Mutual Funds

To most people, Mutual Funds can seem complicated or intimidating or say very much prone to risk of losing money, which is in fact a myth. We are going to try and simplify it for you at its very basic level. Essentially, the money pooled in by a large number of people (or investors) is what makes up a Mutual Fund. These investors may be retail or institutional in nature.

This fund is managed by a professional fund manager.

It is a trust that collects money from a number of investors who share a common investment objective. Then, it invests the money in equities, bonds, money market instruments and/or other securities. Each investor owns units, which represent a portion of the holdings of the fund. The income or gains generated from this collective pool of investment is distributed proportionately amongst the investors after deducting certain expenses, by calculating a scheme’s Net Asset Value or NAV.

Simply say, a Mutual Fund is one of the most viable investment options for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively very low cost.

Mutual funds have advantages and disadvantages compared to direct investing in individual securities. The primary advantages of mutual funds are that they provide economies of scale, a higher level of diversification, they provide liquidity, and they are managed by professional investors. On the negative side, investors in a mutual fund must pay various fees and expenses.

Primary structures of mutual funds include open-end funds, unit investment trusts, and closed-end funds. Exchange-traded funds (ETFs) are open-end funds or unit investment trusts that trade on an exchange. Mutual funds are also classified by their principal investments as money market funds, bond or fixed income funds, stock or equity funds, hybrid funds or other. Funds may also be categorized as index funds, which are passively managed funds that match the performance of an index, or actively managed funds. Hedge funds are not mutual funds; hedge funds cannot be sold to the general public and are subject to different government regulations.

There are three primary structures of mutual funds: open-end funds, unit investment trusts, and closed-end funds. Exchange-traded funds (ETFs) are open-end funds or unit investment trusts that trade on an exchange.

Open-end funds

Open-end mutual funds must be willing to buy back (“redeem”) their shares from their investors at the net asset value (NAV) computed that day based upon the prices of the securities owned by the fund.

Closed-end funds

Closed-end funds generally issue units to the public only once, when they are created through an initial fund offering. Their units are then listed for trading on a stock exchange. Investors who want to sell their units must sell their units to another investor in the market; they cannot sell their units back to the fund. The price that investors receive for their shares may be significantly different from NAV; it may be at a “premium” to NAV (i.e., higher than NAV) or, more commonly, at a “discount” to NAV (i.e., lower than NAV).

Exchange-traded funds

Exchange-traded funds (ETFs) are structured as open-end investment. ETFs combine characteristics of both closed-end funds and open-end funds. ETFs are traded throughout the day on a stock exchange.