The pooling of financial resources together for investment purposes with an objective to minimise risk with varied investment options and maximise returns is the ideology that gave rise to mutual funds. A mutual fund is a fund or a collective investment scheme that pools money from many investors and invests the money in stocks, bonds, short term money market instruments, other securities or assets, or some combination of these investments. This avails investors who ordinarily would find it quite difficult with a small amount of capital to access diversified portfolios of equities, bonds and other securities which are professionally managed for optimal yield.
Mutual funds are operated by fund managers, who invest the fund’s capital to produce capital gains and income for the fund’s investors. Each share that makes up the fund represents an investor’s proportionate ownership of the fund’s holdings and the income those holdings generate. The combined holdings the mutual fund owns are known as its portfolio. The portfolio is structured and maintained to match the investment objectives stated in the prospectus issued by the sponsor of the fund.
Mutual Funds, also known as Unit trusts, can either be Open Ended Funds or Close Ended Funds. Although the focus of this write-up will be mutual funds, it is however noteworthy that other pooled investment vehicles exist that may offer features that you desire.
Open-Ended Fund: This is a fund that has no restrictions on the amount of shares the fund will issue. If demand is high enough, the fund will continue to issue units no matter how many investors there are. Open-ended funds also buy back units when investors wish to sell. By continuously selling and buying back fund units, these funds provide investors with a very useful and convenient investing vehicle.
Close-Ended Fund: This is a publicly traded investment company that raises a fixed amount of capital through an Initial Public Offering (IPO). The fund is then structured, listed and traded like a stock on a stock exchange. It raises a prescribed amount of capital only once through an IPO by issuing a fixed number of shares, which are purchased by investors in the close-ended fund. Unlike regular stocks, close-ended fund stock represents an interest in a specialized portfolio of securities that is actively managed by an investment advisor and which typically concentrates on a specific industry, geographic market or sector.
Advantages of Mutual Funds Investment
1. Dividend/Interest Payments: Income is earned in the form of dividend payments on stocks and interest payment on bonds in the portfolio. A large proportion of this income (minus expenses) is usually distributed by the fund managers to the unit holders in the form of dividends paid out.
2. Capital Gains Distributions: The price of the securities a fund owns may increase. When a fund sells a security that has increased in price, the fund has a capital gain. At the end of the year, most funds distribute these capital gains (minus any capital losses) to investors.
3. Increased Net Asset Value (NAV): If the market value of a fund’s portfolio increases, after deduction of expenses and liabilities, then the value (NAV) of the fund and its units increases. The higher NAV reflects the higher value of your investment.
With respect to dividend payments and capital gains distributions, the fund can send you a warrant or other form of payment, and also gives you a choice to have your dividends or distributions reinvested in the fund to buy more units (often times without paying an additional sales cost).
4. Professional Investment Management: Selecting the best stocks by yourself may be difficult and time consuming. Allowing a professional fund manager to make decisions about stocks selection and also manage your investment saves you all the worries. Professional money managers research, select, and monitor the performance of the securities the fund purchases.
5. Diversification: Diversification is an investing strategy that can be neatly summed up as “Don’t put all your eggs in one basket.” Spreading your investments across a wide range of companies and industry sectors can help lower your risk if a company or sector fails. Some investors find it easier to achieve diversification through ownership of mutual funds rather than through ownership of individual stocks or bonds.
6. Minimal transaction costs: A Mutual fund buys and sells large amounts of securities at a time; its transaction costs are lower than what an individual would pay for securities transactions. This offers the advantage of economies of scale in purchases and sales of securities.
7. Affordability: Some mutual funds accommodate investors who do not have a lot of money to invest by setting relatively low amounts for initial purchases, subsequent monthly purchases, or both. Investing in a mutual fund usually does not require a large sum of money. Most funds do have minimum amounts needed to get started.
8. Liquidity: Just like an individual stock, a mutual fund allows you to request that your shares be converted into cash at any time. Fund investors can readily redeem their shares at the current Net Asset Value (NAV) plus any fees and charges assessed on redemption at any time.
9. Simplicity: Buying a mutual fund is easy! The minimum investment is small. Most funds also have automatic purchase plans whereby as little as less than N20,000 can be invested on a monthly basis.
10. Investor Information: Shareholders receive regular reports from the mutual funds, including details of transactions on a year-to-date basis. The current net asset value of your units (the price at which you may purchase or redeem them) appears in the mutual fund price listings of daily newspapers. You can also obtain pricing and performance results from the mutual funds website or it can be obtained by telephone or email from the mutual funds manager.
11. Life Cycle Planning: You can link your investment plans to future individual and family needs and make changes as your life cycles change. You can invest in growth funds for future academic tuition needs, then move to income mutual funds for retirement, and adjust your investments as your needs change throughout your life.
12. Regulation: Mutual funds are regulated by the Securities and Exchange Commission (‘SEC’) and are subject to the provisions of the Investment and Securities Act of 2007 as amended. The Act requires that all mutual funds register with the SEC and that investors be given a prospectus, which must contain full information concerning the fund’s history, operating policies and cost structure. Additionally, all funds use a bank that serves as the custodian of all the pooled assets and have a trustee to the fund. This safeguard means the securities in the fund are protected from theft, fraud, mis-investment and even the bankruptcy of the fund management company itself.
13. Predictable Price: Price movements of mutual funds are more predictable than those of individual stocks. Their extensive diversification, coupled with outstanding stock selection, makes it highly unlikely that the overall market will move up without carrying almost all stocks in the mutual fund up with it.
14. Safe investment Vehicle: Mutual funds are required to hire an independent trust company to hold and account for all the cash and securities in the pool. The trustee has a legally binding responsibility to protect the interests of every unit holder.
Disadvantages
1. Dilution: Although diversification reduces the amount of risk involved in investing in mutual funds, it can also be a disadvantage due to dilution. For example, if a single security held by a mutual fund doubles in value, the mutual fund itself would not double in value because that security is only one small part of the fund’s holdings.
2. Fees and Expenses: Most mutual funds charge management and operating fees that pay for the fund’s management expenses. In addition, some mutual funds charge high sales commissions, redemption fees and some funds buy and trade shares so often that the transaction costs add up significantly. Some of these expenses are charged on an ongoing basis, unlike stock investments, for which a commission is paid only when you buy and sell.
3. Loss of Control: The managers of mutual funds make all of the decisions about which securities to buy and sell and when to do so. For example, the tax consequences of a decision by the manager to buy or sell an asset at a certain time might not be optimal for you.
4. Deposit Insurance: Mutual funds, although regulated by the government, are not insured against losses. The Nigeria Deposit Insurance Corporation (NDIC) only insures against certain losses by Universal Banks, Micro-finance Banks and Primary Mortgage Institutions not mutual funds.
5. Trading Limitations: Although mutual funds are highly liquid in general, most mutual funds (esp. open-ended funds) cannot be bought or sold in the middle of the trading day. You can only buy and sell them at the end of the day, after the current value of their holdings have been calculated.
Mutual funds are veritable investment vehicles that accommodate a wide variety of investors no matter your investment style and financial goals because they can offer the advantages of diversification and professional management. You can buy mutual funds by contacting fund or Asset management companies directly or through brokers, banks, financial planners, or insurance agents.
