Less Popular Types Of Mutual Funds

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Less Popular Types Of Mutual Funds

Mutual Funds Author: Admin


The mutual funds in this section cannot be classified as either stock funds or bond funds. Some, like lifecycle funds and balanced funds, invest in both stocks and bonds, while others, like money market funds, invest in neither.

Money Market Funds 

Money market funds are among the safest and most stable of all the different types of mutual funds. These funds invest in short-term (one day to one year) debt obligations such as Treasury bills, certificates of deposit, and commercial paper. The main goal is the preservation of principal, accompanied by modest dividends.

These funds are in no way guaranteed or insured by the federal government or any other institution. Although money market mutual funds are among the safest types of mutual funds, it still is possible for money market funds to fail. But given the conservative nature of their investments, such scenarios are highly unlikely. In fact, the biggest risk involved in investing in money market funds is the risk that inflation will outpace the funds’ returns, thereby eroding the purchasing power of the investor’s money.

Income Funds

Income funds focus on providing investors with a steady stream of fixed income. In order to achieve this, they might invest in bonds, government securities, or preferred stocks that pay high dividends. They are considered to be conservative investments since they stay away from volatile growth stocks. Income funds are popular with retirees and other investors who are looking for a steady cash flow without assuming too much risk.

Balanced Funds

The purpose of balanced funds (also sometimes referred to as “hybrid funds”) is to provide investors with a single mutual fund that combines both growth and income objectives. In order to achieve this goal, balanced funds invest in both stocks (for growth) and bonds (for income). Balanced funds typically invest no more than 50% of their money in stocks, with the rest allocated to debt instruments. Such diversified holdings ensure that these funds will manage downturns in the stock market without too much of a loss; the flip side, of course, is that balanced funds will usually enjoy fewer gains than an all-stock fund during a bull market.

Asset Allocation Funds

Asset allocation funds are a type of balanced fund that invests in a number of different asset classes, such as stocks, bonds, and cash. They are similar to balanced funds, except they invest in many other types of asset classes in addition to stocks and bonds (e.g. money market accounts).

International, Global, Regional, and Emerging Markets Funds

If one of the goals in mutual fund investing is diversification, then what better way to achieve that goal than by investing in assets from all over the world? That is the logic underlying global mutual funds (also sometimes called world funds). Such funds invest throughout the world, including in the U.S. Global mutual funds can provide more opportunities for diversification than domestic funds alone. You should take into account, however, that there can be additional risks associated with global funds involving currency fluctuations and political and economic instability abroad.

International funds (sometimes referred to as foreign funds) are similar to global funds but with one major exception: they do not invest in any domestic assets. International funds, therefore, do not offer as great an opportunity for diversification as global funds, but they are useful for investors who want to concentrate their holdings in foreign assets only, or who already have significant domestic investments in their portfolio. As with global funds, international funds can involve risks associated with currency fluctuations and political and economic instability abroad.

Regional funds can be thought of as a particular type of international fund that focuses on only one particular region — for example, Western Europe or Latin America. Even more specific are emerging markets funds that invest only in the capital markets of foreign countries that are undergoing dramatic economic transitions, such as those economies that are transforming from an agricultural economy to an industrialized one (as in the case of many third world countries) or those that are transforming from a state-run economy to a free-market one (as in the case of many former Eastern bloc countries). Emerging markets funds offer potentially higher-than-normal returns due to these economic transitions, but they can also involve a significant amount of risk if the economic transition fails or if there is instability in the country or its currency.

Mortgage-Backed Securities Funds

Mortgage-backed securities funds invest in home mortgage securities that are offered through several government agencies. These agencies, such as “Ginnie Mae” (the Government National Mortgage Association) and “Freddie Mac” (the Federal National Mortgage Association), purchase and then pool together groups of home mortgage loans, which they then later resell to investors (such as mutual funds) as a single security. Mortgage-backed securities funds receive interest payments on the mortgages, which they pass on to shareholders, as well as principal payments, which they use to reinvest in more securities. These funds are considered to be very safe since mortgage-backed securities from the aforementioned agencies are either backed by the federal government or have very high credit ratings. However, these funds may suffer from prepayment risks (in which case the mortgagor may pay off the principal earlier than anticipated) and interest rate fluctuations (which could cause the value of the fund to go up and down).

Hedge Funds

Hedge funds are funds that use a variety of aggressive investing strategies (such as short selling, investing in derivatives, and leverage) to seek higher returns. Hedge funds are exempt from many of the rules and regulations governing other mutual funds, which allows them to accomplish aggressive investing goals. They are restricted by law to no more than 100 investors per fund, and as a result, most hedge funds set exceptionally high minimum investment amounts, ranging anywhere from $250,000 to over $1 million. As with traditional mutual funds, investors in hedge funds pay a management fee; however, hedge funds also collect a percentage of the profits (usually 20%).

