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A mutual fund is a type of professionally managed collective investment scheme that pools
money from many investors to purchase securities.[1] While there is no legal definition of the
term "mutual fund", it is most commonly applied only to those collective investment vehicles
that are regulated and sold to the general public. They are sometimes referred to as "investment
companies" or "registered investment companies."[2] Most mutual funds are "open-ended,"
meaning stockholders can buy or sell shares of the fund at any time. Hedge funds are not
considered a type of mutual fund.
In the United States, mutual funds must be registered with the Securities and Exchange
Commission, overseen by a board of directors (or board of trustees if organized as a trust rather
than a corporation or partnership) and managed by a registered investment adviser. Mutual
funds, like other registered investment companies, are also subject to an extensive and detailed
regulatory regime set forth in the Investment Company Act of 1940.[3] Mutual funds are not
taxed on their income and profits if they comply with certain requirements under the U.S.
Internal Revenue Code.
Mutual funds have both advantages and disadvantages compared to direct investing in individual
securities. They have a long history in the United States. Today they play an important role in
household finances, most notably in retirement planning.
There are 3 types of U.S. mutual funds: open-end, unit investment trust, and closed-end. The
most common type, the open-end fund, must be willing to buy back shares from investors every
business day. Exchange-traded funds (or "ETFs" for short) are open-end funds or unit investment
trusts that trade on an exchange. Open-end funds are most common, but exchange-traded funds
have been gaining in popularity.
Mutual funds are generally classified by their principal investments. The four main categories of
funds are money market funds, bond or fixed income funds, stock or equity funds and hybrid
funds. Funds may also be categorized as index or actively managed.
Investors in a mutual fund pay the fund’s expenses, which reduce the fund's returns/performance.
There is controversy about the level of these expenses. A single mutual fund may give investors
a choice of different combinations of expenses (which may include sales commissions or loads)
by offering several different types of share classes.
Contents
[hide]
1 Structure
o 1.1 Advantages and disadvantages
2 History
3 Leading complexes
4 Types
o 4.1 Open-end funds
o 4.2 Closed-end funds
o
o
4.3 Unit investment trusts
4.4 Exchange-traded funds
5 Investments and classification
o 5.1 Money market funds
o 5.2 Bond funds
o 5.3 Stock or equity funds
o 5.4 Hybrid funds
o 5.5 Index (passively managed) versus actively managed
6 Expenses
o 6.1 Distribution charges
6.1.1 Front-end load or sales charge
6.1.2 Back-end load
6.1.3 12b-1 fees
6.1.4 No-load funds
o 6.2 Management fee
o 6.3 Other fund expenses
o 6.4 Shareholder transaction fees
o 6.5 Securities transaction fees
o 6.6 Controversy
7 Share classes
8 Definitions
o 8.1 Net asset value or NAV
o 8.2 Expense ratio
o 8.3 Average annual total return
o 8.4 Turnover
9 See also
10 Notes
11 References
Structure[edit]
In the US, a mutual fund is registered with the Securities and Exchange Commission (SEC) and
is overseen by a board of directors (if organized as a corporation) or board of trustees (if
organized as a trust). The board is charged with ensuring that the fund is managed in the best
interests of the fund's investors and with hiring the fund manager and other service providers to
the fund.
The fund manager, also known as the fund sponsor or fund management company, trades (buys
and sells) the fund's investments in accordance with the fund's investment objective. A fund
manager must be a registered investment advisor. Funds that are managed by the same fund
manager and that have the same brand name are known as a "fund family" or "fund complex".
Mutual funds are not taxed on their income and profits as long as they comply with requirements
established in the U.S. Internal Revenue Code. Specifically, they must diversify their
investments, limit ownership of voting securities, distribute a high percentage of their income
and capital gains (net of capital losses) to their investors annually, and earn most of the income
by investing in securities and currencies.[4]
Mutual funds pass taxable income on to their investors by paying out dividends and capital gains
at least annually. The characterization of that income is unchanged as it passes through to the
shareholders. For example, mutual fund distributions of dividend income are reported as
dividend income by the investor. There is an exception: net losses incurred by a mutual fund are
not distributed or passed through to fund investors but are retained by the fund to be able to
offset future gains.
Mutual funds may invest in many kinds of securities. The types of securities that a particular
fund may invest in are set forth in the fund's prospectus, which describes the fund's investment
objective, investment approach and permitted investments. The investment objective describes
the type of income that the fund seeks. For example, a "capital appreciation" fund generally
looks to earn most of its returns from increases in the prices of the securities it holds, rather than
from dividend or interest income. The investment approach describes the criteria that the fund
manager uses to select investments for the fund.
A mutual fund's investment portfolio is continually monitored by the fund's portfolio manager or
managers.
Hedge funds are not considered a type of (unregistered) mutual fund. While they are another type
of collective investment vehicle, they are not governed by the Investment Company Act of 1940
and are not required to register with the Securities and Exchange Commission (though many
hedge fund managers must register as investment advisers).
Advantages and disadvantages[edit]
This article contains a pro and con list. Please help improve it by integrating both
sides into a more neutral presentation. (November 2012)
Mutual funds have advantages compared to direct investing in individual securities.[5] These
include:
Increased diversification
Daily liquidity
Professional investment management
Ability to participate in investments that may be available only to larger investors
Service and convenience
Government oversight
Ease of comparison
Mutual funds have disadvantages as well, which include:[6]
Fees
Less control over timing of recognition of gains
Less predictable income
No opportunity to customize
History[edit]
The first mutual funds were established in Europe. One researcher credits a Dutch merchant with
creating the first mutual fund in 1774.[7] The first mutual fund outside the Netherlands was the
Foreign & Colonial Government Trust, which was established in London in 1868. It is now the
Foreign & Colonial Investment Trust and trades on the London stock exchange.[8]
Mutual funds were introduced into the United States in the 1890s.[9] They became popular during
the 1920s. These early funds were generally of the closed-end type with a fixed number of shares
which often traded at prices above the value of the portfolio.[10]
The first open-end mutual fund with redeemable shares was established on March 21, 1924. This
fund, the Massachusetts Investors Trust, is now part of the MFS family of funds. However,
closed-end funds remained more popular than open-end funds throughout the 1920s. By 1929,
open-end funds accounted for only 5% of the industry's $27 billion in total assets.[11]
After the stock market crash of 1929, Congress passed a series of acts regulating the securities
markets in general and mutual funds in particular. The Securities Act of 1933 requires that all
investments sold to the public, including mutual funds, be registered with the Securities and
Exchange Commission and that they provide prospective investors with a prospectus that
discloses essential facts about the investment. The Securities and Exchange Act of 1934 requires
that issuers of securities, including mutual funds, report regularly to their investors; this act also
created the Securities and Exchange Commission, which is the principal regulator of mutual
funds. The Revenue Act of 1936 established guidelines for the taxation of mutual funds, while
the Investment Company Act of 1940 governs their structure.
