Types of Mutual funds

Although there are many variations of the mutual fund, they can basically be broken down into two types:

• Closed Ended Mutual fund
• Open Ended Mutual fund

CLOSED ENDED MUTUAL FUND

A Closed Ended Mutual fund has a set amount of shares for issue or a specific maximum dollar amount it can raise. Once these shares are issued or the amount has been reached, the fund is then closed to new investment. A Closed End Mutual fund is generally traded on the stock exchange, as any publicly listed company would be. The redemption of shares in this type of fund is only possible when there is a buyer for the shares offered for sale.

OPEN ENDED MUTUAL FUND

An Open Ended Mutual fund has no fixed amount of shares for issue and new shares are constantly being offered at the Net Asset Value (NAV). An Open Ended Mutual fund is purchased directly from the fund or one of its sales agents. When an investor sells their shares they are redeemed by the fund, and in most cases is within five working days of the dealing date. Open Ended Mutual funds are redeemed at the net asset value, and offer the convenience and ease of share redemption.

Following are some of the more common types of mutual funds. These can be open-ended or closed-ended.

Equity Funds

Equity funds invest mainly in the stocks of publicly listed companies.  The word equity is just a different word for stock or share.  Fund managers in equity funds purchase the shares of different companies. The performance of the fund is directly linked to the performance of the underlying equities held by the fund. If for example these companies do well so in turn will the fund. Consequently if these companies do poorly then the fund will also.  Equities make up the biggest sector of offshore funds with just over half of the worlds offshore funds falling into this category.

Due to the fact that equities are the largest sector of offshore funds and for this reason an investor would be more likely to deal with this type of fund. A few variations such as Value Fund, Growth Fund and Ethical Fund have been added.

Value Funds

This type of fund also invests in the stocks of publicly listed companies. The key difference between a value fund and a standard equity fund is in the fact that a Value fund will always try to purchase one dollars worth of equity for fifty cents. These funds look for companies that are out of favor at the moment or maybe going through a difficult period. Even though these companies may not be the hot investment they are still strong financially and still maintain sound business practices. The way these funds work is that when these companies become the hot investment or when the actual value of these companies is realized the fund will then increase in value.

Growth Funds

Again this type of fund also invests in the stocks of publicly listed companies. The difference here is that the fund managers of a growth fund believe that a company will pass through three phases throughout its life cycle.  The first of these phases is known as the growth phase. During this time a company undergoes rapid expansion and an increase in market share. The reason for this is that the fund is purchasing the equity on the potential for future earnings.  The second phase is known as maturity when the company has reached its limit and is no longer growing although it still retains its market share. During this time the growth fund may still choose to hold the particular company within its portfolio. The third and final phase is known as decline. During this phase the company has outlived much of its usefulness and no longer retains market share. So in essence the idea of a value fund is to find stocks that are in their infancy and represent the potential for earning power in the future.

Ethical Funds

An ethical fund also invests in the stocks of publicly listed companies. The major difference here is that the fund can only contribute toward ethical companies. The fund cannot invest in any company that derives any part of their income from the manufacture of weapons, tobacco or tobacco related products or any product that may harm the environment or humanity in general. Although you may consider that this approach would narrow the amount of perspective companies for investment and thereby reduce the potential for profit there are actually some quite successful ethical funds one of which has returned in excess of 25% per annum for over six years now.

Index Funds

Index funds or tracker funds as they are sometimes known as are designed to imitate the overall performance of the market. In simple terms these funds mimic the appropriate index that the fund is invested in and hold the same shares in a similar proportion to the shares that make up the index. Index funds tend to have low annual fees, as all the fund manager has to do is buy or sell when there is a change to the specific index. With this type of fund you really don't need to worry if you have the best fund manager or the worst. All investment decisions are dictated solely by the market, which eliminates the chance of a possible bad decision.

An example of an index is the Standard and Poors 500 (S&P 500).

The very fist index fund was created in 1971 and it wasn't until 1976 that an index fund was offered to the general public by the Vanguard group of investment companies.

With the advent of the index fund came the creation of a new style of investing later known as passive investment management. Ironically professional money managers carried this out, which was for the benefit of pension funds and insurance companies.

Fixed Interest Bond Funds.

When taken in the offshore sense a fixed interest bond fund is any fund that has over 70% invested in fixed interest securities also known as bonds. These bonds should for the purpose of this type of fund have a maturity of three or more years.

Fixed interest bonds are the second largest sector of the offshore fund market.

These bonds can be in the form of government treasury bonds, municipal bonds and corporate bonds. This type of investing is considered extremely low risk, as it would be fairly unlikely for a major world government or multinational corporation to default.

This said investing in the government bonds of emerging countries does carry with it a greater level of risk however the yield is also increased.

These types of funds can generally achieve returns that are better than those of money market funds and short-term bond funds. It should also be noted that this type of investment tends to travel in the opposite direction to the respective interest rates of the country that the investment is made in. For example if you had an investment in US T Bills (United States Treasury) and interest rates within the US raised the return on the bond would fall.

