is a professionally managedinvestment fundthat pools money from many investors to purchasesecurities. These investors may be retail or institutional in nature.
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 variousfees and expenses.
Primary structures of mutual funds includeopen-end fundsunit investment trusts, andclosed-end fundsExchange-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 asmoney market funds, bond or fixed income funds, stock or equity funds, hybrid funds or other. Funds may also be categorized asindex funds, which are passively managed funds that match the performance of an index, or actively managed funds.Hedge fundsare not mutual funds; hedge funds cannot be sold to the general public and are subject to different government regulations.
Classification of funds by types of underlying investments
Securities transaction fees incurred by the fund
Further information:Financial history of the Dutch Republic
The first moderninvestment funds(the precursor of todays mutual funds) were established in theDutch Republic. In response to thefinancial crisisof 17721773, Amsterdam-based businessman Abraham (or Adriaan) van Ketwich formed a trust named Eendragt Maakt Magt (unity creates strength). His aim was to provide small investors with an opportunity to diversify.12
Mutual funds were introduced to the United States in the 1890s. Early U.S. funds were generally closed-end funds with a fixed number of shares that often traded at prices above the portfolionet asset value. The first open-end mutual fund with redeemable shares was established on March 21, 1924 as the Massachusetts Investors Trust (it is still in existence today and is now managed byMFS Investment Management).
In the United States, closed-end funds remained more popular than open-end funds throughout the 1920s. In 1929, open-end funds accounted for only 5% of the industrys $27 billion in total assets.
After theWall Street Crash of 1929, theUnited States Congresspassed a series of acts regulating the securities markets in general and mutual funds in particular.
TheSecurities Act of 1933requires that all investments sold to the public, including mutual funds, be registered with the SEC and that they provide prospective investors with aprospectusthat discloses essential facts about the investment.
TheSecurities and Exchange Act of 1934requires that issuers of securities, including mutual funds, report regularly to their investors. This act also created the Securities and Exchange Commission, which is the principal regulator of mutual funds.
TheRevenue Act of 1936established guidelines for the taxation of mutual funds.
TheInvestment Company Act of 1940established rules specifically governing mutual funds.
These new regulations encouraged the development of open-end mutual funds (as opposed to closed-end funds).
Growth in the U.S. mutual fund industry remained limited until the 1950s, when confidence in the stock market returned. By 1970, there were approximately 360 funds with $48 billion in assets.3
The introduction of money market funds in the high interest rate environment of the late 1970s boosted industry growth dramatically. The first retailindex fund, First Index Investment Trust, was formed in 1976 byThe Vanguard Group, headed byJohn Bogle; it is now called the Vanguard 500 Index Fund and is one of the worlds largest mutual funds. Fund industry growth continued into the 1980s and 1990s.
According to Pozen and Hamacher, growth was the result of three factors:
New product introductions (including funds based onmunicipal bonds, various industry sectors, international funds, andtarget date funds) and
Wider distribution of fund shares, including through employee-directed retirement accounts such as401(k), otherdefined contribution plansandindividual retirement accounts(IRAs.) Among the new distribution channels were retirement plans. Mutual funds are now the preferred investment option in certain types of fast-growing retirement plans, specifically in401(k), otherdefined contribution plansand inindividual retirement accounts(IRAs), all of which surged in popularity in the 1980s.
In 2003, the mutual fund industry was involved in ascandalinvolving unequal treatment of fund shareholders. Some fund management companies allowed favored investors to engage inlate trading, which is illegal, ormarket timing, which is a practice prohibited by fund policy. The scandal was initially discovered by formerand led to a significant increase in regulation. In a study about German mutual fundsGomolka(2007) found statistical evidence of illegal time zone arbitrage in trading of German mutual funds5. Though reported to regulatorsBaFinnever commented on these results.
Total mutual fund assets fell in 2008 as a result of thefinancial crisis of 20072008.
At the end of 2016, mutual fund assets worldwide were $40.4trillion, according to the Investment Company Institute.6The countries with the largest mutual fund industries are:
In the United States, mutual funds play an important role in U.S. household finances. At the end of 2016, 22% of household financial assets were held in mutual funds. Their role in retirement savings was even more significant, since mutual funds accounted for roughly half of the assets in individual retirement accounts, 401(k)s and other similar retirement plans.7In total, mutual funds are large investors in stocks and bonds.
