Mutual funds or Unit Trusts, refer to a pool of funds obtained from different investors, individuals or companies, for investing in assets like stocks, bonds, and other financial assets. As such, mutual funds provide an easy and less stressful investment avenue, especially for investment beginners.
Mutual funds are managed by professional fund managers whose goal depends on the type of mutual fund and the investors’ objectives. For instance, investors’ objective might be earning the highest return with minimum risk, so the fund manager invests in fixed-income assets.
Classification of Mutual Funds
There are two broad classifications of mutual funds:
- Closed-end funds refer to mutual funds that offer a limited number of shares to the public through an initial public offer to raise fixed capital. No additional shares are issued after the initial public offering, with the demand and supply heavily dictating the shares’ price. Due to this, close-ended fund shares often trade at a discount of the net asset value (NAV).
- Open-Ended Funds refer to a diversified portfolio of investors’ funds that can directly sell shares and redeem them. The number of shares that can be issued is unlimited, and the share price depends on the Net Asset Value (NAV), which is the price of a fund unit. Typically, the fund will issue shares at the current net asset value, and on sale of the shares, the fund will redeem them.
Types of Mutual Funds
Money Market Funds
These are short-term debt instruments with low risk and, as such lower returns. The environment for this investment option is safe and comprises instruments such as government treasury bills, commercial papers, and negotiated fixed and call deposits.
The underlying assets of money market funds are highly liquid, allowing an investor to withdraw their funds within a short notice of 2 to 5 working days. Money Market Funds in Kenya offer a return of 4% to 10%.
Equity funds, also stock funds, have shares as the primary investment asset. If a fund has more than 60% of its portfolio in shares, it is considered an equity mutual fund.
Depending on the company’s size, the funds are grouped into;
- Large-cap- for shares with companies that have a large market capitalization
- Mid-cap – comprising of companies with a medium market capitalization
- Small-cap – includes stocks for companies with small capitalization.
Market capitalization or market cap is the value of outstanding shares of a publicly-traded company.
Further, equity mutual funds are also classified based on their growth prospects. Growth funds involve investing in stocks that are highly prospective such as innovative companies. On the other hand, value funds look into stocks for companies that are not favored by the market but have great potential.
Thus, a mutual fund can derive its strategy depending on the company size and the growth prospects or a combination of both, making it less risky.
Fixed Income Funds
This mutual fund comprises investment options that give a constant return and include bonds from corporates and government. If a mutual fund has more than 60% of its underlying assets in debt instruments, it’s a fixed income fund.
Debt instruments are considered less risky than shares, making the return lower. However, corporate bonds are riskier than government bonds and offer a higher return.
Balanced / Hybrid Funds
Balanced mutual funds invest in debt instruments and equities to diversify the portfolio and balance the risk and reward ratio. Most balanced funds are actively managed, allowing the fund manager to modify the portfolio’s asset allocation depending on the market conditions.
Benefits of Investing in Mutual Funds
Professional Portfolio Management
Investment in mutual funds is highly lucrative as the individual investor does not have to research, speculate, or trade by themselves. The fund managers do all the work for you.
Mutual funds offer diversification compared to investing in stocks only. This helps reduce portfolio risk even when the market is volatile.
Affordability and Economies of Scale
Because mutual funds involve collecting funds from investors into a large pool, small investors can participate and gain the upper hand in accessing the market without the need for a huge capital outlay. It makes it easy for the investors to reap from the diversification without the high cost of doing so individually.
For example, some mutual funds in Kenya, like money market funds, allow you to start with an initial amount as low as Ksh. 1,000.00.
The ability to invest in mutual funds or withdraw at any time comes with a lot of merits. Open-end mutual funds offer this flexibility, making them a preferred investment option.
Easier Tracking and Regulation
Most institutions that deal with mutual funds offer statements to investors that show how their funds are performing. Other funds are embracing technology where you can access your investment account online or via apps. This, coupled with the fact that mutual funds are diligently regulated, makes them a suitable investment option.
Disadvantages of Mutual Funds
Fees and Commissions
One of the disadvantages of mutual funds is the fees and commission investors pay for the fund’s management, mostly when managed actively.
For instance, some funds in Kenya charge a commission fee of 2% to 2.5% per annum, which can lower your net return. Before investing with any firm, consider other details, including fees and commissions.
Difficulty in Comparison
It is not easy to compare different mutual funds from other companies, especially where information is not made public.
Mutual Funds in Kenya
Mutual funds in Kenya are categorized into three groups. The money market funds for short-term instruments and dividend funds with medium risk and consists of publicly traded shares, government instruments, and corporate bonds. The third category is the balanced fund that is a hybrid for both the money market and dividend funds.
Numerous investment companies in Kenya offer mutual funds, including:
- Britam, which offers different funds like a money market fund, a balanced fund, an equity fund, and the Britam BondPlus Fund.
- Zimele Asset Management, whose mutual funds include a balanced fund and a money market fund
- CIC Group, with products like the CIC Equity Fund, CIC Balanced Fund, CIC Fixed Income Fund, and the CIC Money Market Fund.
- UAP Old Mutual, which has a Money Market Fund, Balanced Fund, and an Equity Fund.
- Sanlam Investments, which offers a Money Market Fund, Dividend Plus Fund, and a balanced fund.
- ICEA Lion, whose unit trusts include an Equity Fund, Growth Fund, Bond Fund, and a Money Market Fund.