There are many different types of funds to choose. In this section, we describe the main ones.
Investors can perform portfolio allocation by choosing different types of mutual funds
Introduction to Commodity Mutual Funds
Commodity funds invest in companies operating in energy, metals, agriculture, and related industries. Note here that if these are equity funds, most of the investments are made in commodity-producing companies such as those that own and explore the mines (i.e. gold, silver) rather than taking possession of physical commodities (i.e., gold and silver bullion). Therefore, a gold fund may invest its capital in gold-mining stocks and nothing in gold bullion. It is possible, however, to invest directly into physical assets, but this can usually be done with exchange-traded funds.
Introduction to Fixed-Income Mutual Funds
For investors looking to enter the world of fixed-income, these funds offer an easy start. In addition to diversification and professional management, investors can create monthly flows of income instead of waiting 6 months for interest payments as it happens with single bond investments. Alternatively, income can be reinvested in the fund. It’s worth to note that an important benefit of these funds is diversification. Fixed-income products such as bonds can lose value not only in the case of a default, but also when their rating is downgraded, or when interest rates change.
Among these funds, the investments are in a variety of fixed-income instruments such as US Treasuries, Municipal Bonds, Corporate Bonds, Foreign Bonds, and others. Also, investments are made in various maturities (short, medium, and long term). Exact investments depend upon particular fund’s objectives and its diversification purposes.
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In this article, we introduce different mutual funds such as equity, commodity, and fixed-income funds. If a fund is a combination of both (i.e., equity and fixed-income), then it is considered to be a balanced mutual fund.
Introduction to Equity Mutual Funds
Equity funds specialize in stock market investing. As a result, most of their holdings are composed of stocks.
Capital Growth Funds
These funds concentrate on investing in the stock market with the intention of generating capital gains. Within this type, more specialist funds can be found such as funds that invest in small, medium, or large capitalization stocks. More information about particular fund’s investment style is provided in a prospectus or fact sheet. The question here is: What is a small, medium, or large cap? There are different interpretations as to that and they differ among countries (a medium cap in the United States may be considered to be a large cap elsewhere). To give a good idea of what is small or large, the following classification is provided:
Company capitalization (USD) / Classification
Less than 250 million Micro cap
From 250 million to 1 billion Small cap
From 1 billion to 5 billion Medium cap
Over 5 billion Large cap
(Note: some classifications consider stocks with market capitalization of 250 billion or more to be Mega caps).
Market capitalization of a stock is based on the number of shares outstanding times its current price and is not about mutual fund’s assets under management. Thus, a medium cap mutual fund can have 10 billion USD under management, while some other small cap funds can have 20 billion USD in assets. What determines the type of a fund are the stocks within its portfolio, so if all the stocks in a portfolio have a market capitalization between 1 and 5 billion USD, then it is a medium cap fund, regardless of assets under management.
The asset manager will stick to the companies that fit within the capitalization. Therefore, a large cap fund will not buy (or, at least, is not supposed to buy) a small cap stock no matter how attractive it seems. The manager must stick to its intended investment style so investors can maintain their desired diversification. An investor may already hold small cap stocks in his or her portfolio, so when buying a large cap mutual fund, the investor expects the fund to only buy large cap stocks. A style drift is not well tolerated within the investment community.
Equity Income Funds
These funds invest a majority of their assets in dividend generating stocks, while also expecting capital gains. This style seeks dividends to add to a total return (capital gains plus dividends) while providing some cushion against stock price declines. The fund manager will look into companies that have a long history of paying dividends and strong balance sheets to sustain them. Normally, this would include stable and mature companies.
Although capital gains in mature companies tend not to be above average, a fund manager can, nevertheless, obtain above average returns when buying companies with distressed stock prices which will likely rebound. Plus, there’s an income component coming from dividends. Here a manager may invest in various cap stocks or choose to concentrate on a particular size such as large cap.
Managers of growth funds will seek companies with above average growth potential, usually in growing rather than mature or declining industries. Many tech or biotech companies can be found as holdings within these funds. Typically, these companies don’t pay out dividends as they tend to reinvest the profits into long-term growth. Capital appreciation, not income, is sought here.
These funds also seek capital growth, and often income. However, capital growth is sought not from hi-flying and relatively new companies (as is the case with many growth funds), but from finding companies with low P/Es and low Price-to-Book ratios. In many cases, these are companies that are trading at a discount as compared to their peers, or to their previous prices. Stocks that declined 50% or more and those that, in the fund manager’s view, have a potential for rebound can be found in Value Funds. These funds, like other mutual funds, may concentrate on specific market caps. For example, there are large cap as well as small cap Value Funds.
The focus here is on particular sector of the economy. There are technology, biotech, healthcare, natural resources, financial services, retail, and transportation funds to name just a few of the many options. Here, an investor may decide to invest in a particular sector (or sectors) for various reasons. An investor may think that a particular sector is undervalued and offers above average growth opportunities. Also, an investment in a specific sector can be made for diversification purposes as certain sectors are not correlated with each other, and may even move in the opposite directions.
Some sectors, such as food and health care, are not affected so much by recessions, while others, such as manufacturing and auto-making, are cyclical sectors, subject to downturns. The risk with sector funds is that these are not well diversified (only one sector), so an investor needs to add them only as a supplement to a portfolio.
Funds that invest abroad
There is a great variety of styles among these funds. There are global, international, regional, and country funds. In the United States, a global fund invests both domestically and internationally. On the other hand, an international fund invests only abroad.
Regional funds focus on a particular region such as Asia Pacific, Eastern & Central Europe, Latin America, Middle East, etc. These funds also have a specific focus. For instance, an international fund may focus only on large cap stocks that provide value. Another fund may seek small cap stocks that provide growth.
Meanwhile, country funds focus on a specific country such as China, Japan, Brazil, etc. What’s important to understand is that these funds lack much of diversification since they invest in a single country.
Since fact sheets and prospectuses can be obtained for free and easily (even instantly from the websites of mutual funds), the only way to find out more about what the funds are all about is to read this information. If an investor has already decided to invest internationally, then the research needs to be done as to which fund to choose among the great, ever growing, and constantly changing variety.