Types Of Mutual Funds - Page 2

Introduction of Mutual Funds

Open-end fund - The term mutual fund is the common name for an open-end investment company. Being open-ended means that, at the end of every day, the fund issues new shares to investors and buys back shares from investors wishing to leave the fund.

Mutual funds may be legally structured as corporations or business trusts but in either instance are classed as open-end investment companies by the SEC.

Other funds have a limited number of shares; these are either closed-end funds or unit investment trusts, neither of which is a mutual fund.

Exchange-traded fund (ETF) - A relatively recent innovation, the exchange-traded fund or ETF, is often structured as an open-end investment company. ETFs combine characteristics of both mutual funds and closed-end funds. ETFs are traded throughout the day on a stock exchange, just like closed-end funds, but at prices generally approximating the ETF's net asset value.

Most ETFs are index funds and track stock market indexes. Shares are issued or redeemed by institutional investors in large blocks (typically of 50,000). Most investors purchase and sell shares through brokers in market transactions.

ETFs are also valuable for foreign investors who are often able to buy and sell securities traded on a stock market, but who, for regulatory reasons, are limited in their ability to participate in traditional U.S. mutual funds.

Funds of funds (FoF) - are mutual funds which invest in other underlying mutual funds (i.e., they are funds comprised of other funds). The funds at the underlying level are typically funds which an investor can invest in individually.

A fund of funds will typically charge a management fee which is smaller than that of a normal fund because it is considered a fee charged for asset allocation services. The fees charged at the underlying fund level do not pass through the statement of operations, but are usually disclosed in the fund's annual report, prospectus, or statement of additional information.

The fund should be evaluated on the combination of the fund-level expenses and underlying fund expenses, as these both reduce the return to the investor.

Most FoFs invest in affiliated funds (i.e., mutual funds managed by the same advisor), although some invest in funds managed by other (unaffiliated) advisors. The cost associated with investing in an unaffiliated underlying fund is most often higher than investing in an affiliated underlying because of the investment management research involved in investing in fund advised by a different advisor.

Recently, FoFs have been classified into those that are actively managed (in which the investment advisor reallocates frequently among the underlying funds in order to adjust to changing market conditions) and those that are passively managed (the investment advisor allocates assets on the basis of on an allocation model which is rebalanced on a regular basis).

Hedge fund - is a private investment fund that charges a performance fee and is typically open to only a limited range of qualified investors. Hedge fund activity in the public securities markets has grown substantially as it constitutes approximately 30% of all U.S. fixed-income security transactions, 55% of U.S. activity in derivatives with investment-grade ratings, 55% of the trading volume for emerging-market bonds, as well as 30% of equity trades. Hedge Funds dominate certain specialty markets such as trading in derivatives with high-yield ratings, and distressed debt.

Index funds - maintain investments in companies that are part of major stock (or bond) indices, such as the S&P 500. The assets of an index fund are managed to closely approximate the performance of a particular published index.

Actively managed fund - attempts to outperform a relevant index through superior stock-picking techniques.

Since the composition of an index changes infrequently, an index fund manager makes fewer trades, on average, than does an active fund manager. For this reason, index funds generally have lower trading expenses than actively managed funds, and typically incur fewer short-term capital gains which must be passed on to shareholders.

Additionally, index funds do not incur expenses to pay for selection of individual stocks (proprietary selection techniques, research, etc.) and deciding when to buy, hold or sell individual holdings. Instead, a fairly simple computer model can identify whatever changes are needed to bring the fund back into agreement with its target index.