Short-Term Bond Funds

Short-term bond funds in the offshore sense invest in bonds with a maturity date of less than three years. This type of fund fits wholly and squarely in between a money market fund and a fixed interest bond fund.  This type of investment can be considered relatively safe but returns only slightly better than those of a money market fund should be expected.

Convertible Bond Funds

In general terms a convertible bond is similar to an unsecured loan made to a corporation however it differs from a loan in that it can be exchanged for shares in the company. This type of investment takes on the best characteristics of a bond and also those of an equity. For example let's say you had convertible bonds in Vander Leigh Industries and they do well which in turn means that the value of their shares increases. When the company's share price exceeds that of the conversion price of the bond the price of the bond would generally increase in accordance with the share. Should the share price of the company fall then the convertible bond takes on the characteristics of a bond in the respect that bonds pay interest and have a limited life span.  With this type of fund you can generally expect a return between fixed interest and equities.  The major advantage of this type of investment is that it still has the potential for capital appreciation whilst on the other hand giving you the peace of mind of interest payments from the bond if the markets turn bad.

Money Market Funds

Money market funds in the offshore sense invest in debt securities with a short maturity date, which is generally under the 1-year mark. Due to the fact that these investments are short-term they tend to have a higher degree of safety associated with them and tend to be used instead of low interest savings accounts. When compared to the risks associated with an equity fund these funds are considered low risk although the returns when compared against an equity fund will probably fall well short.

The debt securities held by a money market fund may vary however they are most commonly government debt issues. Other forms of short-term debt used by money market funds may be Certificates of Deposit (CD's) or commercial paper which maybe in the form of a promissory note or IOU from a corporation.

As with any investment investing in emerging markets will increase the risk.

Warrant Funds

Warrants are a speculative investment instrument. Warrants give the bearer the right to purchase shares in a company at a future time at a fixed price. For a small price generally referred to as a premium warrants offer the potential purchase of a future stake in a company's equity. Warrants have varying time frames of expiration from one year, two years, five years, and ten years or in some instances may carry on in perpetuity.

A warrant is in simplest terms a long-term option. As investing in warrants is exceptionally speculative large amounts of money can be made although conversely large amounts of money can also be lost. This type of investment is certainly not for the feint hearted and is definitely only for experienced investors that can afford to lose the money.   

Derivative Funds

In simplest terms a derivative is a product that is derived from an underlying product. For example orange juice is a derivative of oranges. This type of fund invests in futures and options. An option is similar to a warrant except that it has a limited life of approximately three-months. Futures on the other hand are contracts of shares or commodities that can be bought or sold for delivery at a future date. Futures and options work in the way that they have a price at which they may be purchased today and may have a different price when you choose to sell.  The fund tries to anticipate these price fluctuations and makes a profit by exploiting the difference.

Once again this type of investment is certainly not for the feint hearted and is definitely only for experienced investors that can afford to lose the money.   

Hedge Funds

Hedge funds have gained increasing popularity over the past five years. Originally these funds were set up so that investors could hedge their bets on investments against currencies or interest rate risks. Nowadays due to their increasing popularity hedge funds have broadened their investment spectrum to include equities, fixed interest, commodities and derivatives. The aim of the fund is to make what is termed as an absolute return, which means that they aim to profit regardless of the direction of the market. Hedge funds use derivatives or gearing to leverage their investment and can also use these vehicles to minimize losses.  A hedge fund may invest in a particular company's shares and at the same time purchase exchange traded options of the shares. By doing this the fund manager could technically hedge against the portfolio. For example the fund could purchase the equities of a particular company and then also purchase Put Options speculating that the value of the equity may fall. By investing in this manner when the equity dropped in price the put option would increase in value hopefully counteracting the drop in share price. By utilizing this method a type of insurance is maintained.

Generally a hedge fund is considered to be high risk but in reality a well-managed hedge fund can exhibit much less volatility than that of many equity funds.

Mixed or Balanced Funds

This type of fund is also referred to as an Asset Allocation Fund though they are still most commonly known as balanced funds. The concept behind this type of fund was to be that of a one stop shop where an investor could invest their entire portfolio into one fund. This type of fund diversifies its portfolio through a mix of investment classes. In doing this the fund aims to balance the risk of equity funds with the safer investments of bond funds and money market funds.

By using a fund of this type an investor could conceivably save the fees that would be associated with investing in many different funds. One thing to note about this type of fund is that they do not all invest in the same way or with the same amount of diversification. For example a higher risk rated fund may hold a higher proportion of the funds assets in equities whilst a lower risk rated fund would have a higher proportion of bonds in its portfolio.

Capital Guaranteed Funds

These types of funds will actually guarantee your principle investment. While this type of investment is good for peace of mind you will never become rich from the use of this type of fund. Due to the fact that the fund guarantees the investment their investment strategy will be ultra conservative with the majority of the portfolio being made up of bonds and money market instruments.