Fund Supermarkets

Fund supermarkets are analogous to grocery supermarkets: they allow consumers to buy a variety of goods from different producers at one central location. In the case of fund supermarkets, the consumers are investors, the producers are mutual fund families, and the central location is a brokerage firm. The primary benefit of such an arrangement is simplicity: you get to buy funds from different families and receive all their statements in a single report. Fund supermarkets are also supposed to save on costs, since the funds are usually traded with no commissions and no transaction fees.

In reality, however, the supermarkets charge the fund families a stiff fee, which is then passed off to investors through the form of expense fees or reduced distributions.

Funds of Funds

“Funds of funds” (FOFs) are meta-mutual funds; that is, they are mutual funds that invest in other mutual funds. Just as a normal mutual fund invests in a number of different securities, so an FOF buys shares of many different mutual funds. These funds were designed to achieve even greater diversification than normal mutual funds; however, they suffer from several drawbacks. Expense fees on FOFs are typically higher than those on regular funds because they include part of the expense fees charged by the underlying funds. But even FOFs with low fees may suffer from another disadvantage: duplication. Since FOFs buy many different funds which themselves invest in many different stocks, it is possible for the FOF to own the same stock through several different funds. Most experts say that FOFs are not terribly useful, given that one or a few mutual funds can provide adequate diversification without the second level of fees.

Lifecycle Funds

Starting in the early 1990s, many mutual fund families began offering “lifecycle” funds designed to carry investors from one stage of life to the next. The idea is to offer investors three types of funds — high growth, average growth, and low growth — that they can switch between as their risk tolerance changes once they move from youth to middle age to retirement. Although lifecycle funds all share the common goal of first growing and then later preserving principal, they can contain any mix of stocks, bonds, and cash.

Institutional Funds

Institutional funds are mutual funds that target pension funds, endowments, the wealthy, and other multi-million dollar investors. Their main objective is to reduce risk, so they invest in hundreds of different securities, which makes these funds among the most diversified funds available. They also do not tend to trade securities very often, so they are able to keep operating costs to a minimum. Although in the past investors typically needed at least $1 million in order to invest in an institutional fund, nowadays some discount brokers offer access to these funds for more modest sums of money, such as $1,000-$5,000.

Socially Responsible Funds

Perhaps the most subjective of all the types of mutual funds, socially responsible funds aim to invest only in companies that adhere to certain ethical and moral principles. Exactly what this means obviously varies from fund to fund, but some examples include funds that only invest in environmentally conscious companies (“green funds”), funds that invest in hospitals and health care centers, and funds that avoid investing in alcohol or tobacco companies. Socially responsible funds try to maximize returns while staying within these self-imposed boundaries.

Contrarian Funds

Contrarian funds seek to make a profit by investing in the opposite direction of the prevailing market sentiment. During the extended bull market of the 1990s, this term actually came to be equated with bear market investing, but really it just means investing in the opposing direction. Contrarian funds will invest in bonds when the stock market is high (in anticipation that it will fall) and stocks when the stock market is low (in anticipation it will rise).

GIC Funds

GIC funds are mutual funds that invest solely in guaranteed investment contracts (GICs). GICs are fixed-income debt instruments sold by insurance companies to pensions and other types of retirement plans. They pay a fixed interest rate over a short period of time, usually about 5 years, and they are guaranteed by the insurance agency that issues them, not by the government. As with other mutual funds that invest in debt instruments, GIC funds are generally considered to be conservative investments.

Unit Investment Trusts (UITs)

Unit Investment Trusts (UITs) technically are not a type of mutual fund, but they behave similarly to them. Like mutual funds, UITs pool together money from a group of investors and then use that money to purchase a basket of securities (usually bonds but occasionally stocks). Unlike mutual funds, however, UITs do not later buy and sell more securities for their portfolio — in other words, a UIT’s portfolio is frozen after the initial securities are bought. And unlike mutual funds, UITs have expiration dates (usually anywhere from one to five years); after a UIT expires, investors may choose to receive their investment in cash (minus operating costs and sales charges) or they can roll over their investment into a new UIT. Some investors prefer UITs to mutual funds because UITs typically incur lower annual operating expenses (since they are not buying and selling shares); however, UITs often have steep sales charges and entrance/exit fees that could end up costing more than the fees paid to a mutual fund. The other problem with UITs is that they can only be purchased through the investment houses that created the trust and not on the open market. This can make it difficult for investors to find pricing information for the UIT, and so it can be quite difficult for investors to compare prices across UITs before deciding which one to purchase.

Market Neutral Funds

Neutral funds attempt to provide a higher return than the risk-free rate (the rate on Treasury bills) while neutralizing their risk to zero. They try to accomplish this by fully hedging their portfolios through a series of long and short positions aimed at balancing off any risks to equal zero. Leveraging is used to earn a higher rate of return than the risk-free rate.

Option and Futures Funds

Option and futures funds are among the riskiest mutual funds available. This is because the fund does not own the securities underlying the options or the futures; it only owns the right or the obligation to buy or sell those securities at a certain date in the future. The goal of option and futures funds is primarily capital appreciation, although sometimes they are used to hedge against prevailing market conditions. Most option and futures funds have minimum net worth requirements and are not appropriate investments for inexperienced investors (just as options and futures aren’t appropriate for beginners).