Mutual funds
A fund operated by an
investment company which raises money from shareholders and invests in a group
of assets, in accordance with a stated set of objectives. mutual
funds raise money by selling shares of the fund to the public, much like any other
type of company can sell stock in itself to the public. Mutual funds then take
the money they receive from the sale of their shares (along with any money made
from previous investments) and use it to purchase various investment vehicles,
such as stocks, bonds and money market instruments. In return for the money
they give to the fund when purchasing shares, shareholders receive an equity
position in the fund and, in effect, in each of its underlying securities. For
most mutual funds, shareholders are free to sell their shares at any time,
although the price of a share in a mutual fund will fluctuate daily, depending
upon the performance of the securities held by the fund. Benefits of mutual
funds include diversification and professional money management. Mutual funds
offer choice, liquidity, and convenience, but charge fees and often require a
minimum investment.
"A guide for beginning
investors" defines Mutual Funds as :
A mutual fund is a pool of investments used to buy a large portfolio of
securities that will be managed by a professional advisor. When you buy a share
in a mutual fund, you effectively buy a bit of each security held in the funds
portfolio. Mutual funds are sometime referred to as "investment
companies" whose shares are sold to the public and which invest the
proceeds of these sales in other public companies.
Types of
Mutual Funds
A close ended mutual fund
issue only a certain number of shares . After the
shares are sold and the money is invested in its portfolio of securities,
trading can take place. The company is not
obligated to redeem its shares or issue more shares. These are investment
company shares which are traded on the stock exchange .
The shares are normally traded at below their NAV.
An open ended mutual fund
is by contrast , is constantly offering new shares to
the public and redeeming its outstanding shares. There is no limit to the
number of shares that can be issued. The unit holders buy the units of
the funds and may redeem them on a continuous basis at the prevailing NAV. They
are also called as Unit Trust, because they are registered as trust.
|
Description |
Open-end |
Close-end |
|
Size
of Capital |
No
upper limit |
Fixed |
|
Unit
Prices |
Based
on NAV |
Based
on Market Value |
|
Can be purchased from |
Its own Branches/authorized distribution channels |
Stock Market |
|
Redemption responsibility |
Its management is legally bound to repurchase its units
from customers |
Its management has no responsibility to repurchase its
units from customer |
|
Listing
at Stock Exchange |
May
or may not be |
Compulsory |
Term Definitions
NAV( Net Asset Value)
The funds
NAV is equal to the market value of its underlying assets, which include
stocks, bonds, and other securities in the assets which are held in the
portfolio, minus liabilities divided by the number of units or shares
outstanding. The quality of underlying assets representing NAV is very important . To assess, the investor has to rely on the
mutual fund rating and refer the annual report. Investment managers would like
the NAV of their fund to grow by the appreciation of income or by appreciation
in the market value of Investment.
Risk
Mutual funds
are not risk free investments. When you invest in Mutual Fund (NIT) the risk of
total loss is lessened due to the diversity in the portfolio.
Debt security
This is a security such as a bond
or debenture, in which a specific amount is owed to the purchaser of the
security. These are referred to as fixed-income assets.
Equity Security
This is a security such as a common
or preferred stock in which the purchase of the security actually purchases a
piece of the company and is an owner of the company.
Issuer
The issuer is
the entity from which the security is derived. for
example; mutual funds are the issuers of their shares or units.
Mutual Funds: Different Types Of Funds
No matter what type of investor you are,
there is bound to be a mutual fund that fits your style. According to the last
count there are more than 10,000 mutual
funds in
It's important to understand that each mutual
fund has different risks and rewards. In general, the higher the
potential return, the higher the risk of loss. Although some funds are less
risky than others, all funds have some level of risk - it's never possible to diversify away all risk. This
is a fact for all investments.
Each fund has a predetermined investment objective
that tailors the fund's assets, regions of investments and investment
strategies. At the fundamental level, there are three varieties of mutual
funds:
1) Equity funds (stocks)
2) Fixed-income funds (bonds)
3) Money market funds
All mutual funds are variations of these three asset classes. For example,
while equity funds that invest in fast-growing companies are known as growth
funds, equity funds that invest only in companies of the same sector or region
are known as specialty funds.
Let's go over the many different flavors of funds.
We'll start with the safest and then work through to the more risky.