When confidence in the stock market returned in the 1950s, the mutual fund industry began to
grow again. By 1970, there were approximately 360 funds with $48 billion in assets.[12] The
introduction of money market funds in the high interest rate environment of the late 1970s
boosted industry growth dramatically. The first retail index fund, First Index Investment Trust,
was formed in 1976 by The Vanguard Group, headed by John Bogle; it is now called the
Vanguard 500 Index Fund and is one of the world's largest mutual funds, with more than $100
billion in assets as of January 31, 2011.[13]
Fund industry growth continued into the 1980s and 1990s, as a result of three factors: a bull
market for both stocks and bonds, new product introductions (including tax-exempt bond, sector,
international and target date funds) and wider distribution of fund shares.[14] Among the new
distribution channels were retirement plans. Mutual funds are now the preferred investment
option in certain types of fast-growing retirement plans, specifically in 401(k) and other defined
contribution plans and in individual retirement accounts (IRAs), all of which surged in popularity
in the 1980s. Total mutual fund assets fell in 2008 as a result of the credit crisis of 2008.
In 2003, the mutual fund industry was involved in a scandal involving unequal treatment of fund
shareholders. Some fund management companies allowed favored investors to engage in late
trading, which is illegal, or market timing, which is a practice prohibited by fund policy. The
scandal was initially discovered by then-New York State Attorney General Eliot Spitzer and
resulted in significantly increased regulation of the industry.
At the end of 2011, there were over 14,000 mutual funds in the United States with combined
assets of $13 trillion, according to the Investment Company Institute (ICI), a trade association of
investment companies in the United States. The ICI reports that worldwide mutual fund assets
were $23.8 trillion on the same date.[15]
Mutual funds play an important role in U.S. household finances and retirement planning. At the
end of 2011, funds accounted for 23% of household financial assets. Their role in retirement
planning is particularly significant. Roughly half of assets in 401(k) plans and individual
retirement accounts were invested in mutual funds.[15]
Leading complexes[edit]
At the end of October 2011, the top 10 mutual fund complexes in the United States were:[16]
1. Vanguard
2. Fidelity
3. American Funds (Capital Research)
4. BlackRock
5. PIMCO
6. Franklin Templeton
7. JPMorgan Chase
8. State Street Global Advisors
9. T. Rowe Price
10. Federated Investors
Types[edit]
There are 3 principal types of mutual funds in the United States: open-end funds, unit investment
trusts (UITs); and closed-end funds. Exchange-traded funds (ETFs) are open-end funds or unit
investment trusts that trade on an exchange; they have gained in popularity recently. While the
term "mutual fund" may refer to all three types of registered investment companies, it is more
commonly used to refer exclusively to the open-end type.
Open-end funds[edit]
Main article: Open-end fund
Open-end mutual funds must be willing to buy back their shares from their investors at the end
of every business day at the net asset value computed that day. Most open-end funds also sell
shares to the public every business day; these shares are also priced at net asset value. A
professional investment manager oversees the portfolio, buying and selling securities as
appropriate. The total investment in the fund will vary based on share purchases, share
redemptions and fluctuation in market valuation. There is no legal limit on the number of shares
that can be issued.
Open-end funds are the most common type of mutual fund. At the end of 2011, there were 7,581
open-end mutual funds in the United States with combined assets of $11.6 trillion.[15]
Closed-end funds[edit]
Main article: Closed-end fund
Closed-end funds generally issue shares to the public only once, when they are created through
an initial public offering. Their shares are then listed for trading on a stock exchange. Investors
who no longer wish to invest in the fund cannot sell their shares back to the fund (as they can
with an open-end fund). Instead, they must sell their shares to another investor in the market; the
price they receive may be significantly different from net asset value. It may be at a "premium"
to net asset value (meaning that it is higher than net asset value) or, more commonly, at a
"discount" to net asset value (meaning that it is lower than net asset value). A professional
investment manager oversees the portfolio, buying and selling securities as appropriate.
At the end of 2011, there were 634 closed-end funds in the United States with combined assets of
$239 billion.[15]
Unit investment trusts[edit]
Main article: Unit investment trust
Unit investment trusts or UITs issue shares to the public only once, when they are created. UITs
generally have a limited life span, established at creation. Investors can redeem shares directly
with the fund at any time (as with an open-end fund) or wait to redeem upon termination of the
trust. Less commonly, they can sell their shares in the open market.
Unit investment trusts do not have a professional investment manager. Their portfolio of
securities is established at the creation of the UIT and does not change.
At the end of 2011, there were 6,022 UITs in the United States with combined assets of $60
billion.[15]
Exchange-traded funds[edit]
Main article: Exchange-traded fund
A relatively recent innovation, the exchange-traded fund or ETF is often structured as an openend investment company, though ETFs may also be structured as unit investment trusts,
partnerships, investments trust, grantor trusts or bonds (as an exchange-traded note). ETFs
combine characteristics of both closed-end funds and open-end funds. Like closed-end funds,
ETFs are traded throughout the day on a stock exchange at a price determined by the market.
However, as with open-end funds, investors normally receive a price that is close to net asset
value. To keep the market price close to net asset value, ETFs issue and redeem large blocks of
their shares with institutional investors.
