Types of Mutual Funds Types of Mutual Funds
Open Mutual FundsOpen mutual funds are established by a fund sponsor, usually a mutual fund company. The sponsor has promised in the documents of the fund that it will issue and refund or units of the fund at the fund unit value. This type of fund is valued by the fund company or an outside valuation agent. This means that the investments of the fund are valued at "fair market" value, which is the closing market value for listed public securities. Essentially, the fund company prices all of the fund's holdings at the market close and adds up their value; it then subtracts amounts owing and adds amounts to be received by the fund; and finally it divides this net amount by the number of units outstanding to "strike" the unit value for that day. Any participants withdrawing funds from the fund that day receive this unit value for their funds withdrawn. Any new purchases are made at the same unit value.
Open mutual funds keep some portion of their assets in short-term and money market securities to provide available funds for redemptions. A large portion of most open mutual funds is invested in highly "liquid securities", which means that the fund can raise money by selling securities at prices very close to those used for valuations. Funds also have the ability to borrow money for short periods of time to fund redemptions. The documents of open mutual funds usually provide for the suspension of unit redemptions in "extraordinary conditions" such as major interruptions to the financial markets or total demands for redemptions forming a substantial portion of the fund assets in a short period of time. These clauses were invoked in October, 1987, when the stock market crashed 30% in a few days and the volume of stock transactions caused trading activity to be hours out date.
Illiquid investments, those not actively traded on the public markets, are restricted by government regulators because they are difficult to dispose of in a short period of time. A fund holding an illiquid investment might not be able to sell it in a short period of time or would have to take a significant discount to the valuation level the fund was using. In Canada, most open real estate mutual funds suspended redemptions during the real estate debacle of the early 1990s. Fund participants did not obtain redeemed funds until these funds were restructured into closed-end funds in the mid 1990s and they could sell their units on the stock market.
The valuation of investments that are less liquid and trade infrequently is an important issue for mutual funds.
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Mutual Fund Valuations
Closed Mutual FundsClosed mutual funds are really financial securities that are traded on the stock market. A sponsor, a mutual fund company or investment dealer, will create a "trust fund" that raises funds through an underwriting to be invested in a specific fashion. The fund retains an investment manager to manage the fund assets in the manner specified. A good example of this type of fund are the "country funds" that were underwritten during the international investment euphoria of the early 1990s. An investment dealer would decide that a "Germany" or "Portugal" or "Emerging Country" fund would sell given the popular consensus that these were "no lose" investments. It would then retain a well respected investment advisor to manage the fund assets for a fee and underwrite a public issue that it would sell through retail stock brokers to individual investors. It is interesting to note that many of these funds were caught in the sell-off of the stock market of 1994 and have languished ever since. This has led to the phrase "submerging country" replacing "emerging market" for many of these funds. This is wry proof of the fickleness of investor fashion!
Once underwritten, closed mutual funds trade on stock exchanges like stocks or bonds. Their value is what investors will pay for them. Usually closed mutual funds trade at discounts to their underlying asset value. For example, if the price of the fund assets less liabilities divided by the outstanding units is $10, the fund might trade on the stock market at $9. This fund would be said to be trading at a "10% discount to its net asset value". The reason for this discount is debated by academics, but is due in large part to the lack of liquidity of the fund units and the presence of the management fee.
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Closed-End Fund Discounts
Other Types Of Investment
FundsThere are many other types of investment funds that are quite similar to mutual funds. These look and act like mutual funds but differ in their legal status and nature of their investments. "Pooled funds", for large and sophisticated investors, are unit trusts like mutual funds but fall under prospectus exemptions from securities legislation. "Segregated funds" are really insurance contracts that depend on the value of a portfolio of investments and are legally "variable rate insurance annuity contracts". "Labour Venture Funds" are pools of capital that take advantage of special tax incentives for labour unions to establish investment funds that invest in smaller and start-up businesses. "Royalty Trusts" are closed-ended unit trusts which take the income from a pool of income producing assets and pass this through to investors. For more information on these investment vehicles, click "related articles" below.
Pooled Funds
Insurance Segregated Funds
Labour Venture Funds
Royalty Trusts
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