A mutual fund is a professionally managed type of collective investment bonds (short- or long-term).
r long-term). Both stock and bond funds can invest in
scheme that pools money from many investors and invests typically in
investment securities (stocks, bonds, short-term money market instruments,
other mutual funds, other securities, and/or commodities such as precious
metals).[1] The mutual fund will have a fund manager that trades (buys and
sells) the fund's investments in accordance with the fund's investment
objective. In the U.S., a fund registered with the Securities and Exchange
Commission (SEC) under both SEC and Internal Revenue Service (IRS)
rules must distribute nearly all of its net income and net realized gains from
the sale of securities (if any) to its investors at least annually. Most funds are
overseen by a board of directors or trustees (if the U.S. fund is organized as
a trust as they commonly are) which is charged with ensuring the fund is
managed appropriately by its investment adviser and other service
organizations and vendors, all in the best interests of the fund's investors.
Since 1940 in the U.S., with the passage of the Investment Company Act of
1940 (the '40 Act) and the Investment Advisers Act of 1940, there have been
three basic types of registered investment companies: open-end funds (or
mutual funds), unit investment trusts (UITs); and closed-end funds. Other
types of funds that have gained in popularity are exchange traded funds
(ETFs) and hedge funds, discussed below. Similar types of funds also
operate in Canada, however, in the rest of the world, mutual fund is used as
a generic term for various types of collective investment vehicles, such as
unit trusts, open-ended investment companies (OEICs), unitized insurance
funds, undertakings for collective investments in transferable securities
(UCITS, pronounced "YOU-sits") and SICAVs (pronounced "SEE-cavs").
History
Massachusetts Investors Trust (now MFS Investment Management) was
founded on March 21, 1924, and, after one year, it had 200 shareholders and
$392,000 in assets. The entire industry, which included a few closed-end
funds, represented less than $10 million in 1924.
The stock market crash of 1929 hindered the growth of mutual funds. In
response to the stock market crash, Congress passed the Securities Act of
1933 and the Securities Exchange Act of 1934. These laws require that a
fund be registered with the U.S. Securities and Exchange Commission
(SEC) and provide prospective investors with a prospectus that contains
required disclosures about the fund, the securities themselves, and fund
manager. The Investment Company Act of 1940 sets forth the guidelines
with which all SEC-registered funds must comply.
With renewed confidence in the stock market, mutual funds began to
blossom. By the end of the 1960s, there were approximately 270 funds with
$48 billion in assets. The first retail index fund, First Index Investment
Trust, was formed in 1976 and headed by John Bogle, who conceptualized
many of the key tenets of the industry in his 1951 senior thesis at Princeton
University.[2] It is now called the Vanguard 500 Index Fund and is one of
the world's largest mutual funds, with more than $100 billion in assets.
A key factor in mutual-fund growth was the 1975 change in the Internal
Revenue Code allowing individuals to open individual retirement accounts
(IRAs). Even people already enrolled in corporate pension plans could
contribute a limited amount (at the time, up to $2,000 a year). Mutual funds
are now popular in employer-sponsored "defined-contribution" retirement
plans such as (401(k)s) and 403(b)s as well as IRAs including Roth IRAs.
As of October 2007, there are 8,015 mutual funds that belong to the
Investment Company Institute (ICI), a national trade association of
investment companies in the United States, with combined assets of $12.356
trillion.[3] In early 2008, the worldwide value of all mutual funds totaled
more than $26 trillion.[4]
Usage, investment objectives
Since the Investment Company Act of 1940, a mutual fund is one of three
basic types of investment companies available in the United States.[5]
Mutual funds may invest in many kinds of securities (subject to its
investment objective as set forth in the fund's prospectus, which is the legal
document under SEC laws which offers the funds for sale and contains a
wealth of information about the fund). The most common securities
purchased are "cash" or money market instruments, stocks, bonds, other
mutual fund shares and more exotic instruments such as derivatives like
forwards, futures, options and swaps. Some funds' investment objectives
(and or its name) define the type of investments in which the fund invests.
