

These simple principles are the foundation for the functioning of the funds.

A fund is created when investors put their money together and the fund management company invests it. But what is a fund management company (fund manager) and how do they manage the funds?

A fund manager appointed especially for that manages the investments of a fund. All Estonian fund managers must have the fund manager attestation certificate, which is issued by the Minister of Finance.

The assets of a fund are held at an account opened especially for the fund in the depositary. The fund has a contract with the depositary, the main principle of which is that the depositary undertakes the obligation to hold the assets of the fund and carry out supervision over the activities of the fund management company.

A depositary can be any credit institution (bank) in Estonia that holds the respective activity licence received from the Bank of Estonia. From the point of view of security of the investors, the depositary is one of the most important components, because the assets of the fund (and thus of the investors) are held by the depositary.

The first level of control is the fund management company that is responsible for the performing the conditions of the fund as well as the provisions of the law. The fund management company must have an internal financial controller or financial auditor who carries out supervision in the company.

The second level is the depositary that is responsible for the correct calculation of the net asset value or the NAV of a fund unit. In order to carry out supervision, the depositary has the right to request different reports from the fund management company and interfere into the price calculation process.

The third level is the Financial Supervision Authority or the state supervisory body that checks both the depositary and the fund management company (hereinafter referred to as the “Authority”). To obtain an authorisation necessary to operate as a fund management company, a respective activity licence has to be obtained from the Authority. Regular reports on the activities of the fund as well as the fund management company are submitted to the Authority. In addition to the above, the Authority has the right to carry out on-the-spot checks.