Money Market Funds
The money market consists of short-term debt
instruments, mostly Treasury bills. This is a safe
place to park your money. You won't get great returns, but you won't have to
worry about losing your principal. A typical return is
twice the amount you would earn in a regular checking/savings account and a
little less than the average certificate of deposit (CD).
Bond/Income Funds
Income funds are named appropriately: their purpose
is to provide current income on a steady basis. When referring to mutual funds,
the terms "fixed-income," "bond," and "income"
are synonymous. These terms denote funds that invest primarily in government
and corporate debt. While fund holdings may appreciate in value, the primary
objective of these funds is to provide a steady cashflow
to investors. As such, the audience for these funds consists of conservative
investors and retirees.
Bond funds are likely to pay higher returns than certificates
of deposit and money market investments, but bond funds aren't
without risk. Because there are many different types of bonds, bond funds can
vary dramatically depending on where they invest. For example, a fund
specializing in high-yield junk bonds is much more risky than a fund that
invests in government securities. Furthermore, nearly all bond funds are
subject to interest rate risk, which means that if rates go up the value of the
fund goes down.
Balanced Funds
The objective of these funds is to provide a balanced
mixture of safety, income and capital appreciation. The
strategy of balanced funds is to invest in a combination of fixed income and
equities. A typical balanced fund might have a weighting of 60% equity and 40%
fixed income. The weighting might also be restricted to a specified maximum or
minimum for each asset class.
A similar type of fund is known as an asset
allocation fund. Objectives are similar to those of a balanced fund, but these
kinds of funds typically do not have to hold a specified percentage of any
asset class. The portfolio manager is therefore given freedom to switch the
ratio of asset classes as the economy moves through the business cycle.
Equity Funds
Funds that invest
in stocks represent the largest category of mutual funds. Generally,
the investment objective of this class of funds is long-term capital growth
with some income. There are, however, many different types of equity funds
because there are many different types of equities. A great way to understand
the universe of equity funds is to use a style box, an example of which is below.
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The idea is to classify funds based on both the size
of the companies invested in and the investment style of the manager. The term
value refers to a style of investing that looks for high quality companies that
are out of favor with the market. These companies are characterized by low P/E and price-to-book ratios and high dividend yields. The
opposite of value is growth, which refers to companies that have had (and are
expected to continue to have) strong growth in earnings, sales and cash flow. A
compromise between value and growth is blend, which simply refers to companies
that are neither value nor growth stocks and are classified as being somewhere
in the middle.
For example, a mutual fund that invests in large-cap companies that are in
strong financial shape but have recently seen their share prices fall would be
placed in the upper left quadrant of the style box (large and value). The
opposite of this would be a fund that invests in startup technology companies
with excellent growth prospects. Such a mutual fund would reside in the bottom
right quadrant (small and growth).
Global/International Funds
An international fund (or foreign
fund) invests only outside your home country. Global funds invest anywhere
around the world, including your home country.
It's tough to classify these funds as either riskier
or safer than domestic investments. They do tend to be more volatile and have
unique country and/or political risks. But, on the
flip side, they can, as part of a well-balanced portfolio, actually reduce risk
by increasing diversification. Although the world's economies are becoming more
inter-related, it is likely that another economy somewhere is outperforming the
economy of your home country.
Specialty
Funds
This classification of mutual funds is more of an
all-encompassing category that consists of funds that have proved to be popular
but don't necessarily belong to the categories we've described so far. This
type of mutual fund forgoes broad diversification to concentrate on a certain
segment of the economy.
Sector funds are targeted at
specific sectors of the economy such as financial, technology, health, etc.
Sector funds are extremely volatile. There is a greater
possibility of big gains, but you have to accept that your sector may tank.
Regional funds make it easier
to focus on a specific area of the world. This may mean focusing on a region
(say Latin America) or an individual country (for example, only
Socially-responsible funds (or
ethical funds) invest only in companies that meet the criteria of certain
guidelines or beliefs. Most socially responsible funds don't invest in
industries such as tobacco, alcoholic beverages, weapons or nuclear power. The
idea is to get a competitive performance while still maintaining a healthy
conscience.
Index Funds
The last but certainly not the least important are index funds. This type of
mutual fund replicates the performance of a broad market index such as the S&P 500 or Dow Jones Industrial Average (DJIA). An investor
in an index fund figures that most managers can't beat the market. An index
fund merely replicates the market return and benefits investors in the form of
low fees.