What is a Mutual Fund?

by Manshu on November 16, 2006

in Mutual Funds

A mutual fund is a company that pools money from many investors and invests the money in stocks, debentures/bonds, equities, short-term money market tools or other securities. The income produced through these investments plus the appreciation of capital earned by the scheme are shared by its entity holders depending on the units possessed by them. Thus, mutual funds can be well thought of as financial middleman in the investment trade who collect funds from the people and invest on behalf of the investors. The Investment objectives outlined by a Mutual Fund in its prospectus are binding on the Mutual Fund scheme. The investment goals state the class of securities in which a Mutual Fund can invest. Generally the portfolio of Mutual Funds comprises of various asset classes such as bonds, debentures, equity, and government securities, equipment. Stocks and bonds are the primary assets of the mutual fund while investing in equipment etc. take a back seat.

Like any other corporation, in exchange for cash the mutual fund issues shares of stock to investors. However unlike most corporations, mutual funds do not issue a fixed quantity of stock but with new investments new shares are issued. A mutual fund may be either an actively managed fund or an indexed mutual fund. A fund manager alters actively managed funds regularly in order to maximize their profitability. They fund manager inspects the market and the sectors a fund invests in and reallocate the fund appropriately. An indexed fund follows a different approach by simply taking one of the major indexes and buying according to that index. Indexed funds change much less repeatedly than actively managed funds. However, an active fund is more profit making.

Mutual funds provide transparency, efficient performance, liquidity, tax benefits and a wide range of schemes.

Mutual fund schemes may be classified on the basis of its investment objective and structure.

On the basis of Structure:

Open-ended Funds: An Open-ended Fund allows investors to buy and sell stock in it on an ongoing basis. It is available for subscription all through the year without a fixed maturity. This mutual fund is designed to issue and cash in shares from investors directly rather than through the stock market.

Close-ended Funds: A Close-ended Fund has a predetermined maturity period, ranging from 2 to 14 years. They do not incessantly offer their shares for sale but sell a fixed number of shares in the initial public offering after which the shares characteristically trade on a secondary market. The cost of closed-end fund shares that do business on a secondary market after their initial public offering is dependent on the market. It may be more than or less than the share’s net asset value.

On the basis of Investment Objective:

Growth Funds: Growth funds aim to provide capital appreciation over a long term. These funds look for the rapidly growing companies in the market. Growth managers take up more risk by paying a premium for their stocks to make a portfolio of companies with high price appreciation. These schemes are perfect for investors looking for growth over a long time.

Income Funds: These schemes invest in permanent income securities such as corporate debentures, bonds and Government securities thus aiming at regular and stable income to investors. The capital appreciation is restricted but the risks involved are lower than those in a growth fund.

Balanced Funds:The aim of Balanced Funds is to provide growth as well as regular income. These schemes dispense a part of their income by investing both in equities and fixed income securities in the percentage as mentioned in their offer documents. This proportion affects the risks and the returns associated with the balanced fund. Balanced funds with identical share in fixed income securities and equities are perfect for investors looking for income and reasonable growth.

Money Market Funds: Money market funds invest in government securities, certificates of deposits, and commercial paper of companies, treasury bills, Inter-Bank Call Money and other highly liquid and low-risk securities. They try to keep their net asset value constant and only the dividend yield goes up and down. Returns on these funds may fluctuate depending upon the current interest rates in the market.

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