Mutual Funds

Exchange-traded grantor trusts

An exchange-traded grantor trust share represents a direct interest in a static basket of stocks selected from a particular industry. The leading example is Holding Company Depositary Receipts, or HOLDRS, a proprietary Merrill Lynch product. HOLDRS are neither index funds nor actively-managed; rather, the investor has a direct interest in specific underlying stocks. While HOLDRS have some qualities in common with ETFs, including low costs, low turnover, and tax efficiency, many observers consider HOLDRS to be a separate product from ETFs.[7][23]

[edit] Hedge Fund ETFs

Hedge fund ETFs are a new type of an ETF. A hedge fund ETF tracks a hedge fund and follow a group of hedge fund's activity. These new Hedge Fund ETF's are offered by IndexIQ they include IQ Hedge Multi-Strategy Composite, IQ Hedge Global Macro, IQ Hedge Long/Short Equity, IQ Hedge Event-Driven and IQ Hedge Market Neutral

Each of these hedge fund ETF's follows a general hedge fund strategy (Event-Driven, Market Neutral ect...).[24]

[edit] Leveraged ETFs

A leveraged exchange-traded fund, or simply leveraged ETF, is a special type of ETF that attempts to achieve returns that are more sensitive to market movements than a non-leveraged ETF.[25] Leveraged index ETFs are often marketed as bull or bear funds. A bull ETF fund might for example attempt to achieve daily returns that are 2.0 times more pronounced than the Dow Jones Industrial Average or the S & P 500. A bear fund on the other hand may attempt to achieve returns that are -2.0 times the daily index return, meaning that it will gain twice the loss of the market. Leveraged ETFs require the use of financial engineering techniques, including the use of equity swaps, derivatives and rebalancing to achieve the desired return.[26]. The most common way to construct leveraged ETFs is by trading future contracts.

History

Massachusetts Investors Trust (now MFS Investment Management) was founded on March 21, 1924, and, after one year, it had 200 shareholders and $392,000 in assets. The entire industry, which included a few closed-end funds represented less than $10 million in 1924.

The stock market crash of 1929 hindered the growth of mutual funds. In response to the stock market crash, Congress passed the Securities Act of 1933 and the Securities Exchange Act of 1934. These laws require that a fund be registered with the Securities and Exchange Commission (SEC) and provide prospective investors with a prospectus that contains required disclosures about the fund, the securities themselves, and fund manager. The SEC helped draft the Investment Company Act of 1940, which sets forth the guidelines with which all SEC-registered funds today must comply.

With renewed confidence in the stock market, mutual funds began to blossom. By the end of the 1960s, there were approximately 270 funds with $48 billion in assets. The first retail index fund, First Index Investment Trust, was formed in 1976 and headed by John Bogle, who conceptualized many of the key tenets of the industry in his 1951 senior thesis at Princeton University[2]. It is now called the Vanguard 500 Index Fund and is one of the world's largest mutual funds, with more than $100 billion in assets.

A key factor in mutual-fund growth was the 1975 change in the Internal Revenue Code allowing individuals to open individual retirement accounts (IRAs). Even people already enrolled in corporate pension plans could contribute a limited amount (at the time, up to $2,000 a year). Mutual funds are now popular in employer-sponsored "defined-contribution" retirement plans such as (401(k)s) and 403(b)s as well as IRAs including Roth IRAs.

As of October 2007, there are 8,015 mutual funds that belong to the Investment Company Institute (ICI), a national trade association of investment companies in the United States, with combined assets of $12.356 trillion.[3] In early 2008, the worldwide value of all mutual funds totaled more than $26 trillion.[4]

Usage

Since the Investment Company Act of 1940, a mutual fund is one of three basic types of investment companies available in the United States.[5]

Mutual funds can invest in many kinds of securities. The most common are cash instruments, stock, and bonds, but there are hundreds of sub-categories. Stock funds, for instance, can invest primarily in the shares of a particular industry, such as technology or utilities. These are known as sector funds. Bond funds can vary according to risk (e.g., high-yield junk bonds or investment-grade corporate bonds), type of issuers (e.g., government agencies, corporations, or municipalities), or maturity of the bonds (short- or long-term). Both stock and bond funds can invest in primarily U.S. securities (domestic funds), both U.S. and foreign securities (global funds), or primarily foreign securities (international funds).

Most mutual funds' investment portfolios are continually adjusted under the supervision of a professional manager, who forecasts cash flows into and out of the fund by investors, as well as the future performance of investments appropriate for the fund and chooses those which he or she believes will most closely match the fund's stated investment objective. A mutual fund is administered under an advisory contract with a management company, which may hire or fire fund managers.

Mutual funds are subject to a special set of regulatory, accounting, and tax rules. In the U.S., unlike most other types of business entities, they are not taxed on their income as long as they distribute 90% of it to their shareholders and the funds meet certain diversification requirements in the Internal Revenue Code. Also, the type of income they earn is often unchanged as it passes through to the shareholders. Mutual fund distributions of tax-free municipal bond income are tax-free to the shareholder. Taxable distributions can be either ordinary income or capital gains, depending on how the fund earned those distributions. Net losses are not distributed or passed through to fund investors.

Net asset value
Main article: Net asset value

The net asset value, or NAV, is the current market value of a fund's holdings, less the fund's liabilities, usually expressed as a per-share amount. For most funds, the NAV is determined daily, after the close of trading on some specified financial exchange, but some funds update their NAV multiple times during the trading day. The public offering price, or POP, is the NAV plus a sales charge. Open-end funds sell shares at the POP and redeem shares at the NAV, and so process orders only after the NAV is determined. Closed-end funds (the shares of which are traded by investors) may trade at a higher or lower price than their NAV; this is known as a premium or discount, respectively. If a fund is divided into multiple classes of shares, each class will typically have its own NAV, reflecting differences in fees and expenses paid by the different classes.

Some mutual funds own securities which are not regularly traded on any formal exchange. These may be shares in very small or bankrupt companies; they may be derivatives; or they may be private investments in unregistered financial instruments (such as stock in a non-public company). In the absence of a public market for these securities, it is the responsibility of the fund manager to form an estimate of their value when computing the NAV. How much of a fund's assets may be invested in such securities is stated in the fund's prospectus.

Average Annual Return

US mutual funds use SEC form N-1A to report the average annual compounded rates of return for 1-year, 5-year and 10-year periods as the "average annual total return" for each fund. The following formula is used:[6]

P(1+T)n = ERV

Where:

P = a hypothetical initial payment of $1,000.

T = average annual total return.

n = number of years.

ERV = ending redeemable value of a hypothetical $1,000 payment made at the beginning of the 1-, 5-, or 10-year periods at the end of the 1-, 5-, or 10-year periods (or fractional portion).

Turnover

Turnover is a measure of the fund's securities transactions, usually calculated over a year's time, and usually expressed as a percentage of net asset value.

This value is usually calculated as the value of all transactions (buying, selling) divided by 2 divided by the fund's total holdings; i.e., the fund counts one security sold and another one bought as one "turnover". Thus turnover measures the replacement of holdings.

In Canada, under NI 81-106 (required disclosure for investment funds) turnover ratio is calculated based on the lesser of purchases or sales divided by the average size of the portfolio (including cash).