Mutual funds

A mutual fund is a pool of funds collected from many investors who invest in stocks, bonds and other securities with the aim to achieve high capital gains.

Types of mutual funds

  • Stock Funds
    • Stock funds, also known as equity funds, invest in stocks and, therefore, are highly volatile. Their classification is subject to market capitalisation, investment management style, growth potential and sector allocation.

      Mutual funds are classified into large-cap (investing in companies with market cap larger than £6 billion), mid-cap (investing in companies with a market cap between £650 million and £6 billion) and small-cap (investing in companies with a market cap less than £650 million).

      Investment management refers to active and passive management. Actively managed funds involve a fund manager, who actively manages the fund through research and analysis, forecasting and relevant experience in investment decision making. The main idea of active management is that the market can be outperformed by employing a number of investment strategies that capitalize on mispriced securities to produce higher returns. Passively managed funds are related to indexing. A fund's portfolio mirrors the performance of a market index, and the fund manager's decisions project the index's performance. The main idea of passive management is that the market incorporates any available information at any given time, thus enabling effective decision making.

      Growth funds invest in companies with a long-term growth potential. However, growth funds are highly volatile and fluctuate sharply.

      Mutual funds may invest in specific market sectors with the aim of capitalising on industry growth. Usually, health care funds and real estate funds are preferred, but any sector funds can generate high returns.
  • Bond Funds
    • A bond funds invests in bonds and low-risk debt securities such as government bonds, municipal bonds, convertible bonds or mortgage-backed securities. In general, bonds funds incur low risk and are actively managed to achieve the highest return on investment.
  • Money Market Funds
    • Money market funds invest in short-term, low-risk securities. The goal is to offer investors a safe investment instrument with relatively low returns.
  • Advantages of mutual funds
    • Mutual funds offer many benefits. The following are reasons why you might consider investing in mutual funds.
  • Diversification
    • Mutual funds allow you to select different securities with a different level of risk to offset the losses from one security with returns on another. This means you don't need large amounts of cash to build your portfolio and you can capitalize on the benefits of asset allocation.
  • Low cost
    • If you build your diversified portfolio with 30 stocks you will probably need £60,000 plus commissions. By purchasing a single mutual fund you have access to hundreds of securities at a cost of £1,000 or even less. Ensure you buy more than one mutual fund to achieve sector diversification.
  • Liquidity
    • Mutual funds are traded on the net asset value (NAV) calculated on the closing of trading on the day the order arrives at the fund. This means that you can get in and out of your position quite easily and have prompt access to your money.
  • Flexibility
    • Mutual funds offer flexibility in terms of dividend reinvestment and strategic investment planning. Even if you are a small investor, you can keep a balanced portfolio and manage risk regardless of the market conditions, except in extreme situations.
  • Professional management / Indexing
    • If you lack the knowledge or the skills to manage your own portfolio, fund managers can offer you professional management. By having access on economic research and possessing the necessary skills to evaluate the market conditions in your best interest, fund managers can select the proper asset allocation to meet your investor profile. If, on the other hand, you have the skills to manage your own portfolio, you may select index funds and mirror the performance of a popular index such as S&P 500.
  • Investor Information
    • As a mutual fund shareholder you can receive regular reports from the fund company with details of your transaction on a year-to-date basis. Also, you may check the net asset value of your mutual funds in the daily newspapers.
  • Disadvantages of mutual funds
    • There are also risks involved in investing in mutual funds. The following are things to know before investing in mutual funds.
  • Extra fees
    • Mutual funds incur extra fees, including shareholder fees, operation fees or penalties for early withdrawal. These fees are charged regardless of the performance of the fund and if your fund does not make money, these fees will definitely expand losses.
  • High volatility
    • There is no guaranteed return in any investment, including mutual funds. Yet, unlike fixed-income securities, mutual funds are highly volatile because they include stocks. When selecting a particular mutual fund you should make sure that it matches your risk profile because, even if your portfolio is diversified, high risk mutual funds may depreciate the value of the entire portfolio.