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Introduction to the Concept of Mutual Funds

A Mutual Fund is a collection of stocks, bonds, or other securities. When


you buy a mutual fund, you own the share of the mutual fund. The price of
each mutual fund share is called its NAV or net asset value. That's the
total value of all the securities it owns divided by the number of the mutual
fund's shares.
Mutual fund shares are traded continuously, but their prices adjust at the
end of each business day.

It's important to understand that each mutual fund has different risk and
reward profiles. In general, the higher the potential return, the higher the
risk of potential loss. Although some funds are less risky than others, all
funds have some level of risk – it's never possible to diversify away all risk –
even with so-called money market funds. This is a fact for all investments.
Each mutual fund has a predetermined investment objective that tailors the
fund's assets, regions of investments and investment strategies.
At the most basic level, there are three flavors of mutual funds: those that
invest in stocks (equity funds), those that invest in bonds (fixed-
income funds), those that invest in both stocks and bonds (balanced funds),
and those that seek the risk-free rate (money market funds). Most mutual
funds are variations on the theme of these three asset classes.
History of Mutual Funds
Prof K Geert Rouwenhorst in 'The Origins of Mutual Funds', states that the origin of pooled
investing concept dates back to the late 1700s in Europe, when "a Dutch merchant and broker
invited subscriptions from investors to form a trust to provide an opportunity to diversify for
small investors with limited means." The emergence of "investment pooling" in England in the
1800s brought the concept closer to the US shores.

The enactment of two British laws, the Joint Stock Companies Acts of 1862 and 1867,
permitted investors to share in the profits of an investment enterprise and limited investor
liability to the amount of investment capital devoted to the enterprise. Shortly thereafter, in
1868, the Foreign and Colonial Government Trust was formed in London.

It resembled the US fund model in basic structure, providing "the investor of moderate
means the same advantages as the large capitalists by spreading the investment over a
number of different stocks." More importantly, the British fund model established a direct
link with the US securities markets, helping finance the development of the post-Civil War US
economy.

The stock market crash of 1929 and the Great Depression that followed greatly hampered
the growth of pooled investments until a succession of landmark securities laws, beginning
with the Securities Act, 1933 and concluded with the Investment Company Act, 1940,
reinvigorated investor confidence. Renewed investor confidence and many innovations led to
relatively steady growth in industry assets and number of accounts.
Collective Pooled Investment
You Me
Where?
Money
To
Invest

Smart Market Person


Anand
Mutual Funds

Sarang

Fund Manager

Mutual Bonds/
Rajat Stocks Derivatives
Fund Debt

Aman
Structure in India
Sponsor Trustees Custodian Registrars

Equity Fund Manager


Fund

Asset
Management Debt Investors
Company Fund

Hybrid
Fund Fund Manager
Mutual Fund Companies
Mutual funds are managed by hundreds of companies, who
have hundreds of funds each. Most companies focus on
specific strategies to stand out from the crowd. Here are
the top 10 largest mutual fund companies by size, with
their approach:

• Vanguard - Low management fees.


• Fidelity - Full financial services.
• American - Conservative investment strategies with long-
term investment timeframe.
• Barclays - Targets professional, not individual, investors.
• Franklin Templeton - Bonds, emerging markets, and value
companies.
• PIMCO - Bond funds.
• T. Rowe Price - No-load funds.
• State Street - Targets professional, not individual,
investors.
• Oppenheimer - Actively managed funds.
• Dodge & Cox - Long-term investment timeframe.
Advantages of Mutual

fund companies:
Mutual fund investments in stocks, bonds and other
instruments require considerable expertise and constant
supervision, to allow an investor to take the right decisions.
Small investors usually do not have the necessary expertise
and time to undertake any study that can facilitate informed
decisions. While this is the predominant reason for the
popularity of mutual funds, there are many other benefits :

• Diversification Benefits
• Returns
• Liquidity
• Low Transaction Costs
• Availability of Various Schemes
• Professional Management
• Flexibility