For example, the fund's objective might state "...the fund will seek capital
appreciation by investing primarily in listed equity securities (stocks) of U.S.
companies with any market capitalization range." This would be "stock"
fund or a "domestic/US stock" fund since it stated U.S. companies. A fund
may invest primarily in the shares of a particular industry or market sector,
such as technology, utilities or financial services. These are known as
specialty or sector funds. Bond funds can vary according to risk (e.g., high-
yield junk bonds or investment-grade corporate bonds), type of issuers (e.g.,
government agencies, corporations, or municipalities), or maturity of the
primarily U.S. securities (domestic funds), both U.S. and foreign securities
(global funds), or primarily foreign securities (international funds). Since
fund names in the past may not have provided a prospective investor a good
indication of the type of fund it was, the SEC issued a rule under the '40 Act
which aims to better align fund names with the primary types of investments
in which the fund invests, commonly called the "name rule". Thus, under
this rule, a fund must invest under normal circumstances in at least 80% of
the securities referenced in its name. for example, the "ABC New Jersey Tax
Free Bond Fund" would generally have to invest, under normal
circumstances, at least 80% of its assets in tax-exempt bonds issued by the
state of New Jersey and its political subdivisions. Some fund names are not
associated with specific securities so the name rule has less relevance in
those situations. For example, the "ABC Freedom Fund" is such that its
name does not imply a specific investment style or objective. Lastly, an
index fund strives to match the performance of a particular market index,
such as the S&P 500 Index. In such a fund, the fund would invest in
securities and likely specific derivates such as S&P 500 stock index futures
in order to most closely match the performance of that index.
Most mutual funds' investment portfolios are continually monitored by one
or more employees within the sponsoring investment adviser or management
company, typically called a portfolio manager and their assistants, who
invest the funds assets in accordance with its investment objective and trade
securities in relation to any net inflows or outflows of investor capital (if
applicable), as well as the ongoing performance of investments appropriate
for the fund. A mutual fund is advised by the investment adviser under an
advisory contract which generally is subject to renewal annually.
Types of mutual funds
[edit]Open-end fund, forms of organization, other funds
The term mutual fund is the common name for what is classified as an open-
end investment company by the SEC. Being open-ended means that, at the
end of every day, the fund continually issues new shares to investors buying
into the fund and must stand ready to buy back shares from investors
redeeming their shares at the then current net asset value per share.
Mutual funds must be structured as corporations or trusts, such as business
trusts, and any corporation or trust will be classified by the SEC as an
investment company if it issues securities and primarily invests in non-
government securities. An investment company will be classified by the
SEC as an open-end investment company if they do not issue undivided
interests in specified securities (the defining characteristic of unit investment
trusts or UITs) and if they issue redeemable securities. Registered
investment companies that are not UITs or open-end investment companies
are closed-end funds. Closed-end funds are like open end except they are
more like a company which sells its shares a single time to the public under
an initial public offering or "IPO". Subsequently, the fund's shares trade with
buyers and sellers of shares in the secondary market at a market-determined
price (which is likely not equal to net asset value) such as on the New York
or American Stock Exchange. Except for some special transactions, the fund
cannot continue to grow in size by attracting more investor capital like an
open-end fund may.
[edit]Exchange-traded funds
Main article: Exchange-traded fund
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 buy and sell shares through brokers in market transactions.
Because the institutional investors normally purchase and redeem in in kind
transactions, ETFs are more efficient than traditional mutual funds (which
are continuously issuing and redeeming securities and, to effect such
transactions, continually buying and selling securities and maintaining
liquidity positions) and therefore tend to have lower expenses.
Exchange-traded funds 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.
[edit]Equity funds
Equity funds, which consist mainly of stock investments, are the most
common type of mutual fund. Equity funds hold 50 percent of all amounts
invested in mutual funds in the United States.[7] Often equity funds focus
investments on particular strategies and certain types of issuers.