Mutual Funds: Hedge and Exchanged-Traded Funds

There are numerous kinds of mutual funds that allow investors to receive a secure rate of return with minimal risk.  While the funds have various amounts of risk, it still behooves investors to research each kind of fund and be fully cognizant of the investment they are making.

Open-End Mutual Fund
An open-ended mutual fund issues new shares to investors and buy back shares when investors wish to sell.  These funds do not have restrictions on the amount of shares the fund will issue.  If demand is high enough, the fund will continue to issue shares no matter how many investors there are.  In such funds, when the investment manager determines the total assets are too large to execute its stated objective, the fund will be closed to new investors.  In some extreme cases, it may be closed to new investment by existing fund investors.

Closed Mutual Fund
As referred to above, closed funds are closed either temporarily or permanently to new investors after an investment manager is concerned the asset base is too large to execute his investing style.  Shareholders in a closed mutual fund are allowed to continue investing in that fund, yet they are often precluding from other investments.

These funds differ from closed-end funds.  Despite the similar name, the latter is structured and listed as a stock on a stock exchange.  Closed-end funds have a fixed number of shares and generally invest in technical or other specialized sectors.

Equity Funds
Equity funds are the most common kind of mutual fund; in fact, they hold 50% of all mutual fund investments in the United States.  Equity funds tend to invest in equity as opposed to investments in stock and bond funds.

Bond Funds
Accounting for 18% of mutual fund assets, bond funds presently include term funds, municipal bonds, and high -yield bonds.  Term bond funds have a fixed set of time prior to maturity.  Municipal bond funds have numerous tax advantages and lower risk but at the expense of having lower rates.  High-yield bonds tend to invest in corporate bonds and while there is much potential for a large return, there is also significant risk.

There is presently a misconception that bond funds have little to no risk.  However, this is a falsehood as bond funds are subject to numerous risks i.e. prepayment risks, interest risks, and credit risks.  An investor is responsible for reading all of the fund’s information, and the information can be retrieved from the prospectus, which discloses most risks.

Money Market Funds
Holding 26% mutual fund assets in the United States, Money market funds are a conservative approach to investing with mutual funds.  They receive some of the lower rates of return, though entail the least amount of risk as well.  These funds pay dividends that generally reflect short-term interest rates.  Such typically invest in certificates of deposit, commercial paper of companies, government securities, or other highly liquid securities.  Despite the low amount of risk, it is still important that an investor reads all of the fund’s available information, including its prospectus and most recent shareholder report.

How Mutual Funds Work

Over 80 million people in America alone have investments in mutual funds. While stock markets generally yield a better return than mutual funds, the mutual fund managers have a certain experience and knowledge that laymen may not be able to muster. Investors can often rely on their managers’ understanding the market. It is optimal for mutual funds to be invested within domestic and foreign stock mutual funds, fixed-income mutual funds, or income fund equivalents.

History of Mutual Funds
Mutual funds grew popular in the mid 1980s when investors realized that pooling assets together could result in overall lower risks with moderate returns. In fact, such investments have been around for several hundred years. Mutual funds originated in 1774, when Adriaan van Ketwich convinced investors to pool their investments together and minimize risk so that the poor and middle class could contribute. While there were varying kinds of mutual and investment funds in the 19th century Holland, Scotland, and United States, the first modern mutual fund was created in 1924 and went public in 1928. The stock market crash of 1929 resulted in many of the then 700 closed-end funds losing their popularity while the small open-end funds grew in popularity. The Securities and Exchange Commission was created in 1933 in part to protect consumers’ investments in mutual funds.

Mutual funds grew more popular in the 1950s with an escalating interest in the 1960s, where there was an aggressive growth of mutual funds. In the 1970’s, a ‘no load’ fund, which had no sales commission and where the money went straight to the investors, not their managers, grew in popularity as well. The 1980s and 1990s brought with them a bull market mania, as the stock market grew at an even greater pace. Despite the burst of technology bubble and various scandals, mutual funds are still a growing market with more and more nations opening their markets to the world (i.e. China, Vietnam, etc).

Today – What To Look For
While it is important to look at the past performances and histories of mutual funds, this is no guarantee of any future success. An investor must be cognizant of (1) the fund’s sales fees, and expenses, (2) the taxes required when receiving a distribution, (3) the size of the fund, (4) the fund’s volatility, and (5) changes in the fund’s operations.

When investing in a mutual fund, the consumer must also carefully review the fund’s prospectus and shareholder reports. The investor is responsible for (1) scrutinizing the fund’s expenses and fees, knowing how the fund affects one’s tax bill, (3) considering the age and size of fund, (4) considering the turnover rate, (5) understanding appreciating the volatility of the fund, (6) understanding all the risks the fund requires to achieve returns, (7) learning about any changes in the mutual fund’s operations, (8) investigating the kinds of fees charges and services offered, (9) and assessing how the fund will impact the investor’s portfolio’s diversification.