Most ETFs are index funds. ETFs have been gaining in popularity. At the end of 2011, there
were 1,134 ETFs in the United States with combined assets of $1.1 trillion.[15]
Investments and classification[edit]
The neutrality of this article is questioned because of its systemic bias. Please see
the discussion on the talk page. Please do not remove this message until the issue is
resolved. (August 2012)
Mutual funds are normally classified by their principal investments, as described in the
prospectus and investment objective. The four main categories of funds are money market funds,
bond or fixed income funds, stock or equity funds and hybrid funds. Within these categories,
funds may be subclassified by investment objective, investment approach or specific focus. The
SEC requires that mutual fund names not be inconsistent with a fund's investments. For example,
the "ABC New Jersey Tax-Exempt Bond Fund" would generally have to invest, under normal
circumstances, at least 80% of its assets in bonds that are exempt from federal income tax, from
the alternative minimum tax and from taxes in the state of New Jersey.[17]
Bond, stock and hybrid funds may be classified as either index (passively managed) funds or
actively managed funds.
Money market funds[edit]
Main article: Money market fund
Money market funds invest in money market instruments, which are fixed income securities with
a very short time to maturity and high credit quality. Investors often use money market funds as a
substitute for bank savings accounts, though money market funds are not government insured,
unlike bank savings accounts.
Money market funds strive to maintain a $1.00 per share net asset value, meaning that investors
earn interest income from the fund but do not experience capital gains or losses. If a fund fails to
maintain that $1.00 per share because its securities have declined in value, it is said to "break the
buck". Only two money market funds have ever broken the buck: Community Banker's U.S.
Government Money Market Fund in 1994 and the Reserve Primary Fund in 2008.
At the end of 2011, money market funds accounted for 23% of open-end fund assets.[15]
Bond funds[edit]
Main article: Bond fund
Bond funds invest in fixed income or debt securities. Bond funds can be subclassified according
to the specific types of bonds owned (such as high-yield or junk bonds, investment-grade
corporate bonds, government bonds or municipal bonds) or by the maturity of the bonds held
(short-, intermediate- or long-term). Bond funds may invest in primarily U.S. securities
(domestic or U.S. funds), in both U.S. and foreign securities (global or world funds), or primarily
foreign securities (international funds).
At the end of 2011, bond funds accounted for 25% of open-end fund assets.[15]
Stock or equity funds[edit]
Main article: Stock fund
Stock or equity funds invest in common stocks which represent an ownership share (or equity) in
corporations. Stock funds may invest in primarily U.S. securities (domestic or U.S. funds), in
both U.S. and foreign securities (global or world funds), or primarily foreign securities
(international funds). They may focus on a specific industry or sector.
A stock fund may be subclassified along two dimensions: (1) market capitalization and (2)
investment style (i.e., growth vs. blend/core vs. value). The two dimensions are often displayed
in a grid known as a "style box."
Market capitalization ("cap") indicates the size of the companies in which a fund invests, based
on the value of the company's stock. Each company's market capitalization equals the number of
shares outstanding times the market price of the stock. Market capitalizations are typically
divided into the following categories:
Micro cap
Small cap
Mid cap
Large cap
While the specific definitions of each category vary with market conditions, large cap stocks
generally have market capitalizations of at least $10 billion, small cap stocks have market
capitalizations below $2 billion, and micro cap stocks have market capitalizations below $300
million. Funds are also classified in these categories based on the market caps of the stocks that it
holds.
Stock funds are also subclassified according to their investment style: growth, value or blend (or
core). Growth funds seek to invest in stocks of fast-growing companies. Value funds seek to
invest in stocks that appear cheaply priced. Blend funds are not biased toward either growth or
value.
At the end of 2011, stock funds accounted for 46% of the assets in all U.S. mutual funds.[15]
Hybrid funds[edit]
Hybrid funds invest in both bonds and stocks or in convertible securities. Balanced funds, asset
allocation funds, target date or target risk funds and lifecycle or lifestyle funds are all types of
hybrid funds.
Hybrid funds may be structured as funds of funds, meaning that they invest by buying shares in
other mutual funds that invest in securities. Most fund of funds invest in affiliated funds
(meaning mutual funds managed by the same fund sponsor), although some invest in unaffiliated
funds (meaning those managed by other fund sponsors) or in a combination of the two.
At the end of 2011, hybrid funds accounted for 7% of the assets in all U.S. mutual funds.[15]
Index (passively managed) versus actively managed[edit]
Main articles: Index fund and active management
An index fund or passively managed fund seeks to match the performance of a market index,
such as the S&P 500 index, while an actively managed fund seeks to outperform a relevant index
through superior security selection.
Expenses[edit]
Investors in a mutual fund pay the fund's expenses. These expenses fall into five categories:
distribution charges (sales loads and 12b-1 fees), the management fee, other fund expenses,
shareholder transaction fees and securities transaction fees. Some of these expenses reduce the
value of an investor's account; others are paid by the fund and reduce net asset value.
Recurring fees and expenses—specifically the 12b-1 fee, the management fee and other fund
expenses—are included in a fund's total expense ratio, or simply the "expense ratio". Because all
funds must compute an expense ratio using the same methodology, it allows investors to
compare costs across funds.
Distribution charges[edit]
Main article: Mutual fund fees and expenses
Distribution charges pay for marketing, distribution of the fund's shares as well as services to
investors.
Front-end load or sales charge[edit]
A front-end load or sales charge is a commission paid to a broker by a mutual fund when shares
are purchased. It is expressed as a percentage of the total amount invested or the "public offering
price," which equals the net asset value plus the front-end load per share. The front-end load
often declines as the amount invested increases, through breakpoints. The front-end load is paid
by the shareholder; it is deducted from the amount invested.
Back-end load[edit]
Some funds have a back-end load, which is paid by the investor when shares are redeemed. If the
back-end load declines the longer the investor holds shares, it is called a contingent deferred
sales charges (or CDSC). Like the front-end load, the back-end load is paid by the shareholder; it
is deducted from the redemption proceeds.
12b-1 fees[edit]
Some funds charge an annual fee to compensate the distributor of fund shares for providing
ongoing services to fund shareholders. This fee is called a 12b-1 fee, after the SEC rule
authorizing it. The 12b-1 fee is paid by the fund and reduces net asset value.
No-load funds[edit]
A no-load fund does not charge a front-end load under any circumstances, does not charge a
back-end load under any circumstances and does not charge a 12b-1 fee greater than 0.25% of
fund assets.
Management fee[edit]
The management fee is paid to the fund manager or sponsor who organizes the fund, provides
the portfolio management or investment advisory services and normally lends its brand name to
the fund. The fund manager may also provide other administrative services. The management fee
often has breakpoints, which means that it declines as assets (in either the specific fund or in the
fund family as a whole) increase. The management fee is paid by the fund and is included in the
expense ratio.
