What are mutual funds?
Mutual funds are investment vehicles that pool money collected from multiple investors to invest in diverse securities, like stocks, bonds and other assets such as derivatives. The funds are managed by professional portfolio managers and are typically actively managed.
A complex mutual fund is an investment fund, usually actively managed by a fund manager, which can be leveraged and/or use derivatives as part of the investment strategy. A complex mutual fund may invest in illiquid assets.
There are several types of mutual funds, including:
- Money market funds: These funds invest in short-term, low-risk, high-quality bonds.
- Bond funds: These have a higher risk than money market funds and make long-term investments into bonds specified in the fund’s investment objective.
- Stock funds: These funds invest directly in corporate stocks.
- Balanced or Mix funds: These funds invest in a combination of assets – stocks, bonds and other funds.
- Alternative investment funds: These funds invest in non-traditional assets like direct-infrastructure, derivatives, private equity, non-listed products etc.
A fund has a Key Information Document (KID) which holds basic information about the instrument, such as its investment objective, fund cost and charges, and historical performance.
Leveraged mutual funds
Trading with leverage refers to when borrowed funds or derivatives are used to control a larger position and in order to amplify potential returns (or losses). Mutual funds can be leveraged products, meaning they aim to provide amplified returns based on the performance of the underlying asset.
For example, a 2X leveraged fund may seek to deliver twice the daily return of the underlying asset. However, leverage also increases the potential risk and can result in larger losses. These funds don’t typically come in versions with, e.g., 2X leverage but are more often around 10-30%, if they are utilising leverage.
What affects mutual fund prices?
Mutual fund prices can be influenced by several factors, including:
Market conditions: Changes in overall market performance, economic indicators or investor sentiment can all impact fund prices.
Asset performance: The value of the underlying securities, alternatives or derivatives held by the fund can affect its price.
The issuer of the fund typically calculates a price (NAV, or net asset value) which represents the value of all underlying instruments divided by the number of units in circulation. These are usually calculated daily, but certain instruments may be calculated less frequently.
What are the risks when trading mutual funds?
When trading mutual funds, it’s important to be aware of the potential risks. These include:
- Market risk: The risk that a fund’s value will decrease due to broader market fluctuations.
- Liquidity risk: The risk that a fund holds illiquid assets that are difficult to sell quickly without impacting their prices.
- Other risks: Depending on the specific type of fund, there may be additional risks, such as currency risk, interest rate risk, credit risk or geopolitical risk.
- Psychological risks: Emotional decision-making and lack of discipline can lead to poor trading outcomes.
How much can you lose trading mutual funds?
The maximum loss you can face when trading mutual funds depends on the amount invested and the performance of the fund. If all the underlying assets fell to zero, it would be possible to lose the entire investment.
Potential additional costs/charges with mutual funds
While mutual funds charge different costs, the main cost is the ongoing cost, which represents the annual fee for managing the fund. This covers operational costs, administrative expenses and management fees. The ongoing cost is deducted from the fund’s assets and is reflected in its net asset value.