In this article we will go slightly more in-depth to understand the types of mutual funds according to asset types they invest in. The U.S. has the largest mutual fund market in the world, with $11.6 trillion under management. The mutual funds can be classified as follows:
- Money Market Mutual Fund
- Bond Mutual Fund
- Stock Mutual Fund
- Hybrid or Balanced Fund
“Equity funds made up 45 percent of U.S. mutual fund assets at year-end 2011. Domestic equity funds (those that invest primarily in shares of U.S. corporations) held 33 percent of total industry assets. World equity funds (those that invest primarily in nondomestic corporations) accounted for another 12 percent. Bond funds accounted for 25 percent of U.S. mutual fund assets. Money market funds (23 percent) and hybrid funds (7 percent) held the remainder of total U.S. mutual fund assets” – 2012 Investment Company Factbook
Money Market Fund
Money market funds are often used by investors as substitutes for bank saving deposits. Of course it does not have the capital guarantee of a bank saving account. There are taxable and tax free money market funds. Taxable money market funds invest in federal debt and short term high quality debt. Tax free money market funds invest in short term state and local government debt. The underlying asset matures in not more than 90 days, and sometimes just overnight. There have been instances in money market funds where the NAV (Net Asset Value) of the shares has dipped below US$1 per share. This was known as ‘breaking the buck’. It took the Federal Reserve’s intervention to stop the worsening downward trend. The outflows from money market mutual funds is only now slowing down. Poor interest rates and the European debt crisis have meant poor demand for these funds.
Bond Mutual Funds
A bond mutual fund has in its portfolio a number of individual bonds and sometimes preferred shares. NAV in bond mutual funds is calculated by taking the value of each bond and dividing it by the value of each share. Individual bonds are available in the range of $10,000 to $100,000. By investing into a bond mutual fund an investor can invest in a bond fund with just $100. Maturity of underlying asset in bond mutual funds can vary from 1 year to 30 years. The various kinds of bond mutual funds include:
$124 billion was added to bond fund holdings in 2011. This is a reduced rate compared to the previous year’s $241 billion. Some factors for this slowdown include a reduced appetite across all age groups, an ageing population and lower tolerance for long maturity periods. This has seen more investments flowing to fixed income securities.
Stock Mutual Funds
These funds are traded the most and can be further classified based on portfolio management styles. In an actively managed fund, the portfolio manager hand picks the portfolio stocks. These funds have higher fees as they have dedicated researchers and these funds aim to outperform, not match indices. Trading activity in these funds is higher than passively managed funds. Capital gains and income need to be distributed across the fund and therefore higher taxes. In a passively managed fund, the portfolio is benchmarked against or tracks the performance of different indices. Passively managed funds have lesser opportunities to trade and use a buy and hold strategy and tend to have lower capital gains and therefore lower taxes.
Hybrid or Balanced Funds
Funds that invest in both equities and bonds are called hybrid funds. Hybrid funds are extremely popular now with 90% of assets managed in the funds of funds (funds that invest in other mutual funds). In 2011 there were 1047 fund of funds with total net assets crossing $1 trillion. Balanced funds promise the aggression of equity funds mixed with the promise of long term gains of the bond funds. The balanced fund is usually loaded towards shares in the earlier part of the investors investment and tends to become more conservative as it grows older towards retirement.