Asset Management - Mutual Funds

What is a Mutual Fund?

It amazes me that with mutual funds approaching $50 trillion in global assets that many people don’t really understand what they are. Over the years I have used different methods to explain Mutual Funds, but I think a short fictional story conveys the basics the best.

Many decades ago, a worker realized that after paying all the bills he had $5 left over each month and decided he wanted to invest for the future. He walked into the branch of the local Investment institution and sat down with the investment broker to discuss making the investment.

To his surprise the broker was not too interested in setting up the account or taking a $5 deposit. He suggested placing the monies in a bank account until he had a more substantial amount. The broker went on to explain that such a small amount would allow for the purchase of only one stock or bond creating a rather risky proposition. Furthermore, because of the small amount, the fee to process the transaction would be relatively high and he would not be able to monitor the account. The worker stuffed his $5 back in his pants and went home.

Over the next few weeks, he related the story to family, friends and coworkers and was shocked to learn that most of them had run into the same attitude. Motivated by the mutual frustration he came up with what he believed was a solution.

Why not enter into an agreement with like-minded familiy, friends and co-workers to pool their monies and each month approach the broker with the total of all their savings (let’s assume $100 or $200 a month).

They approached the Broker as a group, and he was so interested that:

• The group was able to diversify their holdings over a number of stocks and bonds.
• Because of the contribution of a fairly substantial amount each month, he even agreed to review the account regularly and make recommendations for additions and changes to the portfolio.
• The broker also agreed to reduce the fees for the entire group.

That is essentially what a Mutual fund is, a group of many people investing in a specific investment mandate to reap the Mutual benefit of Pooled Assets, Diversification, Professional Money Management and Lower Fees.

In actual fact, Dutch merchant, Adriaan van Ketwich, had the foresight to pool money from a number of subscribers to form an investment trust in 1774. The financial risk to the mainly small investors was spread by diversifying across a number of European countries and the American colonies, where investments were backed by income from plantations.

Benefits of Mutual Funds

Risk diversification

Mutual funds help investors lower risk by investing in a broad selection of securities consistent with the mandate of the fund.

Smaller capital outlay

Investors would require a large capital outlay to build a diversified portfolio of individual stocks and bonds. Since mutual funds work on the basis of pooling money, mutual fund investors can have the beneficial ownership of a diversified portfolio of investment securities with a much smaller individual capital outlay.

Investment expertise

"Actively Managed" mutual funds are guided by professional fund managers who are expert in that specific investment sector.
For Exanple: Canadian Dividend funds are managed by experts in dividend paying stocks in Canada; a Global Infrastructure fund is managed by a team of experts around the world concentrated on Infrastructure projects; Emerging Market Bond funds are managed, not by a bond trader in NYC, but by a number of experts most likely located in different locals around the Emerging Markets .

Economies of scale in transaction costs

Since mutual funds buy and sell securities in large volumes, transaction costs on a per unit basis are much lower than what retail investors would likely incur if they buy or sell shares investment securities independantly.

Variety of products

Dozens of fund categories and thousands of funds offer investors a variety of products to suit their risk profiles and investment objectives. In one category alone (e.g. US Equity) you can choose from Growth, Value, Dividend Paying, Large Cap, Small Cap, Defensive, Corporate Class and T Class for tax efficiency, or passive exchange traded funds (ETF), index funds and more....

Variety of modes of investments

Investors can opt for different investment modes like lump sum, systematic investment plans (contribute Weekly, Bi-weekly, Semi-monthly, Monthly, Quarterly etc.) systematic withdrawal plans (deposit to bank account) as well as purchase modes including Front End Load (FEL), Deferred Sales Charge DSC), No Load (NL) and F-Series & FCL for Fee based accounts.

Disciplined investing

Share prices are highly volatile and can induce the investor to buy or sell in the short term due to fear or greed. Mutual funds encourage investors to invest over a long-time horizon, which is essential to creating wealth. Furthermore, systematic investment plans encourage investors to invest in a disciplined manner to meet their long-term financial objectives.