Luxembourg and Ireland are the primary jurisdictions for the registration ofUCITSfunds. These funds may be sold throughout the European Union and in other countries that have adopted mutual recognition regimes.
Mutual funds have advantages and disadvantages compared to investing directly in individual securities:
Increased diversification: A fund diversifies holding many securities. Thisdiversificationdecreases risk.
Daily liquidity: Shareholders of open-end funds and unit investment trusts may sell their holdings back to the fund at regular intervals at a price equal to thenet asset valueof the funds holdings. Most funds allow investors to redeem in this way at the close of every trading day.
Professional investment management: Open-and closed-end funds hire portfolio managers to supervise the funds investments.
Ability to participate in investments that may be available only to larger investors. For example, individual investors often find it difficult to invest directly in foreign markets.
Service and convenience: Funds often provide services such as check writing.
Government oversight: Mutual funds are regulated by a governmental body.
Transparency and ease of comparison: All mutual funds are required to report the same information to investors, which makes them easier to compare to each other.
Mutual funds have disadvantages as well, which include:
In the United States, the principal laws governing mutual funds are:
TheSecurities Act of 1933requires that all investments sold to the public, including mutual funds, be registered with the SEC and that they provide potential investors with aprospectusthat discloses essential facts about the investment.
TheSecurities and Exchange Act of 1934requires that issuers of securities, including mutual funds, report regularly to their investors; this act also created the Securities and Exchange Commission, which is the principal regulator of mutual funds.
TheRevenue Act of 1936established guidelines for the taxation of mutual funds. Mutual funds are not taxed on their income and profits if they comply with certain requirements under the ternal Revenue Code; instead, the taxable income is passed through to the investors in the fund. Funds are required by the IRS to diversify their investments, limit ownership of voting securities, distribute most of their income (dividends, interest, and capital gains net of losses) to their investors annually, and earn most of the income by investing in securities and currencies.
The characterization of a funds income is unchanged when it is paid to shareholders. For example, when a mutual fund distributes dividend income to its shareholders, fund investors will report the distribution as dividend income on their tax return. As a result, mutual funds are often calledpass-through vehicles, because they simply pass on income and related tax liabilities to their investors.
TheInvestment Company Act of 1940establishes rules specifically governing mutual funds. The focus of this Act is on disclosure to the investing public of information about the fund and its investment objectives, as well as on investment company structure and operations.
TheInvestment Advisers Act of 1940establishes rules governing the investment advisers. With certain exceptions, this Act requires that firms or sole practitioners compensated for advising others about securities investments must register with the SEC and conform to regulations designed to protect investors.
TheNational Securities Markets Improvement Act of 1996gave rulemaking authority to the federal government, preempting state regulators. However, states continue to have authority to investigate and prosecute fraud involving mutual funds.
Open-end and closed-end funds are overseen by aboard of directors, if organized as a corporation, or by a board oftrustees, if organized as a trust. The Board must ensure that the fund is managed in the interests of the funds investors. The board hires the fund manager and other service providers to the fund.
The sponsor or fund management company, often referred to as the fund manager,trades(buys and sells) the funds investments in accordance with the funds investment objective. Funds that are managed by the same company under the same brand are known as a fund family or fund complex. A fund manager must be aregistered investment adviser.
In the European Union, funds are governed by laws and regulations established by their home country. However, the European Union has established a mutual recognition regime that allows funds regulated in one country to be sold in all other countries in the European Union, but only if they comply with certain requirements. The directive establishing this regime is theUndertakings for Collective Investment in Transferable Securities Directive 2009, and funds that comply with its requirements are known as UCITS funds.
Regulation of mutual funds in Canada is primarily governed by National Instrument 81-102 Mutual Funds, which is implemented separately in each province or territory. The Canadian Securities Administrator works to harmonize regulation across Canada.13
In the Hong Kong market mutual funds are regulated by two authorities:
The Securities and Futures Commission (SFC) develops rules that apply to all mutual funds marketed in Hong Kong.
The Mandatory Provident Funds Schemes Authority (MPFA) rules apply only to mutual funds that are marketed for use in the retirement accounts of Hong Kong residents. The MPFA rules are generally more restrictive than the SFC rules.
