What are Mutual Funds and Their Types

Mutual fund is a trust which pools the savings of group of investors for investment in capital market instruments. Mutual fund is an ideal tool or instrument for individual who want to invest in stocks, debentures and other securities which otherwise is difficult for them to invest.

The working of mutual fund is very simple. The money pooled by a number of investors in entrusted to a fund manager who is hired by the trust. The fund manager invests money directly in primary market or through brokers in secondary market on behalf of the investors. The fund manager is paid a management fee. If there is a profit on investment, it belongs to the investors. In case there is a loss, it is also shared by the investors.

Categories of mutual funds

There are two categories of mutual funds (1) Open end mutual funds and (2) close end mutual funds. The open end mutual funds are those where subscription and redemption of share are allowed on a continuous basis. Those funds which can issue the shares without any restriction and can provide the facility of buying back from the investors. Since these funds are useful and convenient investing vehicle therefore majority of the funds are open ended.

On the other hand closed-end funds issue limited number of shares to raise money through initial public offerings. The shares can be traded on the stock exchange and the price of these shares depends upon the demand and supply situation. New shareholders must go to the open market to purchase them from existing shareholders since no new shares issued by the manager Mark (2007).

Mutual fund industry in the world

Mutual fund industry is a leading player in the world economy and is a significant constituent of the financial sector. Over the past few decades, mutual fund industry, in the United States, European countries and other parts of the world has exploded Khorana (2005). In 1940, when the modern mutual fund industry began, mutual funds had assets of only $450 million Matthew (2008). Currently the U.S. mutual fund industry has $9.6 trillion in assets and is the largest in the world.

According to ICI fact book (2009) World mutual funds have $19.0 trillion asset under management and total number of mutual funds exceeds 69032 as of year-end 2008. Because mutual funds were cost efficient, easy to invest and provide diversification therefore investors considered mutual funds as the best investment options.

Advantages of mutual funds

The advantages of mutual funds are that the money pooled for investment is managed by expert professional fund managers. The funds are invested in different instruments which reduces the risk of loss. In addition to this, they are well regulated. A mutual fund generates profit from three sources dividend, appreciation of share price and capital gains.

Issues in mutual fund performance

There are two key issues in mutual fund performance that have received considerable attention in the academic literature. The first was whether mutual funds are able to generate abnormal returns relative to a benchmark. The second was whether this performance was persistent, i.e. if it could be identified and exploited by investors.