What are Commingled Funds?

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Examples

Example #1

Consider a group of 10 investors who come together with a fund manager to get their accounts managed separately. As managing individual accounts can be operationally challenging and expensive, the manager tells these people that he will treat this money as one single pool, and whichever assets he will buy from the pool will be divided proportionally based on the capital of each account to the combined capital of all the accounts. Also, individual assets will be apportioned to separate accounts on the reporting date, based on overall allocation ratios of assets in the pooled account.

Example #2

Let’s assume that three investors (A, B, and C) with the capital of $40,000, $60,000, and $100,000 invested in a commingled fund with only these three accounts. The ratio of their capital in the entire pool ($200,000) is 20:30:50. The fund manager takes the pool and invests in three asset classes: stocks, bonds, and treasuries.

A year later, the pool grew to 250,000, and the allocation to three asset classes stood at 40%, 50%, and 10% for stocks, bonds, and treasuries, respectively. At this time, the manager reports the performance and the current state of a portfolio to respective investors. The return on individual accounts is reported to be the same as the return on pooled investments (25% in this case).

This return gives the end of the year-end values of the individual accounts. The manager then reports the assets in these accounts in the same proportion as the pooled account to ascribe different assets in individual accounts. Refer to the below illustration:

Advantages of Commingled Funds

  • All the assets are held in one account, eliminating the need for managing different accounts for different asset classes.These are less expensive due to their lower operational and regulatory overheads.Commingled funds are actively managed portfolios with low expense ratios compared to mutual funds, which have high regulatory supervision and expense ratiosExpense RatiosMutual Fund Expense Ratio is the percentage amount charged by the fund manager in exchange of the services provided. The charges include management expense, advisory fees, travel cost, consultancy charges, however, brokerage cost for trading in excluded.read more.They provide diversification benefits in the portfolioDiversification Benefits In The PortfolioPortfolio diversification refers to the practice of investing in a different assets in order to maximize returns while minimizing risk. This way, the risk is kept to a minimal while the investor accumulates many assets. Investment diversification leads to a healthy portfolio.read more.Like mutual fundsMutual FundsA mutual fund is a professionally managed investment product in which a pool of money from a group of investors is invested across assets such as equities, bonds, etcread more, commingled funds are managed by professional fund managersFund ManagersA fund manager refers to an investment professional responsible for fund investment strategy formulation and implementation. They collect and invest the money from various investors and create a good variety of managed funds catering to the diverse preferences exhibited by the investors. read more.It can be a part of your 401(k) retirement account, which helps the investors get tax benefits.It performs better than mutual funds due to its better focus and lower expenses.

Disadvantages

  • Lack of regulatory supervision and reporting requirements make the commingled funds an opaque investment choice.The illiquidIlliquidIlliquid refers to an asset that cannot be converted to cash. Such assets suffer a valuation loss when sold in exchange for cash. Bonds, stocks and properties are some examples of illiquid investment.read more and non-marketable nature of these investments put these funds away from the reach of many investors.The lack of performance reporting makes tracking these funds in real-time difficult.Details of holdings, expense ratios, and other information are not known for commingled funds as it is known for mutual funds.These are not as readily available as other investment alternatives like mutual funds or exchange-traded fundsExchange-traded FundsAn exchange-traded fund (ETF) is a security that contains many types of securities such as bonds, stocks, commodities, and so on, and that trades on the exchange like a stock, with the price fluctuating many times throughout the day when the exchange-traded fund is bought and sold on the exchange.read more (ETFs).

Limitations

  • It has a pre-specified holding period, which should match the investor’s liquidityLiquidityLiquidity is the ease of converting assets or securities into cash.read more requirements and investment time horizon.Due to their illiquid nature, commingled funds cannot be redeemed in case of emergency requirements.These funds can be purchased only in retirement plans and by institutional investors involved in these plans.

Important Points

  • Special emphasis has to be paid on the asset management companyAsset Management CompanyAn Asset Management Company (AMC) refers to a fund house, which pools money from various sources and invests the same in purchasing capital on behalf of their investors.read more (AMC) managing the respective funds. Any change in fund managers of commingled funds results in style and performance variation, impacting the investor’s capital upwards or downwards.Unethical practices of fund managers can also impact the fund. Investors should keep their objectives and risk tolerance in mind while investing in commingled funds and ensure they are in sync with the fund’s objectives and riskiness.Though not regulated by the SEC, this is reviewed by the United States Office of the Comptroller of the Currency and individual state regulators.

This has been a guide to what commingled funds are and their definition. Here we discuss its examples, how it works, its advantages, and disadvantages. You can learn more from the following articles –

  • Endowment FundClosed-End FundIncome FundsGold Fund