The fund's board of directors reviews the management fee annually. Fund shareholders must vote
on any proposed increase in the management. However, the fund manager or sponsor may agree
to waive all or a portion of the management fee in order to lower the fund's expense ratio.
Other fund expenses[edit]
A mutual fund may pay for other services including:
Board of directors or trustees fees and expenses
Custody fee: paid to a custodian bank for holding the fund's portfolio in safekeeping and
collecting income owed on the securities
Fund administration fee: for overseeing all administrative affairs of the fund such as
preparing financial statements and shareholder reports, preparing and filing a myriad of
SEC filings required of registered investment companies, monitoring compliance with
investment restrictions, computing total returns and other fund performance information,
preparing/filing tax returns and all expenses of maintaining compliance with state "blue
sky" laws
Fund accounting fee: for performing investment or securities accounting services and
computing the net asset value (usually each day the New York Stock Exchange is open)
Professional services fees: legal and auditing fees
Registration fees: for 24F-2 fees owed to the SEC for net sales of registered fund shares
and state blue sky fees owed for selling shares to residents of states in the US and
jurisdictions such as Puerto Rico and Guam
Shareholder communications expenses: printing and mailing required documents to
shareholders such as shareholder reports and prospectuses
Transfer agent service fees and expenses: for keeping shareholder records, providing
statements and tax forms to investors and providing telephone, internet and or other
investor support and servicing
Other/miscellaneous fees
The fund manager or sponsor may agree to subsidize some of these other expenses in order to
lower the fund's expense ratio.
Shareholder transaction fees[edit]
Shareholders may be required to pay fees for certain transactions. For example, a fund may
charge a flat fee for maintaining an individual retirement account for an investor. Some funds
charge redemption fees when an investor sells fund shares shortly after buying them (usually
defined as within 30, 60 or 90 days of purchase); redemption fees are computed as a percentage
of the sale amount. Shareholder transaction fees are not part of the expense ratio.
Securities transaction fees[edit]
A mutual fund pays expenses related to buying or selling the securities in its portfolio. These
expenses may include brokerage commissions. Securities transaction fees increase the cost basis
of investments purchased and reduce the proceeds from their sale. They do not flow through a
fund's income statement and are not included in its expense ratio. The amount of securities
transaction fees paid by a fund is normally positively correlated with its trading volume or
"turnover."
Controversy[edit]
Critics of the fund industry argue that fund expenses are too high. They believe that the market
for mutual funds is not competitive and that there are many hidden fees, so that it is difficult for
investors to reduce the fees that they pay. They argue that the most effective way for investors to
raise the returns they earn from mutual funds is to invest in funds with low expense ratios.
Fund managers counter that fees are determined by a highly competitive market and, therefore,
reflect the value that investors attribute to the service provided. In addition, they note that fees
are clearly disclosed.
Share classes[edit]
A single mutual fund may give investors a choice of different combinations of front-end loads,
back-end loads and 12b-1 fees, by offering several different types of shares, known as share
classes. All of the shares classes invest in the same portfolio of securities, but each has different
expenses and, therefore, a different net asset value and different performance results. Some of
these share classes may be available only to certain types of investors.
Funds offering multiple classes often identify them with letters, though they may also use names
such as "Investor Class", "Service Class", "Institutional Class", etc., to identify the type of
investor for which the class is intended. The SEC does not regulate the names of share classes, so
that specifics of a share class with the same name may vary from fund family to fund family.
Typical share classes for funds sold through brokers or other intermediaries are as follows.:
Class A shares usually charge a front-end sales load together with a small 12b-1 fee.
Class B shares usually don't have a front-end sales load. Instead they, have a high
contingent deferred sales charge, or CDSC that declines gradually over several years,
combined with a high 12b-1 fee. Class B shares usually convert automatically to Class A
shares after they have been held for a certain period.
Class C shares usually have a high 12b-1 fee and a modest contingent deferred sales
charge that is discontinued after one or two years. Class C shares usually do not convert
to another class. They are often called "level load" shares.
Class I are usually subject to very high minimum investment requirements and are,
therefore, known as "institutional" shares. They are no-load shares.
Class R are usually for use in retirement plans such as 401(k) plans. They typically do
not charge loads, but do charge a small 12b-1 fee.
No-load funds often have two classes of shares:
Class I shares do not charge a 12b-1 fee.
Class N shares charge a 12b-1 fee of no more than 0.25% of fund assets.
Neither class of shares typically charges a front-end or back-end load.
Definitions[edit]
Definitions of key terms.
Net asset value or NAV[edit]
Main article: Net asset value
A fund's net asset value or NAV equals the current market value of a fund's holdings minus the
fund's liabilities (sometimes referred to as "net assets"). It is usually expressed as a per-share
amount, computed by dividing net assets by the number of fund shares outstanding. Funds must
compute their net asset value according to the rules set forth in their prospectuses. Funds
compute their NAV at the end of each day that the New York Stock Exchange is open, though
some funds compute their NAV more than once daily.
Valuing the securities held in a fund's portfolio is often the most difficult part of calculating net
asset value. The fund's board typically oversees security valuation.
Expense ratio[edit]
The expense ratio allows investors to compare expenses across funds. The expense ratio equals
the 12b-1 fee plus the management fee plus the other fund expenses divided by average daily net
assets. The expense ratio is sometimes referred to as the "total expense ratio" or TER.
Average annual total return[edit]
The SEC requires that mutual funds report the average annual compounded rates of return for 1year, 5-year and 10-year periods using the following formula:[18]
P(1+T)n = ERV
Where:
P = a hypothetical initial payment of $1,000.
T = average annual total return.
n = number of years.
ERV = ending redeemable value of a hypothetical $1,000 payment made at the beginning of the
1-, 5-, or 10-year periods at the end of the 1-, 5-, or 10-year periods (or fractional portion).
