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Extensive rules and regulations are in place to give less experienced fund investors peace of mind.
This doesn’t protect your investments going down in value at times though. There may be perfectly legitimate reasons for that to happen: for example, if markets perform badly or if a fund manager makes poor investment decisions. The protections are in place to shield you from fraud and deception, not from the risks of investing itself.
Ring-fences and outsiders
One of the most valuable protections in place is that assets within UK regulated funds must be “ring-fenced”. This means fund assets are kept separate from the management company making the investment decisions. It means that if the fund manager goes out of business, investments within the fund will not be lost.
Regulated funds are also subject to a good deal of outside scrutiny. One significant feature is the appointment of an external custodian. This custodian bank keeps fund assets in segregated accounts clearly marked as client’s assets, and at arms’ length from the fund manager. Meanwhile, an external depositary is charged with keeping tabs on the fund’s activities and a firm of independent accountants audits the books.
In short, a lot of trouble is taken to prevent any shenanigans to make sure that the value of the fund is always fairly represented.
How not to do it
In recent times, the most infamous example of fraud involving a fund involved Bernie Madoff. Now serving a 150 year jail term, Madoff ran a US hedge fund which imploded in 2008 after it was exposed as a Ponzi scheme. He appointed a grotesquely unsuitable custodian and auditor. Both were one-man operations, clearly unable (and potentially unwilling) to audit a multi-billion dollar operation with thousands of clients.
While the threat of such fraud can never be fully eliminated, the chances of investing in an independently accredited – yet largely sham – fund are remote.
Understand the rules that protect your investments
The Investment Association