An overview of mutual funds and exchange traded funds

Abstract

It is now common in most parts of the world for investors to invest through mutual funds that pool in money from investors and invest on their behalf. The global asset management industry has grown to $ 55 trillion. This chapter provides an overview of the types of schemes available to investors. We also compare mutual funds with another type of funds called exchange traded funds. This chapter has the following objectives: • Provide an overview of the types of schemes of mutual funds • Compare exchange traded funds with mutual funds • List out the advantages and disadvantages of exchange traded funds vis-a-vis mutual funds Mutual funds offer individual investor an opportunity to diversify investment and provide professional money management often with affordable minimum investment amounts. A mutual fund is a security that pools money from investors to purchase stocks, bonds, or other securities for its portfolio.As a result, investors then typically own a portion of a portfolio that includesmanymore stocks and bonds than they could afford to purchase individually. Investors purchase shares of the portfolio the value of which increase or decrease based on the value of the investments it holds. The fund distributes any income it receives from stock dividends or bond interest to the shareholders, along with any capital gains from the sale of securities. A diversified portfolio with a variety of investments may reduce the impact of one poor performing investment by offsetting it with another that may perform well during the same time period. Therefore, the overall performance of the investments in a mutual fund's portfolio has the potential to provide better returns over the long term. Net new cash flow to stock and hybrid funds was $ 221 billion and investors also reinvested $ 42 billion of dividends in their stock and hybrid funds in 2004 in the United States. Individual investors, directly or indirectly, hold 90% of overall US mutual fund assets, and an even larger share of stock, bond, and hybrid fund assets. In 2004, individuals continued to use funds as one of their primary means to invest. For example, households made $ 360 billion in net purchases of stocks, bonds, and other long-term financial assets during the year, and long-term mutual funds were the principal means of making these purchases. Assets of the global fund management industry increased for the third year running in 2006 to reach a record $ 55.0 trillion. This was up 10% on the previous year and 54% on 2002. Growth during the past three years has been due to an increase in capital inflows and strong performance of equity markets. Pension assets totaled $ 20.6 trillion in 2005, with a further $ 16.6 trillion invested in insurance funds and $ 17.8 trillion in mutual funds. Merrill Lynch also estimates the value of private wealth at $ 33.3 trillion of which about a third was incorporated in other forms of conventional investment management. The United States was by far the largest source of funds under management in 2005 with 48% of the world total. It was followed by Japan with 11% and the UK with 7%. The Asia-Pacific region has shown the strongest growth in recent years. Countries such as China and India offer huge potential and many companies are showing an increased focus in this region. Exhibits 23.1 and 23.2 present the statistics on the worldwide mutual fund industry and league tables in 2006. © 2009 Springer-Verlag Berlin Heidelberg.