What are Commingled Funds?
Commingled Funds are professionally managed funds that are usually offered in retirement accounts (401(k)) that combine assets like bonds and equities from multiple accounts and manage the pool as one account, rather than managing each individual accounts separately.
Consider a group of 10 investors come together to a fund manager to get their individual 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.
Let’s assume that three investors (A, B and C) with the capital of $40,000, $60,000 and $100,000 invest in a commingled fund that has 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, namely stocks, bonds, and treasuries.
A year later, the pool grows 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 they were in 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 as compared to mutual funds which have high regulatory supervision and expense ratios.
- They provide diversification benefits in the portfolio.
- Like mutual funds, commingled funds are managed by professional fund managers.
- It can be a part of your 401(k) retirement account which helps the investors get tax benefits.
- It generally performs better than mutual funds due to their better focus and lower expenses.
- Lack of regulatory supervision and reporting requirements make the commingled funds an opaque investment choice.
- The illiquid and non-marketable nature of these investments put these funds away from the reach of many investors.
- Lack of performance reporting makes it difficult to track these funds in real-time.
- 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 funds (ETFs).
- It has a pre-specified holding period, which should match the investor’s liquidity 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 that too by institutional investors involved in these plans.
- Special emphasis has to be paid on the asset management company (AMC) managing the respective funds.
- Any change in fund managers of commingled funds and result in style and performance variation, which can impact the investor’s capital upwards or downwards.
- Unethical practices of fund managers can also impact the fund.
- Investors should keep their own objectives and risk tolerance in mind while investing in commingled funds and ensure that 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 are commingled funds and its definition. Here we discuss its examples, how it works along with advantages, and disadvantages. You can learn more from the following articles –