Turnover[edit]
Turnover is a measure of the volume of a fund's securities trading. It is expressed as a percentage
of average market value of the portfolio's long-term securities. Turnover is the lesser of a fund's
purchases or sales during a given year divided by average long-term securities market value for
the same period. If the period is less than a year, turnover is generally annualized.
money from many investors to purchase securities.[1] While there is no legal definition of the
term "mutual fund", it is most commonly applied only to those collective investment vehicles
that are regulated and sold to the general public. They are sometimes referred to as "investment
companies" or "registered investment companies."[2] Most mutual funds are "open-ended,"
meaning stockholders can buy or sell shares of the fund at any time. Hedge funds are not
considered a type of mutual fund.
In the United States, mutual funds must be registered with the Securities and Exchange
Commission, overseen by a board of directors (or board of trustees if organized as a trust rather
than a corporation or partnership) and managed by a registered investment adviser. Mutual
funds, like other registered investment companies, are also subject to an extensive and detailed
regulatory regime set forth in the Investment Company Act of 1940.[3] Mutual funds are not
taxed on their income and profits if they comply with certain requirements under the U.S.
Internal Revenue Code.
Mutual funds have both advantages and disadvantages compared to direct investing in individual
securities. They have a long history in the United States. Today they play an important role in
household finances, most notably in retirement planning.
There are 3 types of U.S. mutual funds: open-end, unit investment trust, and closed-end. The
most common type, the open-end fund, must be willing to buy back shares from investors every
business day. Exchange-traded funds (or "ETFs" for short) are open-end funds or unit investment
trusts that trade on an exchange. Open-end funds are most common, but exchange-traded funds
have been gaining in popularity.
Mutual funds are generally classified by their principal investments. The four main categories of
funds are money market funds, bond or fixed income funds, stock or equity funds and hybrid
funds. Funds may also be categorized as index or actively managed.
Investors in a mutual fund pay the fund’s expenses, which reduce the fund's returns/performance.
There is controversy about the level of these expenses. A single mutual fund may give investors
a choice of different combinations of expenses (which may include sales commissions or loads)
by offering several different types of share classes.
Contents
[hide]
1 Structure
o 1.1 Advantages and disadvantages
2 History
3 Leading complexes
4 Types
o 4.1 Open-end funds
o 4.2 Closed-end funds
o
o
4.3 Unit investment trusts
4.4 Exchange-traded funds
5 Investments and classification
o 5.1 Money market funds
o 5.2 Bond funds
o 5.3 Stock or equity funds
o 5.4 Hybrid funds
o 5.5 Index (passively managed) versus actively managed
6 Expenses
o 6.1 Distribution charges
6.1.1 Front-end load or sales charge
6.1.2 Back-end load
6.1.3 12b-1 fees
6.1.4 No-load funds
o 6.2 Management fee
o 6.3 Other fund expenses
o 6.4 Shareholder transaction fees
o 6.5 Securities transaction fees
o 6.6 Controversy
7 Share classes
8 Definitions
o 8.1 Net asset value or NAV
o 8.2 Expense ratio
o 8.3 Average annual total return
o 8.4 Turnover
9 See also
10 Notes
11 References
Structure[edit]
In the US, a mutual fund is registered with the Securities and Exchange Commission (SEC) and
is overseen by a board of directors (if organized as a corporation) or board of trustees (if
organized as a trust). The board is charged with ensuring that the fund is managed in the best
interests of the fund's investors and with hiring the fund manager and other service providers to
the fund.
The fund manager, also known as the fund sponsor or fund management company, trades (buys
and sells) the fund's investments in accordance with the fund's investment objective. A fund
manager must be a registered investment advisor. Funds that are managed by the same fund
manager and that have the same brand name are known as a "fund family" or "fund complex".
Mutual funds are not taxed on their income and profits as long as they comply with requirements
established in the U.S. Internal Revenue Code. Specifically, they must diversify their
investments, limit ownership of voting securities, distribute a high percentage of their income
and capital gains (net of capital losses) to their investors annually, and earn most of the income
by investing in securities and currencies.[4]
Mutual funds pass taxable income on to their investors by paying out dividends and capital gains
at least annually. The characterization of that income is unchanged as it passes through to the
shareholders. For example, mutual fund distributions of dividend income are reported as
dividend income by the investor. There is an exception: net losses incurred by a mutual fund are
not distributed or passed through to fund investors but are retained by the fund to be able to
offset future gains.
Mutual funds may invest in many kinds of securities. The types of securities that a particular
fund may invest in are set forth in the fund's prospectus, which describes the fund's investment
objective, investment approach and permitted investments. The investment objective describes
the type of income that the fund seeks. For example, a "capital appreciation" fund generally
looks to earn most of its returns from increases in the prices of the securities it holds, rather than
from dividend or interest income. The investment approach describes the criteria that the fund
manager uses to select investments for the fund.
A mutual fund's investment portfolio is continually monitored by the fund's portfolio manager or
managers.
Hedge funds are not considered a type of (unregistered) mutual fund. While they are another type
of collective investment vehicle, they are not governed by the Investment Company Act of 1940
and are not required to register with the Securities and Exchange Commission (though many
hedge fund managers must register as investment advisers).
Advantages and disadvantages[edit]
This article contains a pro and con list. Please help improve it by integrating both
sides into a more neutral presentation. (November 2012)
Mutual funds have advantages compared to direct investing in individual securities.[5] These
include:
Increased diversification
Daily liquidity
Professional investment management
Ability to participate in investments that may be available only to larger investors
Service and convenience
Government oversight
Ease of comparison
Mutual funds have disadvantages as well, which include:[6]
Fees
Less control over timing of recognition of gains
Less predictable income
No opportunity to customize
History[edit]
The first mutual funds were established in Europe. One researcher credits a Dutch merchant with
creating the first mutual fund in 1774.[7] The first mutual fund outside the Netherlands was the
Foreign & Colonial Government Trust, which was established in London in 1868. It is now the
Foreign & Colonial Investment Trust and trades on the London stock exchange.[8]
Mutual funds were introduced into the United States in the 1890s.[9] They became popular during
the 1920s. These early funds were generally of the closed-end type with a fixed number of shares
which often traded at prices above the value of the portfolio.[10]
The first open-end mutual fund with redeemable shares was established on March 21, 1924. This
fund, the Massachusetts Investors Trust, is now part of the MFS family of funds. However,
closed-end funds remained more popular than open-end funds throughout the 1920s. By 1929,
open-end funds accounted for only 5% of the industry's $27 billion in total assets.[11]
After the stock market crash of 1929, Congress passed a series of acts regulating the securities
markets in general and mutual funds in particular. The Securities Act of 1933 requires that all
investments sold to the public, including mutual funds, be registered with the Securities and
Exchange Commission and that they provide prospective investors with a prospectus that
discloses essential facts about the investment. The Securities and Exchange Act of 1934 requires
that issuers of securities, including mutual funds, report regularly to their investors; this act also
created the Securities and Exchange Commission, which is the principal regulator of mutual
funds. The Revenue Act of 1936 established guidelines for the taxation of mutual funds, while
the Investment Company Act of 1940 governs their structure.
