An Overview of Mutual Funds
Mutual funds are a type of pooled investments that require a small investment for participation as opposed to hedge funds which can require a minimum of US$1 million, sometimes more. The kinds of products that are available in a financial supermarket vary therefore on the proposed investment. Certain mutual funds require investments as small as $50, while others are available in the range of US $1,000,000 and more.
Mutual funds can be defined as a co-mingled investment pool in which investors in the fund each have a pro-rata (in proportion to) claim on the income and the value of the fund.
The value of a mutual fund is called the net asset value or NAV. It is calculated on a daily basis, on the closing value of the securities in its portfolio. Given below is a snapshot of the global mutual fund market between 2005 and 2011. (Source: Fact sheet 2012 of the Investment Company Institute)
If we were to look at 2011 percentage figures for these continents it would look like this:
Mutual funds are favored by investors and institutions alike. To understand how a mutual fund works let us look at an example. An investment firm that wants to start a fund has decided to do so with a target of US$10million. It aims to do this with five individuals and two institutions.
The net asset value of the fund is US$10 million. This is divided into 100,000 shares with each share having an initial value of $100. This fund is given to a portfolio manager to manage. The net asset value will change depending on the value of the assets in the portfolio. The fund is christened FastGrowth100.
The FastGrowth100 mutual fund is an open-ended fund. This fund will accept fresh investment money and issue additional shares at a value equal to the net asset value of the fund at the time of investment. An open ended fund will allow for removal of funds at the NAV at that point of time. If the fund value increases to US$15 million, the new value per share would be $150. If an investor wants to put in US$0.96 million, it would create 6400 new shares. Post investment the Net Asset Value of the fund would be 15.96 million, with a total of 106400 shares.
Let’s say investor C wants to withdraw her shares from the fund totally. Now the fund will need to liquidate $0.75 million in assets to retire 5000 shares at a NAV of US$150. There is a net inflow US$210,000 and 1400 new shares would be created.