In Taiwan, mutual funds are regulated by the Financial Supervisory Commission (FSC).16
There are three primary structures of mutual funds:open-end fundsunit investment trusts, andclosed-end fundsExchange-traded funds(ETFs) are open-end funds or unit investment trusts that trade on an exchange.
Open-end mutual funds must be willing to buy back (redeem) their shares from their investors at thenet asset value(NAV) computed that day based upon the prices of the securities owned by the fund. In the United States, open-end funds must be willing to buy back shares at the end of every business day. In other jurisdictions, open-funds may only be required to buy back shares at longer intervals. For example, UCITS funds in Europe are only required to accept redemptions twice each month (though most UCITS accept redemptions daily).
Most open-end funds also sell shares to the public every business day; these shares are priced at NAV.
Most mutual funds are open-end funds. In the United States at the end of 2016, there were 8,066 open-end mutual funds with combined assets of $16.3 trillion, accounting for 86% of the U.S. industry.7
Closed-end funds generally issue shares to the public only once, when they are created through aninitial public offering. Their shares are then listed for trading on astock exchange. Investors who want to sell their shares must sell their shares to another investor in the market; they cannot sell their shares 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).
In the United States, at the end of 2016, there were 530 closed-end mutual funds with combined assets of $300 billion, accounting for 1% of the U.S. industry.17
Unit investment trusts (UITs) are issued to the public only once when they are created. UITs generally have a limited life span, established at creation. Investors can redeem shares directly with the fund at any time (similar to an open-end fund) or wait to redeem them upon the trusts termination. Less commonly, they can sell their shares in the open market.
Unlike other types of mutual funds, unit investment trusts do not have a professional investment manager. Their portfolio of securities is established at the creation of the UIT.
In the United States, at the end of 2016, there were 5,103 UITs with combined assets of less than $0.1 trillion.17
Exchange-traded funds (ETFs) are structured as open-end investment companies or UITs. ETFs combine characteristics of both closed-end funds and open-end funds. ETFs are traded throughout the day on a stock exchange. Anarbitragemechanism is used to keep the trading price close tonet asset valueof the ETF holdings.
In the United States, at the end of 2016, there were 1,716 ETFs in the United States with combined assets of $2.5 trillion, accounting for 13% of the U.S. industry.7
Mutual funds are normally classified by their principal investments, as described in the prospectus and investment objective. The four main categories of funds are money market funds, bond or fixed income funds, stock or equity funds, and hybrid funds. Within these categories, funds may be sub-classified by investment objective, investment approach or specific focus.
The types of securities that a particular fund may invest in are set forth in the fundsprospectus, a legal document which describes the funds investment objective, investment approach and permitted investments. The investment objective describes the type of income that the fund seeks. For example, a capital appreciation fund generally looks to earn most of its returns from increases in the prices of the securities it holds, rather than from dividend or interest income. The investment approach describes the criteria that the fund manager uses to select investments for the fund.
Bond, stock, and hybrid funds may be classified as either index (or passively-managed) funds or actively managed funds.
Money market funds invest inmoney marketinstruments, which are fixed income securities with a very short time to maturity and high credit quality. Investors often use money market funds as a substitute for banksavings accounts, though money market funds are not insured by the government, unlike bank savings accounts.
In the United States, money market funds sold to retail investors and those investing in government securities may maintain a stable net asset value of $1 per share, when they comply with certain conditions. Money market funds sold to institutional investors that invest in non-government securities must compute a net asset value based on the value of the securities held in the funds.
In the United States, at the end of 2016, assets in money market funds were $2.7 trillion, representing 14% of the industry.18
Bond funds invest in fixed income or debt securities. Bond funds can be sub-classified according to:
The specific types of bonds owned (such ashigh-yield or junk bonds, investment-gradecorporate bonds, government bonds ormunicipal bonds)
The maturity of the bonds held (i.e., short-, intermediate- or long-term)
The country of issuance of the bonds (such as U.S., emerging market or global)
The tax treatment of the interest received (taxable or tax-exempt)
In the United States, at the end of 2016, assets in bond funds were $4.1 trillion, representing 22% of the industry.18
Stock or equity funds invest incommon stocks. Stock funds may focus on a particular area of the stock market, such as
Stocks that the portfolio managers deem to be a good
relative to the value of the companys business
Stocks within a certain market capitalization range
In the United States, at the end of 2016, assets in Stock funds were $10.6 trillion, representing 56% of the industry.18
Hybrid funds invest in both bonds and stocks or inconvertible securities. Balanced funds, asset allocation funds, target date or target risk funds, and lifecycle or lifestyle funds are all types of hybrid funds.
