Part two — what mutual funds are and what they are not.

The basic review: mutual funds are legal structures holding pools of investor money — your money. In return, you, the investor, are provided with a mutual fund fact sheet listing the number of shares you own (of the fund) and its current market price. You decide what to invest in. Your mutual fund portfolio manager does the work, managing your cash for you. Seems relatively simple, does it not? If it is, why doesn’t everyone set aside a small reserve to begin the investing process? Reasons vary, but people just do not do it.

Over the years, readers have told me that they have never invested (or given up investing) in capital markets because the decision-making process is intimidating, the concepts are confusing and they hate the uncomfortable lack-of-control feeling, particularly when their investment fluctuates in value.

However, even if you never invest individually, if you are employed in Bermuda, a certain cash percentage is withheld from your wages (accompanied by your employer match) for your pension contributions. Your pension funds are invested. Please consider this series as another opportunity here to better understand, at least, the structure of your pension mutual funds — your invested savings that may represent your largest asset at retirement.

The structure

Mutual funds exist, almost always, within the confines of domestic (and international) investment companies, think Fidelity, Bermudian and foreign banks, and independent investment firms. Each mutual fund is a separate entity/set up similar to a company.

It must exist in legal form. Most importantly, each mutual fund is registered (similar to a company in the Bermuda Government companies register) on a securities exchange, while touting an international security identification number (ISIN for trading and research purposes).

A Bermuda mutual fund incorporated in Bermuda held in Bermuda dollars will generally be lodged on the Bermuda Stock Exchange.*

Most individual mutual funds also consist of administration staff, portfolio managers, investment advisers, an independent third-party custodian who holds the fund and its shares, a Board of Directors, shareholders (you as investor included), an outside auditor, accountants, legal advisers, and a corporate secretary.

The mutual fund recipe book — the prospectus

Legally, and seriously, a mutual fund MUST provide you with a prospectus — think of this incredibly large document, if you will, as the mutual fund recipe book! All information is provided on the workings of the fund within its verbiage. Openness, ethics, and transparency are absolutely paramount here.

If you are solicited by a ‘fund company’ that cannot provide you with this information, you had better do more research very carefully. Your new and exciting investment may be an undocumented sham.

And there is more; the fund must provide within the prospectus a written investment policy statement — this is the recipe that denotes the percentage of securities invested in stocks, bonds, cash, or other alternative investments.

The prospectus must also disclose the risks linked to the mutual fund investment, fees and commissions to invest, tax issues, liabilities of the fund, borrowing and leverage employed to escalate returns, share value calculations, anti-money laundering and related compliance issues, processes and penalties for redemptions, shareholders’ rights to inspect the fund documents, receive reports such as annual financial statements, auditor reports and so on.

We call it a recipe book because the mandate of the prospectus and the investment policy statement, like making a great cake, must be followed during the life of the fund.

Deviations, known as style drift, from the original policy, say 60 percent stocks and 40 percent bonds, are not taken lightly by investment advisers.

Mutual funds are considered separate independent entities, but their investment performance is not guaranteed. Unlike bank deposits, mutual funds are not held on the balance sheets of the bank.

Actually, bank deposits are not guaranteed either, as the world observed when high net worth depositors of the Bank of Cyprus were assessed a 47.5 percent haircut (levied on accounts over 100,000 EUROs) in June 2013.**

Currency

But first, the investing process starts with your cash (Bermuda dollars) that has no validity outside Bermuda. Therefore, your cash must be converted to a major trading currency (US dollars).

He is standing at a foreign currency exchange window waiting his turn to convert euros into pounds sterling.

“Are you open on Saturdays?” says he to the exhausted-looking lady at the window. She smirked. “We never close.” “What? Never?” “No, we work two-twelve hour shifts — 24 hours every day.”

A quick walk reveals multiple currency exchange shops within sight in this multicultural teeming neighbourhood. Changing money is a very big business.

And that is the way it is in the investment and currency world. Day in, day out, global trading in currencies (Forex, FX, as well as investments of all calibres) never stops. Currency trading, according to the Bank for International Settlements in assessing the 2013 Triennial Central Bank Survey of Foreign Exchange and Over-The-Counter Derivatives Markets Activity show that trading in foreign exchange markets averaged $5.3 trillion per day in April 2013.***

Mutual funds registered in a multi-jurisdictional financial environment need a constant interplay of flexible currency transactions when one currency is valued against another in a global context. How else could a portfolio manager possibly buy different country investment assets?

This is a difficult concept, say for Americans or Canadians to understand, given that they may have dealt for most of their lives, with only one currency and only invested in their domestic currency security assets.

Bermudians who wanted to invest in the past, possibly due to exchange controls along with difficulty in trading in foreign markets, generally focused only on Bermuda security assets purchased with Bermuda dollars.

Local stocks, the occasional bond offering were the only choices. Enter the Electronic Age.

Things have changed. Bermuda today is far ahead in financial market sophistication relative to provincial North American markets.

Which mutual fund?

Now, what should you invest in? And what kind of a mutual fund? So far, I’ve talked a lot of boring dry stuff.

The composition of mutual fund investment assets can take many different forms, although each mutual fund must follow the original dictates of the investment policy statement.

FYI — some readers will, no doubt, be rather sceptical of the basic discussions and analogies used within the Bermuda mutual fund series. However, a new learning process starts with the basics. If you have never paid any attention to your pension before, or you want to consider investing on a small scale now, hopefully, this series will jump-start your own investment education.

Next — part 3 in the series, we take a quick basic overview of securities. Then, we are going to pick only one specific mutual fund type to follow given that almost all Bermuda financial institutions and investment firms carry this mutual fund product.

Homework: Review the mutual fund fact sheet and prospectus for the Butterfield Bermuda Fund Limited, a home-grown investment product featuring investment ownership of local assets in Bermuda dollars. Link provided below. Send any questions regarding investing to me anytime.

*http://www.bam.butterfieldgroup.com/ButtInvestProds/forms_and_downloads/Documents/Bermuda%20Fund%20%20June%2030%202013.pdf

** Final ‘haircut’: Cyprus to levy deposits by 47.5% http://rt.com/business/cyprus-crisis-bailout-deposit-631/

** Wikipedia. Foreign Exchange Market, a very good explanation of currency transactional processes and exchange rate determination.

This article is for general investment education and illustrative purposes only and cannot be used for personal financial planning or investment advice.

The author makes no representation as to the accuracy, timeliness, or validity of investment products or valuations.

Investments are not guaranteed, are subject to market fluctuations and past performance does not represent future results.

The author is not affiliated in any way with Butterfield Bank and or its investment subsidiary Butterfield Asset Management Limited, nor is she compensated for, or provides, or accepts referrals for any products or services discussed within the above article.

Martha Harris Myron CPA CFP JSM Masters of Law: International Tax and Financial Services,

Appointed to the Professional Tax Advisory Council, American Citizens Abroad, Geneva, Switzerland

President: The Pondstraddler* Life™ Consultancy: international financial planning, publications, presentations for the challenging lifestyles of multinational individuals and their families residing, working, crossing borders, and straddling ponds in the North Atlantic Quadrangle.

Specific focus for residents of Bermuda, the premier international finance centre. Contact: martha@pondstraddler.com

* Pondstraddler. A person with one foot on each shore whose heart resides in both countries*