Mutual funds

A mutual fund is a pool of money collected from several investors; the fund is managed by an asset management company. The money is invested in a variety of stocks, bonds and money market instruments. The stocks, bonds, and other assets which funds, own constitute the funds portfolio.
In Pakistan, there are around 25 asset management companies offering different kinds of funds. Mutual Funds Association of Pakistan (MUFAP) is the body that ensures transparency, high ethical conduct and growth of mutual funds industry in Pakistan.
Types of mutual funds Mutual funds can be grouped by objective and structure
--- By structure a fund can be classified as an 'Open' ended fund or 'Closed' ended fund
1. Open-end funds are publicly offered; their shares can be purchased and redeemed at their net asset value (NAV), by the fund. NAV is the market value of all the assets that a company holds minus the fund's liabilities. The fund buys back from the investors at the NAV computed at the end of the day. From a manager's viewpoint, redeeming shares at a known NAV can be risky since the manager might not be able to realise the assets at NAV. Many open-end funds track various indices of a country.
2. Closed-end funds issue shares once, through an IPO (initial public offer). The funds are not redeemable thus the number of shares remains fixed. The fund's share is listed on a stock exchange for trading so investors can trade their shares at any time with another investor. The value of the shares of a closed-end fund is determined by the demand and supply for that fund. The value of the share can deviate from its NAV; thus selling at a premium or discount. The premium is often expressed as percentage of NAV. In the closed-end fund, the fund manager doesn't have to be concerned about liquidity since the investors cannot redeem shares. That is why emerging market funds, which have high risk of redemption, are usually structured as closed-end funds.
--- By objective, funds can be classified into stock funds, income funds, hybrid funds, pension funds, and specialty funds. They can also be classified according to the investment strategies like global equity funds, high yield debt funds, and Islamic equity funds.
Why should you invest in a mutual fund? What benefits will an investor enjoy by investing in a mutual fund? Mutual fund investors enjoy benefits like diversification, liquidity, convenience, professional management, access to specific markets, and a defined strategy.
Diversification: Mutual funds invest in a variety of assets; thus minimising the risk which individual investors face by holding a few securities. Another factor is that Individual investors cannot invest in many securities because of high transaction cost and other restraints.
Liquidity: Mutual fund is a liquid investment; investors can at any time sell their holding at the NAV (for an Open ended fund) and get their money back.
Convenience: Mutual funds also enable investors to purchase and sell their holdings through their fund, broker, telephone or internet. Mutual funds provide monthly and quarterly account statements and investors education.
Defined strategy: Mutual funds might have a defined objective such as growth, income; and small cap. Investors can choose the strategy which suits their objective the best. Managers at some mutual funds also guide investors in formulating investment policy statement keeping in mind their risk tolerance.
Access to specific markets: Closed end country funds invest in markets outside the reach of the general public. They invest in stocks of the country for which the fund is named (eg stocks of Indian companies). The International Finance Corporation (IFC) and the World Bank have been instrumental in launching country funds.
What are the risks of investing in mutual funds? What are costs of investing mutual fund?
Credit risk: A rating downgrade of a fixed income security by a reputable credit rating agency can bring down the value of investment in the mutual fund; especially in case of a debt fund. For instance, if Moody's downgrades Pakistan's debt rating, the value of Pakistan's government issued bonds, T-Bills would fall; consequently, reducing the value of investments in mutual fund.
Country risk: Country risk includes the effects of political, economic and natural events in a country on investment. The country risk is high for closed-end country funds of emerging markets. For example, the value of investments in a country struck by floods would see a sharp decline.
Equity investment risk: Investment in mutual funds reduces individual securities' risk but does not fully eradicate risk of investing in securities; for example risks which affect the entire market. Another risk is the deviation of a closed-end fund's market price from it net asset value.
Managers' risk: One of the advantages of investing in a mutual fund is professional management, but this at times can turn into a risk if the manger does not perform his/her duty, or if the management's personal interests are not aligned with that of the investors.
Loads: Load is a charge that investors pay to purchase shares of mutual funds. There are two kinds of loads; front end and back end load. A front end load is charged when an investor purchases shares and a back end load is paid when an investor sells his shares.
Management fee: The fee charged for the portfolio manager's compensation. Usually is a small percentage of the asset value example 0.5 percent, charged annually.
Other fee: There are different fees charged like distribution, transfer agent fee and custody fee, etc that are used for the running and administration of the mutual fund.
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