Mutual Funds - An Introduction And Brief History
By
Sachin A.
Each one of us does not have the expertise or the time to
build and manage an investment portfolio. There is an
excellent alternative available – mutual funds.
A mutual fund is an investment intermediary by which people
can pool their money and invest it according to a
predetermined objective.
Each investor of the mutual fund gets a share of the pool
proportionate to the initial investment that he makes. The
capital of the mutual fund is divided into shares or units
and investors get a number of units proportionate to their
investment.
The investment objective of the mutual fund is always
decided beforehand. Mutual funds invest in bonds, stocks,
money-market instruments, real estate, commodities or other
investments or many times a combination of any of these.
The details regarding the funds’ policies,
objectives, charges, services etc are all available in the
fund’s prospectus and every investor should go
through the prospectus before investing in a mutual fund.
The investment decisions for the pool capital are made by a
fund manager (or managers). The fund manager decides what
securities are to be bought and in what quantity.
The value of units changes with change in aggregate value
of the investments made by the mutual fund.
The value of each share or unit of the mutual fund is
called NAV (Net Asset Value).
Different funds have different risk – reward profile.
A mutual fund that invests in stocks is a greater risk
investment than a mutual fund that invests in government
bonds. The value of stocks can go down resulting in a loss
for the investor, but money invested in bonds is safe
(unless the Government defaults – which is rare.) At
the same time the greater risk in stocks also presents an
opportunity for higher returns. Stocks can go up to any
limit, but returns from government bonds are limited to the
interest rate offered by the government.
History of Mutual Funds:
The first “pooling of money” for investments
was done in 1774. After the 1772-1773 financial crisis, a
Dutch merchant Adriaan van Ketwich invited investors to
come together to form an investment trust. The goal of the
trust was to lower risks involved in investing by providing
diversification to the small investors. The funds invested
in various European countries such as Austria, Denmark and
Spain. The investments were mainly in bonds and equity
formed a small portion. The trust was names Eendragt Maakt
Magt, which meant “Unity Creates Strength”.
The fund had many features that attracted investors:
- It had an embedded lottery.
- There was an assured 4% dividend, which was slightly less
than the average rates prevalent at that time. Thus the
interest income exceeded the required payouts and the
difference was converted to a cash reserve.
- The cash reserve was utilized to retire a few shares
annually at 10% premium and hence the remaining shares
earned a higher interest. Thus the cash reserve kept
increasing over time – further accelerating share
redemption.
- The trust was to be dissolved at the end of 25 years and
the capital was to be divided among the remaining
investors.
However a war with England led to many bonds defaulting.
Due to the decrease in investment income, share redemption
was suspended in 1782 and later the interest payments were
lowered too. The fund was no longer attractive for
investors and faded away.
After evolving in Europe for a few years, the idea of
mutual funds reached the US at the end if nineteenth
century. In the year 1893, the first closed-end fund was
formed. It was named the “The Boston Personal
Property Trust.”
The Alexander Fund in Philadelphia was the first step
towards open-end funds. It was established in 1907 and had
new issues every six months. Investors were allowed to make
redemptions.
The first true open-end fund was the Massachusetts
Investors’ Trust of Boston. Formed in the year 1924,
it went public in 1928. 1928 also saw the emergence of
first balanced fund – The Wellington Fund that
invested in both stocks and bonds.
The concept of Index based funds was given by William Fouse
and John McQuown of the Wells Fargo Bank in 1971. Based on
their concept, John Bogle launched the first retail Index
Fund in 1976. It was called the First Index Investment
Trust. It is now known as the Vanguard 500 Index Fund. It
crossed 100 billion dollars in assets in November 2000 and
became the World’s largest fund.
Today mutual funds have come a long way. Nearly one in two
households in the US invests in mutual funds. The
popularity of mutual funds is also soaring in developing
economies like India. They have become the preferred
investment route for many investors, who value the unique
combination of diversification, low costs and simplicity
provided by the funds.
About the Author: Know more about mutual funds at
http://www.completeonlinetrading.com
Source:
www.isnare.com