When confidence in the stock market returned in the 1950s, the mutual fund industry began to
grow again. By 1970, there were approximately 360 funds with $48 billion in assets.[12] The
introduction of money market funds in the high interest rate environment of the late 1970s
boosted industry growth dramatically. The first retail index fund, First Index Investment Trust,
was formed in 1976 by The Vanguard Group, headed by John Bogle; it is now called the
Vanguard 500 Index Fund and is one of the world's largest mutual funds, with more than $100
billion in assets as of January 31, 2011.[13]
Fund industry growth continued into the 1980s and 1990s, as a result of three factors: a bull
market for both stocks and bonds, new product introductions (including tax-exempt bond, sector,
international and target date funds) and wider distribution of fund shares.[14] Among the new
distribution channels were retirement plans. Mutual funds are now the preferred investment
option in certain types of fast-growing retirement plans, specifically in 401(k) and other defined
contribution plans and in individual retirement accounts (IRAs), all of which surged in popularity
in the 1980s. Total mutual fund assets fell in 2008 as a result of the credit crisis of 2008.
In 2003, the mutual fund industry was involved in a scandal involving unequal treatment of fund
shareholders. Some fund management companies allowed favored investors to engage in late
trading, which is illegal, or market timing, which is a practice prohibited by fund policy. The
scandal was initially discovered by then-New York State Attorney General Eliot Spitzer and
resulted in significantly increased regulation of the industry.
At the end of 2011, there were over 14,000 mutual funds in the United States with combined
assets of $13 trillion, according to the Investment Company Institute (ICI), a trade association of
investment companies in the United States. The ICI reports that worldwide mutual fund assets
were $23.8 trillion on the same date.[15]
Mutual funds play an important role in U.S. household finances and retirement planning. At the
end of 2011, funds accounted for 23% of household financial assets. Their role in retirement
planning is particularly significant. Roughly half of assets in 401(k) plans and individual
retirement accounts were invested in mutual funds.[15]
Leading complexes[edit]
At the end of October 2011, the top 10 mutual fund complexes in the United States were:[16]
1. Vanguard
2. Fidelity
3. American Funds (Capital Research)
4. BlackRock
5. PIMCO
6. Franklin Templeton
7. JPMorgan Chase
8. State Street Global Advisors
9. T. Rowe Price
10. Federated Investors
Types[edit]
There are 3 principal types of mutual funds in the United States: open-end funds, unit investment
trusts (UITs); and closed-end funds. Exchange-traded funds (ETFs) are open-end funds or unit
investment trusts that trade on an exchange; they have gained in popularity recently. While the
term "mutual fund" may refer to all three types of registered investment companies, it is more
commonly used to refer exclusively to the open-end type.
Open-end funds[edit]
Main article: Open-end fund
Open-end mutual funds must be willing to buy back their shares from their investors at the end
of every business day at the net asset value computed that day. Most open-end funds also sell
shares to the public every business day; these shares are also priced at net asset value. A
professional investment manager oversees the portfolio, buying and selling securities as
appropriate. The total investment in the fund will vary based on share purchases, share
redemptions and fluctuation in market valuation. There is no legal limit on the number of shares
that can be issued.
Open-end funds are the most common type of mutual fund. At the end of 2011, there were 7,581
open-end mutual funds in the United States with combined assets of $11.6 trillion.[15]
Closed-end funds[edit]
Main article: Closed-end fund
Closed-end funds generally issue shares to the public only once, when they are created through
an initial public offering. Their shares are then listed for trading on a stock exchange. Investors
who no longer wish to invest in the fund cannot sell their shares back to the fund (as they can
with an open-end fund). Instead, they must sell their shares to another investor in the market; the
price they receive may be significantly different from net asset value. It may be at a "premium"
to net asset value (meaning that it is higher than net asset value) or, more commonly, at a
"discount" to net asset value (meaning that it is lower than net asset value). A professional
investment manager oversees the portfolio, buying and selling securities as appropriate.
At the end of 2011, there were 634 closed-end funds in the United States with combined assets of
$239 billion.[15]
Unit investment trusts[edit]
Main article: Unit investment trust
Unit investment trusts or UITs issue shares to the public only once, when they are created. UITs
generally have a limited life span, established at creation. Investors can redeem shares directly
with the fund at any time (as with an open-end fund) or wait to redeem upon termination of the
trust. Less commonly, they can sell their shares in the open market.
Unit investment trusts do not have a professional investment manager. Their portfolio of
securities is established at the creation of the UIT and does not change.
At the end of 2011, there were 6,022 UITs in the United States with combined assets of $60
billion.[15]
Exchange-traded funds[edit]
Main article: Exchange-traded fund
A relatively recent innovation, the exchange-traded fund or ETF is often structured as an openend investment company, though ETFs may also be structured as unit investment trusts,
partnerships, investments trust, grantor trusts or bonds (as an exchange-traded note). ETFs
combine characteristics of both closed-end funds and open-end funds. Like closed-end funds,
ETFs are traded throughout the day on a stock exchange at a price determined by the market.
However, as with open-end funds, investors normally receive a price that is close to net asset
value. To keep the market price close to net asset value, ETFs issue and redeem large blocks of
their shares with institutional investors.