Hybrid funds may be structured asfunds of funds, meaning that they invest by buying shares in other mutual funds that invest in securities. Many funds of funds invest in affiliated funds (meaning mutual funds managed by the same fund sponsor), although some invest in unaffiliated funds (i.e., managed by other fund sponsors) or some combination of the two.
In the United States, at the end of 2016, assets in hybrid funds were $1.4 trillion, representing 7% of the industry.18
Funds may invest in commodities or other investments too.
Investors in a mutual fund pay the funds expenses. Some of these expenses reduce the value of an investors account; others are paid by the fund and reducenet asset value.
The management fee is paid by the fund to the management company or sponsor that organizes the fund, provides the portfolio management or investment advisory services and normally lends its brand to the fund. The fund manager may also provide other administrative services. The management fee often has breakpoints, which means that it declines as assets (in either the specific fund or in the fund family as a whole) increase. The funds board reviews the management fee annually. Fund shareholders must vote on any proposed increase, but the fund manager or sponsor can agree to waive some or all of the management fee in order to lower the funds expense ratio.
Index funds generally charge a lower management fee than actively-managed funds.
Distribution charges pay for marketing, distribution of the funds shares as well as services to investors. There are three types of distribution charges.
Front-end load or sales charge. Afront-end loadorsales chargeis acommissionpaid to abrokerby a mutual fund when shares are purchased. It is expressed as a percentage of the total amount invested or the public offering price, which equals the net asset value plus the front-end load per share. The front-end load often declines as the amount invested increases, throughbreakpoints. The front-end load is paid by the investor; it is deducted from the amount invested.
Back-end load. Some funds have aback-end load, which is paid by the investor when shares are redeemed. If the back-end load declines the longer the investor holds shares, it is called a contingent deferred sales charges (CDSC). Like the front-end load, the back-end load is paid by the investor; it is deducted from the redemption proceeds.
Distribution and services fee. Some funds charge an annual fee to compensate the distributor of fund shares for providing ongoing services to fund shareholders. In the United States, this fee is sometimes called a 12b-1 fee, after the SEC rule authorizing it. The distribution and services fee is paid by the fund and reduces net asset value.
Distribution charges generally vary for each share class.
A mutual fund pays expenses related to buying or selling the securities in its portfolio. These expenses may includebrokeragecommissions. These costs are normally positively correlated with turnover.
Shareholders may be required to pay fees for certain transactions, such as buying or selling shares of the fund. For example, a fund may charge a flat fee for maintaining an individual retirement account for an investor. Some funds charge redemption fees when an investor sells fund shares shortly after buying them (usually defined as within 30, 60 or 90 days of purchase). Redemption fees are computed as a percentage of the sale amount. Shareholder transaction fees are not part of the expense ratio.
A mutual fund may pay for other services including:
Board of directors or trustees fees and expenses
Custody fee: paid to acustodian bankfor holding the funds portfolio in safekeeping and collecting income owed on the securities
Fund administrationfee: for overseeing all administrative affairs such as preparing financial statements and shareholder reports, SEC filings, monitoring compliance, computing total returns and other performance information, preparing/filing tax returns and all expenses of maintaining compliance with stateblue sky laws
Fund accounting fee: for performing investment or securities accounting services and computing thenet asset value(usually every day theNew York Stock Exchangeis open)
Professional services fees: legal and auditing fees
Registration fees: paid to the SEC and state securities regulators
Shareholder communications expenses: printing and mailing required documents to shareholders such as shareholder reports and prospectuses
Transfer agent service fees and expenses: for keeping shareholder records, providing statements and tax forms to investors and providing telephone, internet and or other investor support and servicing
The fund manager or sponsor may agree to subsidize some of these charges.
The expense ratio equals recurring fees and expenses charged to the fund during the year divided by average net assets. The management fee and fund services charges are ordinarily included in the expense ratio. Front-end and back-end loads, securities transaction fees and shareholder transaction fees are normally excluded.
