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Mutual fund

A mutual fund is an investment fund that pools money from many investors to purchase securities. The term is typically used in the United States, Canada, and India, while similar structures across the globe include the SICAV in Europe ('investment company with variable capital'), and the open-ended investment company (OEIC) in the UK.

Mutual funds are often classified by their principal investments: money market funds, bond or fixed income funds, stock or equity funds, or hybrid funds.[1] Funds may also be categorized as index funds, which are passively managed funds that track the performance of an index, such as a stock market index or bond market index, or actively managed funds, which seek to outperform stock market indices but generally charge higher fees. The primary structures of mutual funds are open-end funds, closed-end funds, and unit investment trusts. Over long duration passively managed funds consistently overperform actively managed funds.[2][3][4]


Open-end funds are purchased from or sold to the issuer at the net asset value of each share as of the close of the trading day in which the order was placed, as long as the order was placed within a specified period before the close of trading. They can be traded directly with the issuer.[5]


Mutual funds have advantages and disadvantages compared to direct investing in individual securities. The advantages of mutual funds include economies of scale, diversification, liquidity, and professional management.[6] As with other types of investment, investing in mutual funds involves various fees and expenses.


Mutual funds are regulated by governmental bodies and are required to publish information including performance, comparisons of performance to benchmarks, fees charged, and securities held. A single mutual fund may have several share classes, for which larger investors pay lower fees.


Hedge funds and exchange-traded funds are not typically referred to as mutual funds, and each is targeted at different investors, with hedge funds being available only to high-net-worth individuals.[7]

History[edit]

Early history[edit]

The first modern investment funds, the precursor of mutual funds, were established in the Dutch Republic. In response to the financial crisis of 1772–1773, Amsterdam-based businessman Abraham (or Adriaan) van Ketwich formed a trust named Eendragt Maakt Magt ("unity creates strength"). His aim was to provide small investors with an opportunity to diversify.[9][10]


The first investment trust in the UK, the Scottish American Investment Trust formed in 1873, is considered the "most obvious progenitor" to the mutual fund, according to Diana B. Henriques.[11]


One of the earliest investment companies in the U.S. similar to a modern mutual fund was the Boston Personal Property Trust that was founded in 1893; however, its original intent was as a workaround to Massachusetts law restricting corporate real estate holdings rather than investing.[12] Early U.S. funds were generally closed-end funds with a fixed number of shares that often traded at prices above the portfolio net asset value.[13] The first open-end mutual fund with redeemable shares was established on March 21, 1924, as the Massachusetts Investors Trust, which is still in existence today and managed by MFS Investment Management.[14][15]


In the U.S., there were nearly six times as many closed-end funds as mutual funds in 1929.[16]


After the Wall Street Crash of 1929, the United States Congress passed a series of acts regulating the securities markets in general and mutual funds in particular.

These new regulations encouraged the development of open-end mutual funds (as opposed to closed-end funds).[17]


In 1936, U.S. mutual fund industry was nearly half as large as closed-end investment trusts. But mutual funds had grown to twice as large as closed-end funds by 1947; growth would accelerate to ten times as much by 1959. In terms of dollar amounts, mutual funds in the U.S. totaled $2 billion in value in 1950 and about $17 billion in 1960.[18] The introduction of money market funds in the high-interest rate environment of the late 1970s boosted industry growth dramatically.


The first retail index funds appeared in the early 1970s, aiming to capture average market returns rather than doing detailed company-by-company analysis as earlier funds had done. Rex Sinquefield offered the first S&P 500 index fund to the general public starting in 1973, while employed at American National Bank of Chicago.[19][20] Sinquefield's fund had $12 billion in assets after its first seven years.[21] John "Mac" McQuown also began an index fund in 1973, though it was part of a large pension fund managed by Wells Fargo and not open to the general public.[19] Batterymarch Financial, a small Boston firm then employing Jeremy Grantham, also offered index funds beginning in 1973 but it was such a revolutionary concept they did not have paying customers for over a year.[19] John Bogle was another early pioneer of index funds with the First Index Investment Trust, formed in 1976 by The Vanguard Group; it is now called the "Vanguard 500 Index Fund" and is one of the largest mutual funds.[19]


Beginning the 1980s, the mutual fund industry began a period of growth.[8] According to Robert Pozen and Theresa Hamacher, growth was the result of three factors:


The 2003 mutual fund scandal involved unequal treatment of fund shareholders whereby some fund management companies allowed favored investors to engage in prohibited late trading or market timing. The scandal was uncovered by former New York Attorney General Eliot Spitzer and led to an increase in regulation.


