Equity funds

Equity funds pool investors’ money and use expert fund managers to invest across a wide range of company shares. They therefore provide diversified, professionally managed exposure to the growth potential of global stock markets.

Things to consider when choosing an equity fund

1. Deciding where to invest

The first thing to work out when selecting equity funds is where to invest. A good starting point could be to look at funds investing in the UK market, before looking to add diversification through funds that invest in international markets. More experienced investors may look to add risk by considering emerging market equity funds as well as sector or thematic funds.

UK equity funds

UK investors often prefer to have at least some of their portfolio invested in their home market. This is because they have more familiarity with the political and economic backdrop, greater knowledge of the investment opportunities, and they do not expose their investments to foreign exchange risk.

Equity funds can provide UK investors with a variety of ways to access the growth potential of the UK stock market. You can choose from funds investing mainly in large, internationally-focused UK companies, through to funds investing in smaller and medium–sized companies that are more exposed to the fortunes of the domestic UK economy. However, smaller companies can be less financially secure than larger companies and so can be much more volatile.

International equity funds

Beyond the UK, there are a large number of equity funds offering exposure to stock markets around the world. They may focus on a single market, such as Japan or the US, on a region, such as Europe, or on the whole of the global stock market.

Adding international diversification to your portfolio can also help spread investment risk and provide the chance to share in the growth of the world’s most dynamic economies and companies. Investing outside of the UK also offers investors the chance to capitalise on opportunities in industries that may only have a small representation in the UK market.

If you are prepared to do some research into different markets, you could consider investing in single markets, particularly in combination with each other to add diversification to your portfolio. Alternatively, you could choose a broader regional or global approach, and let the expert fund manager make the decisions on where to invest for you.

If you are a sterling investor, investing in markets outside the UK exposes you to additional risk from exchange rate fluctuations. As with all types of risk, you should make sure you are comfortable with this before you invest.

Emerging market funds

Broadly speaking, the faster growth of the economies of emerging markets such as Brazil, Russia, India and China mean they offer better long-term return potential than developed markets such as the UK, the US and Europe.

However, they have historically been more volatile than developed markets. Single-country emerging market funds in particular involve high levels of volatility, so they are only suitable for experienced investors and you may wish to combine them with lower risk investments.

Sector and theme funds

Rather than focusing on a geographical area, some equity funds provide investors with exposure to long-term investment themes and trends, such as changing global consumer patterns or rising infrastructure demand. You may also want to consider funds that are focused on particular industries, such as mining, or healthcare, to add further diversification. Please note that investments may be concentrated in one industry sector and as a result, may be more volatile than more broadly diversified investments.

2. Deciding on the right type of equity fund

Once you’ve decided on where you want to invest, you need to choose the right type of equity fund to give you exposure to your chosen market. Some funds are managed closely to a benchmark and others have much more investment freedom. Some funds invest only in high dividend paying stocks, or will focus just on stocks with certain other characteristics

Size: Broad market or smaller company funds

Some equity funds provide you with broad exposure to companies of all sizes, while some focus only on large or small companies.

Larger companies often sell their goods and services around the world, offering international exposure, while smaller companies are often more exposed to their local economies. Smaller companies may be more innovative and faster-growing, but they are often more volatile.

Style: Growth or value funds

Most equity funds provide access to a broad range of stocks from across the market in which they invest. However, some funds will focus only on stocks defined as either being growth stocks or value stocks.

Growth stocks are able to maintain very strong growth in profits, perhaps due to rising demand for a new product or service. Strong profits growth would be expected to drive share prices higher over time. Value stocks, on the other hand, have depressed share prices, perhaps due to being out of favour with investors, and so may offer attractive long-term value.

Dividend: Equity income funds

Many companies return profits to shareholders through a regular dividend. Some funds focus on stocks paying the most attractive dividends to offer investors the chance to earn an attractive and rising income. This income can also be reinvested, potentially providing a more stable source of return from the stock market.

Market risk: Benchmark aware or unconstrained funds

Traditionally, equity funds have been managed with reference to a benchmark index (eg the FTSE All Share). These benchmark aware funds often closely resemble the index, so they are well diversified and fund performance will deviate only slightly from the performance of the market.

Unconstrained funds allow fund managers to invest only in the stocks they like and ignore those they don’t like. These unconstrained portfolios can look very different to, and perform very differently to, the markets in which they invest. They therefore have more potential to outperform the market, but can be much more volatile.