To facilitate comparisons of expenses, regulators generally require that funds use the same formula to compute the expense ratio and publish the results.
In the United States, a fund that calls itselfno-loadcannot charge a front-end load or back-end load under any circumstances and cannot charge a distribution and services fee greater than 0.25% of fund assets
Critics of the fund industry argue that fund expenses are too high. They believe that the market for mutual funds is not competitive and that there are many hidden fees, so that it is difficult for investors to reduce the fees that they pay. They argue that the most effective way for investors to raise the returns they earn from mutual funds is to invest in funds with low expense ratios.
Fund managers counter that fees are determined by a highly competitive market and, therefore, reflect the value that investors attribute to the service provided. They also note that fees are clearly disclosed.
Mutual funds in the United States are required to report the average annual compounded rates of return for one-, five-and ten year-periods using the following formula:19
ERV = ending redeemable value of a hypothetical $1,000 payment made at the beginning of the one-, five-, or ten-year periods at the end of the one-, five-, or ten-year periods (or fractional portion).
Market capitalization equals the number of a companys shares outstanding multiplied by the market price of the stock. Market capitalization is an indication of the size of a company. Typical ranges of market capitalizations are:
Mega cap – companies worth $200 billion or more
Big/large cap – companies worth between $10 billion and $200 billion
Mid cap – companies worth between $2 billion and $10 billion
Small cap – companies worth between $300 million and $2 billion
Micro cap – companies worth between $50 million and $300 million
Nano cap – companies worth less than $50 million
A funds net asset value (NAV) equals the current market value of a funds holdings minus the funds liabilities (this figure may also be referred to as the funds net assets). It is usually expressed as a per-share amount, computed by dividing net assets by the number of fund shares outstanding. Funds must compute their net asset value according to the rules set forth in their prospectuses. Most compute their NAV at the end of each business day.
Valuing the securities held in a funds portfolio is often the most difficult part of calculating net asset value. The funds board typically oversees security valuation.
A single mutual fund may give investors a choice of different combinations of front-end loads, back-end loads and distribution and services fee, by offering several different types of shares, known as share classes. All of them invest in the same portfolio of securities, but each has different expenses and, therefore, a different net asset value and different performance results. Some of these share classes may be available only to certain types of investors.
Typical share classes for funds sold through brokers or other intermediaries in the United States are:
shares usually charge a front-end sales load together with a small distribution and services fee.
shares usually do not have a front-end sales load; rather, they have a highcontingent deferred sales charge(CDSC) that gradually declines over several years, combined with a high12b-1fee. Class B shares usually convert automatically to Class A shares after they have been held for a certain period.
shares usually have a high distribution and services fee and a modest contingent deferred sales charge that is discontinued after one or two years. Class C shares usually do not convert to another class. They are often called level load shares.
are usually subject to very high minimum investment requirements and are, therefore, known as institutional shares. They are no-load shares.
are usually for use in retirement plans such as401(k)plans. They typically do not charge loads, but do charge a small distribution and services fee.
No-load funds in the United States often have two classes of shares:
Neither class of shares typically charges a front-end or back-end load.
Turnoveris a measure of the volume of a funds securities trading. It is expressed as a percentage of average market value of the portfolios long-term securities. Turnover is the lesser of a funds purchases or sales during a given year divided by average long-term securities market value for the same period. If the period is less than a year, turnover is generally annualized.
List of mutual-fund families in the United States
List of U.S. mutual funds by assets under management
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U.S. Securities and Exchange Commission,Mutual Funds and ETFs: A Guide for Investors
(Venture capital fundMezzanine investment fundsVulture fund)
Loan qualifying investor alternative investment fund(LQIAIF)
Qualifying investor alternative investment fund(QIAIF)
Economic, financial and business history of the Netherlands
Economic history of the Netherlands (15001815)
Early modern industrialization in the Dutch Republic(1580s1700s)
Pulp and paper industry in the Dutch Republic
Amsterdam Stock ExchangeBeurs van Hendrick de Keyser)
Public companypublicly traded companypublicly listed company)
Collective investment schemesinvestment funds)
Economic globalizationcorporate globalization)
This page was last edited on 22 April 2019, at 18:07