In a 2007 study about German mutual funds, Johannes Gomolka and Ralf Jasny found statistical evidence of illegal time zone arbitrage in trading of German mutual funds.[23] Though reported to regulators, BaFin never commented on these results.

Increased opportunity for : A fund diversifies by holding many securities. This diversification decreases risk.

diversification

Daily liquidity: In the United States, mutual fund shares can be redeemed for their net asset value within seven days, but in practice the redemption is often much quicker. This liquidity can create which poses challenges, which in part motivated an SEC liquidity management rule in 2016.[24]

asset–liability mismatch

Professional investment management: Open-and closed-end funds hire portfolio managers to supervise the fund's investments.

Ability to participate in investments that may be available only to larger investors. For example, individual investors often find it difficult to invest directly in foreign markets.

Service and convenience: Funds often provide services such as check writing.

Government oversight: Mutual funds are regulated by a governmental body

Transparency and ease of comparison: All mutual funds are required to report the same information to investors, which makes them easier to compare to each other.

[22]

Regulation and operation[edit]

United States[edit]

In the United States, the principal laws governing mutual funds are:

The specific types of bonds owned (such as , investment-grade corporate bonds, government bonds or municipal bonds)

high-yield or junk bonds

The maturity of the bonds held (i.e., short-, intermediate- or long-term)

The country of issuance of the bonds (such as the U.S., emerging market or global)

The tax treatment of the interest received (taxable or tax-exempt)

Front-end load or sales charge. A 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 investor; it is deducted from the amount invested.

front-end load

Back-end load. Some funds have a , 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 charge (CDSC). Like the front-end load, the back-end load is paid by the investor; it is deducted from the redemption proceeds.

back-end load

Distribution and services fee. Some funds charge an annual fee to compensate the distributor of fund shares for providing ongoing services to fund shareholders. In the United States, this fee is sometimes called a , after the SEC rule authorizing it. The distribution and services fee is paid by the fund and reduces net asset value.

12b-1 fee

Definitions of key terms[edit]

Average annual total return[edit]

Mutual funds in the United States are required to report the average annual compounded rates of return for one-, five-and-ten year-periods using the following formula:[35]

Farina, Richard H.; Freeman, John P.; Webster, James (1969). (PDF). Notre Dame Law Review. 44: 732–983.

"The Mutual Fund Industry: A Legal Survey"

(1995). Fidelity's World: The Secret Life and Public Power of the Mutual Fund Giant. New York: Scribner. ISBN 0-684-81299-1.

Henriques, Diana B.

Pozen, Robert; Hamacher, Theresa (2015). (2nd ed.). Hoboken, New Jersey: Wiley. ISBN 978-1118929940.

The Fund Industry: How Your Money is Managed

Lemke, Thomas P.; Lins, Gerald T.; Smith, A. Thomas (March 6, 1997). . LexisNexis. ISBN 978-0-8205-2005-6.

Regulation of Investment Companies

Lemke, Thomas P.; Lins, Gerald T.; McGuire, W. John (December 18, 2020). . LexisNexis. ISBN 978-0-7698-9131-6.

Regulation of Exchange-Traded Funds

Ammann, Manuel; Kind, Axel; Wilde, Christian (2010). (PDF). Journal of Banking and Finance. 34 (11): 2600–2613. doi:10.1016/j.jbankfin.2010.04.016.

"What drives the performance of convertible-bond funds?"

U.S. Securities and Exchange Commission

Mutual Funds and ETFs: A Guide for Investors