Mutual Fund Investment
Strategies Mutual Fund Investment
Strategies
Mutual funds are classified by mutual fund surveys into categories based on their investment policy and the predominant type of assets held. The broad categories are:
Funds specify their "investment policies" in their trust indentures' and public prospectus'. These can allow the manager a wide range of latitude in investing a fund's assets. While this in itself isn't bad, it has led to many funds bearing little resemblance to their name. A well known "Mortgage and Income Fund" in Canada held mostly equities and very few bonds or mortgages. While this led to good long-term performance, it led to the fund being classified in the Income Fund section of several mutual fund performance surveys. Investment professionals acquainted with this fund considered it to be a Balanced or Equity Fund.
Regulators in both the United States and Canada have become concerned that the performance of some funds has been quite different than their name would suggest. For example, in 1993 and early 1994, some money market funds in the United States held "derivatives" of longer-term mortgage-backed securities (MBS). Money market funds usually restrict their holdings to fixed income securities less than one year in term to assure that their holdings can be redeemed quickly and at a price close to their quoted value. The structure and valuation of the MBS derivatives was based on expected cash flows from the underlying mortgages. The quickly rising interest rates of 1994 led to much lower prepayment rates than anyone had expected and caused the term of some MBS derivatives to lengthen considerably. Where most money market securities offer good protection against rising interest rates, the MBS derivatives lengthened in term and fell substantially in value. This led to capital losses in money market funds holding these securities, something which investors in these funds didn't expect. In some cases, the mutual fund sponsors contributed to the funds to compensate for the losses although they were not legally obligated to do so.
Sector funds are based on specific areas or "sectors" within a broader asset class or mutual fund grouping. "High yield" or "junk bond" funds are bond funds which invest in lower quality "junk" or "less than investment grade" bonds. "Resource" equity funds invest in the equities of companies in the resource industry.
Theme funds invest according to a particular investment philosophy or "theme". Traditional "growth" and "value" equity funds are based on interpretations of these investment philosophies. More recently, funds have been created that reflect a particular "investment theme". An example of this is the Talvest "New Economy" Equity Fund in Canada which invests in companies identified as in the "New Economy" in the belief that these companies will outperform traditionally based industries. Environmental funds invest in companies which have "environmentally friendly" policies. "Emerging market" funds reflect the investment theme that emerging country economies will grow faster than the more established economies.
There would seem to be little constraint on the type of fund that could be created. In reality, most funds are established by marketing imperative. A fund sponsor will only establish a type of fund if there is the sufficient prospect of assembling enough assets to provide a profitable return. This means that new types of funds usually gurgle up from the well of "investor fashion".
For example, take the mania that developed over international investing in 1993. Studies showing the higher returns and decreased risk of international diversification had been around for years. Successful international managers like the Templeton group had long offered international mutual funds. The fall of the "Iron Curtain", the establishment of the North American Free Trade Area and the strong economies of the Asian "Tigers" combined to capture investors' imaginations and make a very attractive and easy "sales pitch". A very liquid financial market and strong historical performance numbers translated into greed and plenty of money available for investment. Mutual fund companies rushed to create foreign and international funds. The money flowing into small foreign markets caused these markets to surge higher in price, producing stellar investment returns for foreign and international funds. This strong performance caused even more funds to be created, further fuelling the surging prices of foreign markets. This cycle continued until the Federal Reserve tightened monetary policy in January, 1994. The combination of the Fed tightening and the collapse of the Mexican peso and stock market caused a major setback for most international funds. Some of the funds created at this time have lagged the returns of the domestic U.S. and Canadian markets ever since!
Investment Strategy
Asset Mix
Asset Class Strategies
Bond
Management Strategies
Equity Management Styles
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