Most ETFs are index funds. ETFs have been gaining in popularity. At the end of 2011, there
were 1,134 ETFs in the United States with combined assets of $1.1 trillion.[15]
Investments and classification[edit]
The neutrality of this article is questioned because of its systemic bias. Please see
the discussion on the talk page. Please do not remove this message until the issue is
resolved. (August 2012)
Mutual funds are normally classified by their principal investments, as described in the
prospectus and investment objective. The four main categories of funds are money market funds,
bond or fixed income funds, stock or equity funds and hybrid funds. Within these categories,
funds may be subclassified by investment objective, investment approach or specific focus. The
SEC requires that mutual fund names not be inconsistent with a fund's investments. For example,
the "ABC New Jersey Tax-Exempt Bond Fund" would generally have to invest, under normal
circumstances, at least 80% of its assets in bonds that are exempt from federal income tax, from
the alternative minimum tax and from taxes in the state of New Jersey.[17]
Bond, stock and hybrid funds may be classified as either index (passively managed) funds or
actively managed funds.
Money market funds[edit]
Main article: Money market fund
Money market funds invest in money market instruments, which are fixed income securities with
a very short time to maturity and high credit quality. Investors often use money market funds as a
substitute for bank savings accounts, though money market funds are not government insured,
unlike bank savings accounts.
Money market funds strive to maintain a $1.00 per share net asset value, meaning that investors
earn interest income from the fund but do not experience capital gains or losses. If a fund fails to
maintain that $1.00 per share because its securities have declined in value, it is said to "break the
buck". Only two money market funds have ever broken the buck: Community Banker's U.S.
Government Money Market Fund in 1994 and the Reserve Primary Fund in 2008.
At the end of 2011, money market funds accounted for 23% of open-end fund assets.[15]
Bond funds[edit]
Main article: Bond fund
Bond funds invest in fixed income or debt securities. Bond funds can be subclassified according
to the specific types of bonds owned (such as high-yield or junk bonds, investment-grade
corporate bonds, government bonds or municipal bonds) or by the maturity of the bonds held
(short-, intermediate- or long-term). Bond funds may invest in primarily U.S. securities
(domestic or U.S. funds), in both U.S. and foreign securities (global or world funds), or primarily
foreign securities (international funds).
At the end of 2011, bond funds accounted for 25% of open-end fund assets.[15]
Stock or equity funds[edit]
Main article: Stock fund
Stock or equity funds invest in common stocks which represent an ownership share (or equity) in
corporations. Stock funds may invest in primarily U.S. securities (domestic or U.S. funds), in
both U.S. and foreign securities (global or world funds), or primarily foreign securities
(international funds). They may focus on a specific industry or sector.
A stock fund may be subclassified along two dimensions: (1) market capitalization and (2)
investment style (i.e., growth vs. blend/core vs. value). The two dimensions are often displayed
in a grid known as a "style box."
Market capitalization ("cap") indicates the size of the companies in which a fund invests, based
on the value of the company's stock. Each company's market capitalization equals the number of
shares outstanding times the market price of the stock. Market capitalizations are typically
divided into the following categories:
Micro cap
Small cap
Mid cap
Large cap
While the specific definitions of each category vary with market conditions, large cap stocks
generally have market capitalizations of at least $10 billion, small cap stocks have market
capitalizations below $2 billion, and micro cap stocks have market capitalizations below $300
million. Funds are also classified in these categories based on the market caps of the stocks that it
holds.
Stock funds are also subclassified according to their investment style: growth, value or blend (or
core). Growth funds seek to invest in stocks of fast-growing companies. Value funds seek to
invest in stocks that appear cheaply priced. Blend funds are not biased toward either growth or
value.
At the end of 2011, stock funds accounted for 46% of the assets in all U.S. mutual funds.[15]
Hybrid funds[edit]
Hybrid funds invest in both bonds and stocks or in convertible securities. Balanced funds, asset
allocation funds, target date or target risk funds and lifecycle or lifestyle funds are all types of
hybrid funds.
Hybrid funds may be structured as funds of funds, meaning that they invest by buying shares in
other mutual funds that invest in securities. Most fund of funds invest in affiliated funds
(meaning mutual funds managed by the same fund sponsor), although some invest in unaffiliated
funds (meaning those managed by other fund sponsors) or in a combination of the two.
At the end of 2011, hybrid funds accounted for 7% of the assets in all U.S. mutual funds.[15]
Index (passively managed) versus actively managed[edit]
Main articles: Index fund and active management
An index fund or passively managed fund seeks to match the performance of a market index,
such as the S&P 500 index, while an actively managed fund seeks to outperform a relevant index
through superior security selection.
Expenses[edit]
Investors in a mutual fund pay the fund's expenses. These expenses fall into five categories:
distribution charges (sales loads and 12b-1 fees), the management fee, other fund expenses,
shareholder transaction fees and securities transaction fees. Some of these expenses reduce the
value of an investor's account; others are paid by the fund and reduce net asset value.
Recurring fees and expenses—specifically the 12b-1 fee, the management fee and other fund
expenses—are included in a fund's total expense ratio, or simply the "expense ratio". Because all
funds must compute an expense ratio using the same methodology, it allows investors to
compare costs across funds.
Distribution charges[edit]
Main article: Mutual fund fees and expenses
Distribution charges pay for marketing, distribution of the fund's shares as well as services to
investors.
Front-end load or sales charge[edit]
A front-end load or sales charge is a commission paid to a broker by a mutual fund when shares
are purchased. It is expressed as a percentage of the total amount invested or the "public offering
price," which equals the net asset value plus the front-end load per share. The front-end load
often declines as the amount invested increases, through breakpoints. The front-end load is paid
by the shareholder; it is deducted from the amount invested.
Back-end load[edit]
Some funds have a back-end load, which is paid by the investor when shares are redeemed. If the
back-end load declines the longer the investor holds shares, it is called a contingent deferred
sales charges (or CDSC). Like the front-end load, the back-end load is paid by the shareholder; it
is deducted from the redemption proceeds.
12b-1 fees[edit]
Some funds charge an annual fee to compensate the distributor of fund shares for providing
ongoing services to fund shareholders. This fee is called a 12b-1 fee, after the SEC rule
authorizing it. The 12b-1 fee is paid by the fund and reduces net asset value.
No-load funds[edit]
A no-load fund does not charge a front-end load under any circumstances, does not charge a
back-end load under any circumstances and does not charge a 12b-1 fee greater than 0.25% of
fund assets.
Management fee[edit]
The management fee is paid to the fund manager or sponsor who organizes the fund, provides
the portfolio management or investment advisory services and normally lends its brand name to
the fund. The fund manager may also provide other administrative services. The management fee
often has breakpoints, which means that it declines as assets (in either the specific fund or in the
fund family as a whole) increase. The management fee is paid by the fund and is included in the
expense ratio.
