How a Fund Is BuiltEasy

A fund is not one company. It is a legal wrapper, a manager, a depositary, an administrator, a custodian and a transfer agent — six parties with different jobs, and the point of the arrangement is that no one of them can act alone.

8 min read · 1 382 words

The thing a factsheet never shows

A fund factsheet names a manager, a strategy and a number. Behind that number is a structure with at least six parties in it, most of which the investor never hears about — and the separation between them is not administrative tidiness. It is the mechanism that makes a fund a different proposition from handing money to somebody who says they will invest it.

Reading a fund factsheet covers the document. This is what sits underneath it.

The six parties

• The fund itself — a legal vehicle: a company, a unit trust, a partnership, a contractual arrangement, depending on jurisdiction and type. The assets belong to it, not to the manager. That single sentence is the whole of investor protection here, and it is why a manager's insolvency is not automatically the investor's problem.
• The management company — makes the investment decisions, or delegates them to an investment manager, and is authorised and supervised to do so. It is paid a fee out of the fund's assets.
• The depositary — holds the assets in safekeeping and, crucially, has an oversight duty: it checks that the manager is doing what the fund's own documents permit, that subscriptions and redemptions are handled properly, and that the value being published was arrived at correctly. It is liable for the loss of assets it holds. A depositary is not a filing cabinet; it is a second party with an independent obligation.
• The custodian — the safekeeping half, sometimes the same entity as the depositary, sometimes a network of sub-custodians in each market where the fund holds something. Custody describes the seat; who actually holds my shares follows the chain from a statement to a register.
• The administrator — computes the value. Prices the portfolio, accrues the fees, accounts for income and expenses, and strikes the net asset value. Independent of the manager on purpose: a manager marking its own portfolio and publishing the result is the arrangement every failure in this area has in common.
• The transfer agent — keeps the register of who owns what, processes subscriptions and redemptions, applies the dealing cut-off. Unglamorous, and the party an investor's instruction actually reaches.

Plus an auditor, and for a listed or exchange-traded vehicle a set of market makers and authorised participants — physical versus synthetic ETFs covers what changes when the wrapper trades.

How a value is actually struck

The net asset value is a computation with a timestamp, and the timestamp is the part people skip:

1. A valuation point — a defined moment, written in the fund's documents. Every holding is priced as of that moment, using a defined source and a defined rule for each asset type.
2. Fair value adjustments — where a market was closed at the valuation point, or where a price is stale, the rule says what to use instead. A fund holding Asian equities and valued at a European close is pricing markets that shut hours earlier, which is precisely the gap that stale-price arbitrage exploits and that swing pricing and fair-value adjustments exist to close.
3. Accruals — management fee, performance fee, administration, audit, income receivable, tax. Accrued daily so that the value is right on every day rather than lurching when an invoice arrives.
4. Divide — by the shares in issue, per class.

The result is one number per class per valuation point, and it is the price at which everybody who dealt that day dealt.

Forward pricing: why you do not know the price when you order

An open-ended fund almost always deals at forward prices. Instructions received before a cut-off are executed at the value struck after that cut-off — a price nobody knows yet at the moment of ordering.

That feels backwards and it is the only version that is safe. Dealing at the last published value would let somebody buy at a stale price after the market had already moved, and the profit would come out of the existing holders. Forward pricing removes the possibility by construction. The cost is that an investor commits without knowing the price, which is a real trade-off between two kinds of unfairness and is resolved in favour of the holders who are already there.

This is also the sharpest structural difference from an exchange-traded fund, where a continuous price on the exchange means the buyer knows exactly what they paid — and where the value of the underlying is a separate number from the price, with the gap between them being its own subject.

Share classes: one portfolio, several prices

A single portfolio can carry many classes, differing in fee level, minimum investment, currency, hedging, and whether income is distributed or accumulated. Each class has its own value because each carries its own accruals, and none of them owns a different set of assets.

Two consequences worth holding on to. A currency-hedged class runs a hedge inside the fund whose costs and residual basis belong to that class alone — hedged versus unhedged covers what that does to a return. And an accumulating class does not earn more than a distributing one; it retains rather than pays, which is a tax and administrative difference rather than a performance one, as that comparison sets out.

Where the structure fails

• The promise does not match the assets. Daily dealing over holdings that take weeks to sell is a mismatch that is invisible until enough people ask at once. Woodford in 2019 is the public example; liquidity is the mechanism, and gates, notice periods, side pockets and swing pricing are the defences, each of which makes the promise smaller than the marketing implied.
• Valuation of what has no price. Unlisted holdings are valued by a policy rather than a market, and the further a portfolio sits from quoted prices the more the published value is an opinion — model risk from the fund side.
• Delegation without oversight. Portfolio management, administration and custody can all be delegated. The obligations do not travel with the work, which is exactly what a depositary's oversight duty is there to enforce.
• A single party doing two jobs. Every large fund fraud in the historical record has the same shape somewhere in it: the entity making the decisions was also the entity reporting what those decisions were worth. The separation described on this page is the direct answer to it.
• Costs that do not appear as a fee. Trading costs, the effect of flows on the portfolio, and the drag of holding cash for redemptions are all real and none of them is the ongoing charge. Costs and fees takes it layer by layer.

Who needs this

Fund operations runs it end to end. Portfolio management works inside the constraints it creates. Custody and operations hold and move the assets. And anybody comparing two funds is comparing two structures as much as two strategies — see ETF versus fund versus certificate, where the wrapper decides more than the holdings do.

What to take away

• The assets belong to the fund, not the manager. Everything else follows from that.
• Six parties, separated on purpose: the party that decides is not the party that values, and neither is the party that holds.
• The value is a computation at a defined moment, with fee accruals and a stated rule for stale prices.
• Forward pricing means you order without knowing the price, and that protects the holders already in the fund.
• Classes share one portfolio and differ only in accruals, currency treatment and distribution policy.