Indirect Investment

An indirect investment is an investment made through an intermediary vehicle, such as a mutual fund, exchange-traded fund, investment trust, or pension fund, which itself owns the underlying assets, such as shares, bonds, or property, on behalf of the fund's investors. The investor holds a stake in the pooled vehicle rather than owning the underlying shares, bonds, or property directly, which is the defining feature distinguishing indirect investment from direct investment, where the investor owns the underlying asset itself.

Indirect investment is the dominant way most ordinary individual investors participate in financial markets, since pooled vehicles provide access to diversification, professional management, and economies of scale that would be difficult or expensive for a single investor to replicate on their own with smaller amounts of money.

Buying a single company's shares directly on a stock exchange is a direct investment; buying units in a fund that itself holds shares in hundreds of different companies is an indirect investment. The investor's financial fate still depends on how the underlying assets perform, but the investor never personally holds or manages those specific underlying shares, bonds, or properties, relying instead on the fund manager or structure to do so on their behalf.

• Mutual funds and exchange-traded funds, pooling money from many investors to buy a diversified basket of securities.
• Pension funds and workplace retirement plans, where contributions are pooled and invested collectively on behalf of plan members.
• Real estate investment trusts, allowing investors to gain exposure to property markets without directly owning or managing physical buildings.
• Investment trusts and closed-end funds, which pool capital and are themselves traded on an exchange, adding a further layer between the investor and the underlying holdings.

Indirect investment offers diversification and professional management at relatively low cost, particularly through widely available index funds and exchange-traded funds, but it also introduces a layer of fees charged by the fund or its manager, and generally gives the individual investor less control over specific holdings compared with managing a directly owned portfolio. The investor also takes on a degree of reliance on the fund manager's skill and the fund's own structure, since poor management decisions or structural problems at the fund level can affect returns even if the broader market the fund is exposed to performs reasonably well.

For most individual investors without significant time, expertise, or capital to build and actively manage a large diversified portfolio of individual securities themselves, indirect investment through funds offers a practical, cost-effective way to gain broad market exposure, which is why indirect vehicles such as index funds and target-date retirement funds have become the default building blocks of most ordinary retirement savings plans around the world.

When an investor holds an indirect stake through a fund, the fund itself, rather than the individual investor, generally exercises any shareholder voting rights attached to the underlying shares it holds, meaning indirect investors typically have far less direct influence over the governance of individual companies than someone who holds those same shares directly in their own name. Large fund managers, as a result, have become significant voting powers in corporate governance simply by virtue of the enormous pooled holdings they vote on behalf of millions of indirect investors.

Every layer of indirect investment typically adds a fee, whether an annual management charge on a fund, a platform fee charged by the broker or pension provider holding the fund on an investor's behalf, or, for some older or more complex products, multiple layers of fees stacked on top of each other. Comparing the total, all-in cost of an indirect investment, not just its headline management fee, is an important step before committing to a specific pooled vehicle over its direct alternative.

• U.S. Securities and Exchange Commission