Mutual funds and their various portfolios under management are addressed towards individual investors (both men and women) who are otherwise busy with their mainstream careers; and probably have very little time available to attend to their personal investments. A mutual fund is a portfolio comprising of various financial instruments ranging from investment grade stocks traded in the stock markets to high grade bonds and government securities depending on the underlying objectives of the specified mutual fund under study; and the corpus of the same is managed by fund managers and financial specialists.
As investors, we have the choice to buy shares or units in a mutual fund in addition to or instead of stocks of underlying corporate entities we may directly purchase from the stock markets. However, it would be prudent to read the prospectus or offer document to understand the nuances of the mutual fund we may have under study for further investment. The price per share or unit of a mutual fund is called its Net Asset Value (or NAV); and in the case of a new launch would be the New Fund Offer (or NFO). The Net Asset Value of a mutual fund, would be the value of the assets under management less its liabilities on a per share or unit basis.
The mutual funds can be categorized into various styles depending on its objective like aggressive growth, growth, balanced and income; in addition they may also be categorized on the basis of international geographies. While the aggressive growth mutual funds would include the stocks of underlying corporate entities with high potential for growth; the growth mutual funds would include stocks of underlying corporate entities with reasonably good growth potential; the balanced mutual funds would include a mix of investment grade non-speculative stocks and high grade bonds; and the income mutual funds would be similar to the balanced mutual funds with a higher weightage being given to high grade bonds and government securities.
So, in a manner of speaking the categories of the mutual funds would depend directly on the asset mix comprising it.
A further classification of mutual funds would depend on its management style; which are actively managed mutual funds and passively managed mutual funds. In the case of the actively managed mutual funds the fund managers are mandated and required to select probable winning stocks and bonds. A further sub-classification would depend on the market capitalization (small, mid and large) of the stocks approved for onward investment by the mutual fund. The performance benchmark would be the various indices quoted on the stock market on a daily basis. Thus, it would be a consistent outperformance of a mutual fund with reference to its benchmark that would attract investors (both big and small) to it.
In the case of the passively managed mutual funds, the fund managers are expected to hold and manage stocks and/or securities very similar to, if not identical to that of a mandated index. Here the objective would be not to outperform but to perform inline with the mandated index.
We as investors, would be required to read the fine print of the mutual fund offer document or prospectus; with specific reference to important information usually available on the first page and the charter of fees and expenses charged to the investors (which would include commissions, exchange and transaction charges, redemption charges amongst other projections of costs of the mutual fund; some of which are charged to investors). Further, the investors should appraise themselves of the objectives and future plans of the mutual funds they may have under study for onward investment.
The investors should also be aware that mutual funds are mainly of two types; namely, the open ended mutual fund and closed ended mutual fund. In the case of the former there is no upper limit to the shares or units a mutual fund issue, hold and transact in at a later date. In case of a further inflow of money (through investor purchases) the fund itself is expanded through the issue of further shares or units. These of course, are more popular amongst both investors and mutual funds. However, the shares or units of open-ended mutual funds are issued, redeemed or otherwise only at the office of the mutual fund through instructions of a fund manager.
Now, in the case of close-ended mutual funds the number of shares or units the mutual fund can hold or issue is constant, thereby limiting it. Once the shares or units are sold through an initial offering, they are traded or transacted only through a pre-determined stock exchange. Further, the investor may benefit from the realization that the price of these closed ended mutual funds is dependent on the demand and supply of it, and not necessarily on its NAV (even if the latter be calculated on a daily basis). So, in a sense the share or unit of a closed ended mutual fund is quite similar to stocks traded on the stock exchange.
The investors should also appraise themselves, as to whether the mutual funds they may have under study for onward investment are load or no-load mutual funds. This would have a direct bearing on the charges at the time of applying for the mutual fund or while redeeming from it. The other charges which maybe in addition to the redemption charges should be clearly understood and documented before investing.
The investor must understand and realize that, investing in mutual funds would also expose them to the various market risks to the extent specified in the objectives of the mutual fund under study for onward investment. However, to reduce these risks the investor may consider ways and means to avoid making the common errors in investment management.