The fund's board of directors reviews the management fee annually. Fund shareholders must vote
on any proposed increase in the management. However, the fund manager or sponsor may agree
to waive all or a portion of the management fee in order to lower the fund's expense ratio.
Other fund expenses[edit]
A mutual fund may pay for other services including:
Board of directors or trustees fees and expenses
Custody fee: paid to a custodian bank for holding the fund's portfolio in safekeeping and
collecting income owed on the securities
Fund administration fee: for overseeing all administrative affairs of the fund such as
preparing financial statements and shareholder reports, preparing and filing a myriad of
SEC filings required of registered investment companies, monitoring compliance with
investment restrictions, computing total returns and other fund performance information,
preparing/filing tax returns and all expenses of maintaining compliance with state "blue
sky" laws
Fund accounting fee: for performing investment or securities accounting services and
computing the net asset value (usually each day the New York Stock Exchange is open)
Professional services fees: legal and auditing fees
Registration fees: for 24F-2 fees owed to the SEC for net sales of registered fund shares
and state blue sky fees owed for selling shares to residents of states in the US and
jurisdictions such as Puerto Rico and Guam
Shareholder communications expenses: printing and mailing required documents to
shareholders such as shareholder reports and prospectuses
Transfer agent service fees and expenses: for keeping shareholder records, providing
statements and tax forms to investors and providing telephone, internet and or other
investor support and servicing
Other/miscellaneous fees
The fund manager or sponsor may agree to subsidize some of these other expenses in order to
lower the fund's expense ratio.
Shareholder transaction fees[edit]
Shareholders may be required to pay fees for certain transactions. For example, a fund may
charge a flat fee for maintaining an individual retirement account for an investor. Some funds
charge redemption fees when an investor sells fund shares shortly after buying them (usually
defined as within 30, 60 or 90 days of purchase); redemption fees are computed as a percentage
of the sale amount. Shareholder transaction fees are not part of the expense ratio.
Securities transaction fees[edit]
A mutual fund pays expenses related to buying or selling the securities in its portfolio. These
expenses may include brokerage commissions. Securities transaction fees increase the cost basis
of investments purchased and reduce the proceeds from their sale. They do not flow through a
fund's income statement and are not included in its expense ratio. The amount of securities
transaction fees paid by a fund is normally positively correlated with its trading volume or
"turnover."
Controversy[edit]
Critics of the fund industry argue that fund expenses are too high. They believe that the market
for mutual funds is not competitive and that there are many hidden fees, so that it is difficult for
investors to reduce the fees that they pay. They argue that the most effective way for investors to
raise the returns they earn from mutual funds is to invest in funds with low expense ratios.
Fund managers counter that fees are determined by a highly competitive market and, therefore,
reflect the value that investors attribute to the service provided. In addition, they note that fees
are clearly disclosed.
Share classes[edit]
A single mutual fund may give investors a choice of different combinations of front-end loads,
back-end loads and 12b-1 fees, by offering several different types of shares, known as share
classes. All of the shares classes invest in the same portfolio of securities, but each has different
expenses and, therefore, a different net asset value and different performance results. Some of
these share classes may be available only to certain types of investors.
Funds offering multiple classes often identify them with letters, though they may also use names
such as "Investor Class", "Service Class", "Institutional Class", etc., to identify the type of
investor for which the class is intended. The SEC does not regulate the names of share classes, so
that specifics of a share class with the same name may vary from fund family to fund family.
Typical share classes for funds sold through brokers or other intermediaries are as follows.:
Class A shares usually charge a front-end sales load together with a small 12b-1 fee.
Class B shares usually don't have a front-end sales load. Instead they, have a high
contingent deferred sales charge, or CDSC that declines gradually over several years,
combined with a high 12b-1 fee. Class B shares usually convert automatically to Class A
shares after they have been held for a certain period.
Class C shares usually have a high 12b-1 fee and a modest contingent deferred sales
charge that is discontinued after one or two years. Class C shares usually do not convert
to another class. They are often called "level load" shares.
Class I are usually subject to very high minimum investment requirements and are,
therefore, known as "institutional" shares. They are no-load shares.
Class R are usually for use in retirement plans such as 401(k) plans. They typically do
not charge loads, but do charge a small 12b-1 fee.
No-load funds often have two classes of shares:
Class I shares do not charge a 12b-1 fee.
Class N shares charge a 12b-1 fee of no more than 0.25% of fund assets.
Neither class of shares typically charges a front-end or back-end load.
Definitions[edit]
Definitions of key terms.
Net asset value or NAV[edit]
Main article: Net asset value
A fund's net asset value or NAV equals the current market value of a fund's holdings minus the
fund's liabilities (sometimes referred to as "net assets"). It is usually expressed as a per-share
amount, computed by dividing net assets by the number of fund shares outstanding. Funds must
compute their net asset value according to the rules set forth in their prospectuses. Funds
compute their NAV at the end of each day that the New York Stock Exchange is open, though
some funds compute their NAV more than once daily.
Valuing the securities held in a fund's portfolio is often the most difficult part of calculating net
asset value. The fund's board typically oversees security valuation.
Expense ratio[edit]
The expense ratio allows investors to compare expenses across funds. The expense ratio equals
the 12b-1 fee plus the management fee plus the other fund expenses divided by average daily net
assets. The expense ratio is sometimes referred to as the "total expense ratio" or TER.
Average annual total return[edit]
The SEC requires that mutual funds report the average annual compounded rates of return for 1year, 5-year and 10-year periods using the following formula:[18]
P(1+T)n = ERV
Where:
P = a hypothetical initial payment of $1,000.
T = average annual total return.
n = number of years.
ERV = ending redeemable value of a hypothetical $1,000 payment made at the beginning of the
1-, 5-, or 10-year periods at the end of the 1-, 5-, or 10-year periods (or fractional portion).
Turnover[edit]
Turnover is a measure of the volume of a fund's securities trading. It is expressed as a percentage
of average market value of the portfolio's long-term securities. Turnover is the lesser of a fund's
purchases or sales during a given year divided by average long-term securities market value for
the same period. If the period is less than a year, turnover is generally annualized.
