An overview of mutual funds and exchange traded funds

An overview of mutual funds and exchange traded funds

[Chapter Introduction and Objectives]:
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 includes many more 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 II % 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.

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