What is a ‘Mutual Fund’

A mutual fund is an investment vehicle made up of a pool of money collected from many investors for the purpose of investing in securities such as stocks, bonds, money marketinstruments and other assets. Mutual funds are operated by professional money managers, who allocate the fund’s investments and attempt to produce capital gains and/orincome for the fund’s investors. A mutual fund’s portfolio is structured and maintained to match the investment objectives stated in its prospectus.

 

BREAKING DOWN ‘Mutual Fund’

Mutual funds give small or individual investors access to professionally managed portfolios of equities, bonds and other securities. Each shareholder, therefore, participates proportionally in the gains or losses of the fund. Mutual funds invest in a wide amount of securities, and performance is usually tracked as the change in the total market cap of the fund, derived by aggregating performance of the underlying investments.

Mutual fund units, or shares, can typically be purchased or redeemed as needed at the fund’s current net asset value (NAV) per share, which is sometimes expressed as NAVPS. A fund’s NAV is derived by dividing the total value of the securities in the portfolio by the total amount of shares outstanding.

Kinds of Mutual Funds

Mutual funds are divided into several kinds of categories, representing the kinds of securities the mutual fund manager invests in.

One of the largest is the fixed income category. A fixed income mutual fund focuses on investments that pay a fixed rate of return, such as government bonds, corporate bonds or other debt instruments. The idea is the fund portfolio generates a lot of interest income, which can then be passed on to shareholders.

Another group falls under the moniker “index funds.”  The investment strategy is based on the belief that it is very hard, and often expensive, to try to consistently beat the market. So the index fund manager simply buys stocks that correspond with a major market index such as the S&P 500 or the Dow Jones Industrial Average. This strategy requires less research from analysts and advisors, so there are fewer expenses to eat up returns before they are passed on to shareholders. These funds are often designed with cost-sensitive investors in mind.

If an investor seeks to gain diversified exposure to the Canadian equity market, he can invest in the S&P/TSX Composite Index, which is a mutual fund that covers 95% of the Canadian equity market. The index is designed to provide investors with a broad benchmark index that has the liquidity characteristics of a narrower index. The S&P/TSX Composite Index is comprised largely of the financials, energy and materials sectors of the Canadian stock market, with sector allocations of 35.54%, 20.15% and 14.16%, respectively. Performance of the fund is tracked as the percentage change to its overall adjusted market cap.

Balanced funds invest in both stocks and bonds with the aim of reducing risk of exposure to one asset class or another. Another name for this type is “asset allocation fund.” An investor may expect to find the allocation of these funds among asset classes relatively unchanging, though it will differ among funds. Though their goal is asset appreciation with lower risk, these funds carry the same risk and are as subject to fluctuation as other classifications of funds.

Other common types of mutual funds are money market funds, sector funds, equity funds, alternative funds, smart-beta funds, target-date funds and even funds-of-funds, or mutual funds that buy shares of other mutual fund.