It is the responsibility of a fund manager to invest the funds in an appropriate manner, selecting stocks and determining how long to hold them and when to sell them. This is done while upholding fairness among all investors so that they all get the most profitable returns.
You need to combine all people’s money and invest it as one unit, known as a fund. This should mean that all investors will experience the same returns.
Considering this, how do we guarantee a fair division of profits among all the customers?
We can begin by offering shares in exchange for the investment from each investor and assigning a corresponding value to them.
You can assign any initial value – 5, 10, 50 or even 100 – it doesn’t matter; the most common choice, however, is Rs.10, and that is what we will go with.
We issue shares with a notional value of Rs.10/- to all our investors, with the amount of shares held estimated according to how much they have invested. As an example, someone who has put in Rs. 65,000 would get…
= 6500 shares.
The table now looks like this –
27,500 shares were distributed among the five investors, each with a notional value of 10. This corresponds to a total corpus of Rs.275,000/-.
Now that the fund has been set up and shares assigned to investors, the fund manager can get down to what he does best – selecting stocks and investing funds.
In your role as a fund manager, it is your call to invest the funds, i.e. Rs.275,000/- across ten stocks in an evenly distributed portfolio. In doing so, you have chosen to divide the amount equally among all the stocks.
The corpus amounts to Rs.275,000/-, with each stock receiving an investment of Rs.27,500/-.
The allocation of funds to the ten stocks is as follows –
It is evident that Rs.27,500/- has been allocated across ten distinct stocks with various values.
Two things are now in place at this stage:
– Shares are distributed among investors according to the amount they each invested, with each receiving an appropriate number of shares.
– The funds are placed into the markets through investments in ten different stocks.
Once investments have been made in the market, the value of the entire fund relies on the daily performance of each share. Certain stocks may increase while others may decrease, resulting in a gain or a loss that must be shared by all investors. The amount each investor is affected by their initial input into the fund.
Let us carry on with the example to understand how the P&L passes through. I have randomly assigned each of these stocks a percentage change.
As can be observed, the stock prices on day 2 have fluctuated, causing a corresponding change in invested value across each share. This variation has resulted in a portfolio value of Rs.277,844 and a one day return of Rs.2,844/- or 1.0340%.
The profit of Rs.2,844/- must be divided among the five investors according to the amount they put in. To guarantee fairness, we need to make certain that their notional value rise (or falls) by the same proportion as the fund – 1.0340% for this situation.
The initial notional value on day one was 10.
P&L % in funds – 1.0340%
New notional value (day 2) – 10 *(1+1.0340%) = 10.1034
Hence, multiplying the number of shares by the new notional value of 10.1034 should give the investor their new investment value.
As is evident, the percentage of increase for all investors has been the same, but the absolute amount gained by each depends on their initial investment.