Mutual Funds and Other Pooled Investments

Mutual Funds and Other Pooled Investments

Separately Managed Accounts

SMAs, also referred to as managed accounts, wrap accounts, or individually managed accounts, are portfolios managed exclusively for the investor according to their investment, tax preferences, and requirements. The investor owns the underlying assets directly, unlike a mutual fund. Due to the individually tailored nature of SMAs, the minimum investment amount is significantly higher than that of a mutual fund, and institutional investors use them.

Many investors choose to participate in a pooled investment vehicle rather than assemble a portfolio of securities by themselves. There are several types of pooled investment vehicles. Mutual and exchange-traded funds (ETFs) tend to have low minimums, while hedge funds and private equity funds may require large investment amounts.

Pooled Investments

Mutual Funds

The value of a mutual fund is referred to as the Net Asset Value (NAV). It is computed based on the closing price of the fund’s underlying securities. Each investor owns a number of shares in the fund, which represents a pro-rata claim on the value of the mutual fund.

Open-end Fund

An open-end mutual fund will accept new investor inflows and issue new investors shares in the mutual fund priced at the NAV of the fund at the time of investment. Investors can also sell their mutual fund shares at the prevailing NAV. Therefore, the total number of shares at the disposal of the mutual fund will change depending on its net inflows or outflows.

The portfolio manager of an open-end fund has to manage the cash inflows and outflows. They may, in fact, have to liquidate fund assets to meet redemption requests. Otherwise, they may feel pressure stemming from the demand for more investment opportunities when there are large inflows to the fund. The structure makes it easy for the mutual fund to grow in size by attracting investor assets.

Closed-end Fund

A closed-end fund will not create new shares when a new investor wants to buy shares. Instead, an existing investor will have to sell their shares to the new investor. The total number of shares in issue is fixed. Transactions do not necessarily occur at the NAV of the fund but may be at a premium or discount to NAV.

The portfolio manager of a closed-end fund does not have to manage the cash inflows and outflows. Closed-end funds tend to attract fewer investor assets and only make up a small portion of the mutual fund universe.

Load and No-load Funds

Mutual funds can also be classified as load or no-load funds. A load fund charges investors a sales charge fee to buy, hold or sell shares in the fund. Retail brokers usually sell these funds. The brokers may receive a portion of the fee as a commission. These types of funds are increasingly becoming less popular.

A no-load fund does not charge a transaction-based fee but an annual fee based on a percentage of the fund’s NAV.

Types of Mutual Funds

Mutual funds are broadly classified according to the type of underlying assets they invest in.

Money Market Funds

Money market funds are often seen as substitutes for bank deposits. However, they are not insured in the same way. Therefore, there is some degree of risk over a bank deposit. Money market funds are either taxable or tax-free. Taxable money market funds invest in short-term corporate and federal government debt. Tax-free funds invest in short-term state and local government debt.

Bond Mutual Funds

Bond mutual funds invest in individual bonds and, occasionally, preference shares. A key difference between bond funds and money market funds is the maturity of the underlying bonds. Money market funds may hold positions with an overnight maturity. They rarely last longer than 90 days. A bond fund holds positions with maturities between 1 and 30 years. They also hold bonds of various credit ratings.

Stock Mutual Funds

Stock or equity mutual funds have the most assets under management globally. They can either be actively or passively managed. A passive fund is designed to track a particular index through a buy-and-hold strategy. On the other hand, an actively managed fund comprises equity securities selected by the portfolio manager seeking outperformance. The fees on actively managed funds are higher than those on passive funds and tend to be traded more actively. This more active trading has a tax implication. It attracts higher taxes relative to an index fund.

Hybrid or Balanced Funds

Hybrid or balanced funds invest in both equities and bonds. These funds are gaining popularity as lifecycle funds that target a particular retirement date become more sought after. A lifecycle fund tilts the mix of equities and bonds as the time for retirement draws near.

Other Pooled Investments

In addition to mutual funds, other pooled investments, such as Exchange-Traded Funds (ETFs), separately managed accounts (SMAs), hedge funds, buyout funds, and venture capital funds, are available to investors.

Exchange-traded Funds

ETFs track a basket of securities decided upon by the sponsor. The sponsor interacts with institutional investors who deposit the securities basket with the sponsor and receive creation units in the ETF in return. These units can then be sold to the public by the institutional investor. The institutional investor can also return their units to the plan sponsor in exchange for the securities basket. This creation and redemption mechanism helps ensure the ETF units are priced close to the NAV.

When an investor buys an index fund, the investor buys the shares directly from the fund. However, when an investor buys an ETF, the investor buys the units (shares) from other investors in the same way one buys trading equity securities. ETFs are priced throughout the trading day, and the purchase of an ETF share in the open market may not be conducted at the NAV but at a price that represents investor demand at the time. Under normal market conditions, this is usually close to the NAV.

ETF expenses tend to be lower than index funds, but brokerage is incurred when transacting. Dividends that arise in an ETF are paid out directly to the shareholders. Index funds and mutual funds tend to reinvest dividends.

The minimum investment amount for ETFs tends to be smaller than that for mutual funds, and investors may choose to buy a single share of the ETF.

Hedge Funds

Hedge fund strategies tend to be more complex than those of mutual funds. They can make use of leverage and extensive derivative positions. Many hedge funds are more loosely regulated than mutual funds. However, to be exempted from regulations, they may not market themselves to the general public.

The minimum investment amounts are usually high – millions of dollars – and hedge funds may impose liquidity restrictions. This means that investors have to commit to retaining and maintaining their investments for a particular period of time.

Buyout and Venture Capital Funds

Both buyout and venture capital funds invest in equity positions. Buyout funds aim to buy all the shares of a public company, thereby occasioning the privatization of the company. Often, large amounts of debt are issued in order to buy all the shares. This is known as a leveraged buyout (LBO). The intention is to use the company’s cash flow to pay down the debt and restructure the company. This makes the restructured operation suitable for an initial public offering (IPO) or sale to another company, thus providing an exit to investors.

Venture capital (VC) funds do not buy established companies but finance companies in a start-up phase. In addition to financing, VC funds offer close oversight and management input. As with buyout funds, the intention is to list or sell the funded company in a finite and relatively short time to create an exit for investors.


Which option correctly represents the characteristics of ETFs and index funds?

A. Index funds are priced throughout the trading day like equity securities.

B. When investors purchase an ETF, they pay a brokerage fee.

C. ETFs are always priced at the net asset value (NAV) at which investors transact at the closing price a day.


The correct answer is B.

ETFs trade like equity securities throughout the trading day. When buying ETF shares, investors pay a brokerage amount.

Option C is incorrect. ETFs are usually priced close to NAV but may be priced at a premium or discount, given market forces (supply and demand).

Option A is incorrect. Index funds are priced at NAV, do not attract brokerage fees, and are transacted at the closing price on the day.

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