A closer look at the equity fund industry

People have been doing commerce for thousands of years. In 1602, the Dutch East India company became the first publicly traded company. Its initial capital offering ushered in a new way for companies around the world to raise money. Today, almost all countries have a stock exchange with the most active ones being in the developed countries.

Companies become public for a number of reasons. First, the market offers a cheaper way of raising money than in the debt market. Second, it allows venture capitalists who invested in the company to exit. Third, being public gives a company a good public image which helps it improve sales. Finally, an IPO can help a company attract better employees by offering perks like stock options.

An equity fund is an investment product made up of a number of publicly-listed companies. The composition of an equity fund differs from manager to manager. There are managers who prefer having a few companies in a fund, while others prefer having hundreds of companies in a fund. Other managers create funds that are in the same industry. For example, a few years ago, activist manager Carl Icahn created a fund to specialize in the auto industry. Other managers have created funds to specialize in healthcare, retail, and financial services.

Equity funds generate income when the stock price of the constituent companies rise. The stock rises because of several reasons such as revenue and earnings growth, change of management, the overall trend of the market and when there is consolidation in an industry. They also generate income from the dividends offered by a company. For example, a dividend income equity fund will make money from the appreciation of the stock price and from the dividends offered by the company.

Types of equity funds

Broadly, equity funds are classified into four categories. These are: geographical, industry, market capitalization, and investing style.

Geographical equity funds

These are funds that invest according to the geographical location of the companies. Examples of these are:

  • World Equity Funds: These equity funds invest in companies from around the world. For example, a world fund may be composed of companies from the United States, Europe, Asia, Asia-Pacific and Africa. The main hindrance of these funds is that of currency. For example, if an American company has a global fund that invests in all these continents, the total profits could be affected if the currencies of these continents lose value.

  • Domestic Equity Funds: These are equity funds that invest in the home country of the investor. For example, an American domestic fund invests purely in American companies. The benefit of such funds is that there are usually limited currency headwinds. Also, the investor does not need to know a lot about global developments.

  • Emerging Market Funds: These are funds that invest in companies from the emerging markets. These are countries that have certain characteristics of countries in the developed countries but have not yet reached the standards to qualify as developed countries. Examples of these countries are Brazil, India, Indonesia, and South Africa.

  • Frontier Markets Funds: These are equity funds that invest in the frontier markets. These are developing countries that are more developed than the least developed countries. They are known to be risky. Examples are Kenya, Botswana, Slovenia and Sri Lanka.

Based on market capitalization

These equity funds invest in companies based on their market capitalization. The market capitalization refers to the value of a company according to the market. It is calculated by multiplying the number of outstanding shares and the current share price. These equity funds are:

  • Mega Cap Funds: These are funds that specialize in large companies with market capitalizations worth hundreds of billions of dollars. These companies are usually very large, diversified, and derive most of their income from almost all regions. Examples of these companies are Apple, Amazon, Walmart and Facebook.

  • Large Cap Funds: These funds are similar to mega cap funds. The only difference is that they invest in companies with market capitalization between $10 billion and $100 billion. Examples of companies in this group are General Mills, Twitter, Target, and Ecolab.

  • Mid-Cap Funds: These ones invest in companies with market capitalization of between $1 billion and $10 billion. Most of the companies in this group are usually in their growth phase. Examples of these are Helen of Troy, Snap and LogMeIn.

  • Small-Cap Funds: These funds invest in small companies that are valued at between $100 million and $1 billion. Examples of these companies are Boot Barn, Unisys and Fossil Group.

  • Penny Stocks: These are funds that invest in small companies that are valued from below $1 million up to $100 million. These companies are known for their little or no disclosures and their volatility.

Based on industry

These are equity funds that invest in companies of various industries. In the United States, stocks are divided in 11 industries. These industries are: communication services, consumer discretionary, consumer staples, materials, energy, financials, healthcare, industrials, utilities, information technology, and real estate. These industries are then divided into 69 sub industries. For example, the financial industry is divided into banks, capital markets, insurance, mortgage REITs, thrifts and mortgage finance and consumer finance.

Essentially, industry-based equity funds use an industrial approach to allocate capital. Some prefer investing in one industry while others prefer to invest in a variety of industries.

Based on the investing style

These are funds that invest according to the stage of the companies. Their examples are:

  • Growth Equity Funds: These funds invest in relatively small companies that mostly don’t make any profits. Instead, the companies are known for their growth. For example, a company like Tesla is highly valued but it has never generated a profit. Instead, investors believe that it will generate impressive results when it starts scaling. Examples of growth companies that have started generating excellent profits are Google and Facebook.

  • Income Equity Funds: These funds invest in companies that are known for their dividends. These companies don’t have a lot of growth and as a result, their stock prices don’t rise as fast. They however pay handsome dividends. Examples of such companies are AT&T, Microsoft, and Proctor and Gamble.

  • Index Equity Funds: These are equity funds that track indices. Examples of indices are the Dow Jones Industrial Average, S&P and DAX.

  • Private Equity Funds: These equity funds invest in companies that are not public. These generate income when the companies are then taken public.

How to invest in an equity fund

There are two ways in which you can invest in an equity fund. First, you can create an account with one of the companies that offer such mutual fund products. Examples of companies that allow you to invest in such funds are Fidelity and Vanguard. After creating an account, you should research the equity funds that are available and select the one that suits your investment style. For example, if you are interesting in technology, you might invest in an equity fund that invests in technology companies.

The other option is where you create your own equity fund. To do this, you need to decide the type of equity fund you want to create. These types have been explained above.

Next, you should take time to create your portfolio. This is where you select the companies that you will invest in. To do this, you need to look at the revenue and earnings growth, the valuation, the historical performance, future guidance, the industrial growth, the management quality of the companies.

Finally, you should look to invest in companies according to their weight. For example, if you believe that company A will have the most growth, it should form the biggest part of the portfolio. You should repeat this among all the companies.

After equity fund, what's next?

The benefit of equity funds is that they are well-diversified. However, they are mostly suitable for long-term investments and they don’t generate huge returns in the short term. This is because the gains in company A are often brought down by the losses in company B.

Therefore, alongside investing in equity funds, you might consider trading. This is where your goal is to generate short-term profits by buying and selling financial securities like equities, bonds, indices, commodities and currencies.

To do this, you need to have an account with an online CFD broker. You also need to learn the factors that cause the price of securities to move up and down. And, you should start trading while maintaining a high level of risk management.