What are Mutual Funds?
Mutual funds are a type of financial vehicle that consists of a pool of money from different investors that make up a portfolio. This portfolio can include stocks, bonds, options and other assets. These funds are typically managed by experienced money managers that have proven returns on interests through trading skills or profitable algorithms. The money managers receive a percentage of profits at the end of each quarter. The portfolios are focused on following the investment objective set out in the prospectus.
The benefit that mutual funds give to smaller or individual investors is that it gives you access to having your capital invested by professionally managed funds of equities, bonds, or other securities. The mutual funds share gains and losses proportionally with investors, as performance is tracked through the change in the total market cap of the funds. A good way to think of mutuals funds is like getting your friends to put money together to buy a house and using the newly acquired property to make a return on the initial investment.
Since mutual funds pool money together, it would make sense that the funds that have the most money to spend can buy a portfolio of different equities to ensure a hedged and safe returns. Typically, the value of the mutual fund depends on the securities that it buys and will provide returns if the underlying is performing well. Essentially, buying a share or unit in a mutual fund is investing in the performance of the overall portfolio.
Unlike owning shares in a company, owning shares in a mutual fund does not grant access to voting rights for its holders. As previously stated, a share in a mutual fund represent an investment in a variety of securities in one holding. The price of the mutual fund is referred to as the net asset value (NAV) per share. A mutual fund’s NAV can be calculated by dividing the total value of the securities in the portfolio by the total amount of shares outstanding. The outstanding shares are shares held by all shareholders, institutional investors, insiders or company officers. Mutual fund shares can be purchased at the NAV price during typical market hours, but unlike a stock, it does not move until the NAV is settled at the end of the trading day.
Mutual funds generally hold over hundreds of different securities which allow for diversification in a portfolio. This can help minimize the risk of holding one share of a stock that declines over time as the mutual fund would only lose a fraction of value since it is priced into the overall net asset value.
The net assets of a mutual fund is 100,000 and the share outstanding is 10,000. What is the NAV? 10 (100000/10000)
If the net assets are increased to 150,000 and the shares outstanding remain the same, what is the NAV? 15 (150000/100000)
An investor redeems 2000 shares at the new price of the NAV, what will be the net assets in this scenario? 120,000 (8000 * 15)
Mark to Market
The current value of the portfolio forms the base of the net assets of the scheme and therefore the NAV. It means that the portfolio was to be liquidated then this would be the value that would be realized and distributed to the investors. Therefore, the portfolio has to reflect the current market price of the securities held. This process of valuing the portfolio on a daily basis at current value is called marking to market. The price is taken from the market where the securities are traded.
Open-ended and Closed-ended Scheme
A mutual fund offers two types of scheme open-ended or closed-ended scheme
- An open-ended Scheme allows the investor to invest in additional units and redeem investment continuously at current NAV. The scheme is for the perpetuity unless the investors decided to wind up the scheme. The unit capital of the scheme is not fixed but changes with every investment or redemption made by the investor.
- A closed-ended Scheme is for a fixed period or tenor.fund It offers units to the investors only during the new offer (NFO). The scheme is closed for the transactions for the investor. The units allotted are redeemed by the fund at the prevailing NAV when the term is over and the fund ceases to exist from the same. In the interim, if the investor wants to exit from the investment he can do so by selling the units to the other investors on the stock exchange where they are listed. The unit capital of the closed-ended the scheme does not change over the life of the scheme since transactions between investors on the stock exchange does not affect the fund.
Interval funds are the variant of the closed-ended funds which become open-ended during specified periods. During these periods investors can purchase and redeem units like in an open-ended fund. The specified transaction period is for a minimum period of 2 days and there must be a minimum gap of 15 days between two transaction periods.
1. A mutual fund’s investments have to be marked to market every day.
2. Mutual funds usually cannot take a controlling interest in a company
3. Mutual funds have to list the kinds of securities in which they can invest