Equity funds explained

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Even if you’re new to investments, you may already know that the traditional way to get into investing is to buy shares in companies. Equity funds take investing a step further, and you could consider adding them to your investment portfolio. On this page, you’ll learn more about what equity funds are, how they work and the difference between equity funds and individual stocks.

An equity fund is a type of mutual fund that specifically invests in stocks. Either actively managed by a fund manager or passively managed (meaning there’s no fund manager to handle your investment), an equity fund is a investment fund that buys ownership in a company in the form of stocks.

Equity funds tend to focus their investments on countries, regions, industries and investment styles. They do this to diversify and spread the amount of risk involved in each investment.

This graph shows that equity funds are the most commonly-used funds in the US:

*https://www.nerdwallet.com/blog/investing/what-is-an-equity-fund/

To understand how equity funds work, you first need to learn the difference between active and passive investing.

Active investing:

Equity funds are often managed by fund managers who make decisions on where to invest and what stocks to buy, after completing thorough research and analysis. This is also called active investing. The gains you make will depend solely on the performance of the stocks the fund manager purchases, and the values of these stocks can either increase or decrease in value. Equity funds are considered a lower-risk investment compared with other types of funds due to their diversification, with their investments typically spanning a range of different companies.

The aim of an actively managed equity fund is to provide a continuous flow of profit to investors. The fund manager will attempt to do this by buying stocks and shares, i.e. equity, in smaller companies they believe have good potential to grow. Alternatively, the fund may seek reliable investments that pay regular dividends.

Passive investing:

Passive investing could be considered a more long-term strategy, whereby investors will buy and hold a diverse portfolio of assets and seek to match the market rather than out-perform it. An example of passive investing would be an exchange traded fund (ETF), a type of pooled investment security which tracks a particular index, such as the S&P 500, and which does not rely on a fund manager.

Equity funds can be an ideal investment vehicle for new investors who would like support as they take their first steps into investing, or for those who don’t have a large amount of capital to invest. Pooling money from different investors allows equity funds to diversify and reduce administration costs, without demanding huge amounts of capital from their investors.

There are many different types of equity funds, and each can be broken down into the category the fund focuses on.

• International equity funds invest in foreign stocks
• Global equity funds invest in stocks around the world, including domestically
• Worldwide equity funds invest in stocks around the world, whether they’re domestic or international assets
• Domestic equity funds invest solely in their home country

• Micro-cap equity funds – these types of equity funds invest in publicly-traded companies worth a few million pounds on the stock market, which are stocks with the smallest market capitalisation.
• Small-cap equity funds – these funds invest in companies with a small market capitalisation, but bigger than micro-caps.
• Mid-cap equity funds – invest in companies with medium market capitalisation
• Large-cap equity funds – these types of equity funds invest in companies that have a large market capitalisation
• Mega-cap equity funds – invest in the largest companies in the world, often worth billions

• Private equity funds, which are private, closed-end funds which invest only in companies that are not publicly traded or listed. These funds are for high net-worth investors only and have high minimum investment requirements
• Equity income funds, which own a portion of a business that pays dividends. These funds are designed to provide income for the investor, rather than just capital growth from the shares owned
• Dividend growth funds invest in businesses that tend to increase their dividends per share at a much faster rate than the stock market
• Index equity funds are a common investment choice that mimics the performance of a specific index, such as the FTSE 100. These types of funds are often passively managed.
• Industry-specific equity funds focus on tracking a specific area of the economy or industry. This type of fund might be appealing if you have a specific type of business in mind you want to invest in
• Value funds seek to purchase undervalued stocks that are analysed based on dividend yield
• Growth funds invest in stocks that have a high potential for growth, such as in the technology industry

Investing your money into an equity fund ultimately depends on the financial goal you wish to achieve. For example, if there’s a specific company you want to invest in, an equity fund might not be the best option for you because there’s no guarantee where your investment will go.

Equity funds are managed in a way that’s aimed to be beneficial for all investors. However, if you think that a certain industry will prove to be beneficial in the future, investing in an industry-specific equity fund might be a better choice for you.

There are two ways to invest money into an equity fund, and you’re free to choose the option you feel most comfortable with.

You can invest in an equity fund either by opening an account directly with a mutual fund family or by buying shares in an equity fund by opening a brokerage account. These accounts are offered online by various institutions, and there are usually minimum deposit requirements.

You might want to shop around for the most cost-efficient option, and it’s important to research a fund thoroughly before choosing to invest.

Equity funds are taxed depending on your income tax band because dividends and capital gains earned from equity funds are taxable.

If you’re a basic-rate taxpayer, you’ll pay 20% tax on dividends or capital gains you earn from your equity fund. Higher-rate taxpayers will pay 40% tax, while additional-rate taxpayers will pay 45% tax.

The main difference between equity funds and individual stocks is how you purchase stocks. With equity funds, stocks are purchased in baskets and include multiple types of stocks from different companies. Equity funds purchase stocks this way because it lowers the risk should an individual stock lose its value.

Individual stocks are purchased on an exchange, such as the London Stock exchange, meaning that if you purchase stocks, you own a portion of that company. The risks are therefore often higher, because if the company you own stocks in fails, you may lose the entire value of your investment.

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