A Mutual Fund is a professionally managed pool of funds collected from many investors for profitable investment in different types of investment vehicles (as guided by the fund’s investment objectives). Dividend is periodically paid to each subscriber based on their holding in the fund. They are also known as Unit Trusts.
Investment objectives create one of the categorizations of mutual funds – money market funds invest only in money market instruments; ethical funds avoid investments that may compromise one’s values e.g. tobacco and alcohol companies; equity funds limit their investments to the stock market, REITs invest in the real estate and infrastructure products, etc.
Mutual funds may be the best investment vehicle for the small beginner for many reasons. We are advised to do a thorough due diligence (DD) before investing. We are then expected to continue to monitor the performance of our investment. Not many beginners know what to look for during a DD exercise and since small investors cannot afford to pay for good investment advice, we end up at the mercy of unscrupulous stockbrokers. Investment in a mutual fund shifts the responsibility of due diligence and continuous monitoring to the fund managers. These professionals monitor the investment environment daily and invest only in the best products. A small beginner is thus able to enjoy otherwise inaccessible professional advice and management.
Another advantage of mutual funds for the small beginner is diversification. A fundamental requirement of investment management is portfolio diversification; following the adage – do not put all your eggs in one basket. If an investor in the stock market with one hundred thousand Naira decides to diversify her portfolio into five different blue-chip companies, she would have achieved the diversification objective but would not enjoy the dividends because trivial amounts of money would come in at five different times and so would not be useful for any significant purpose. If, however, she spends the one hundred thousand Naira on mutual fund units, the fund manager adds her money to the large pool of funds and spends it on as many equities as they choose. At the end of the year, they pay one dividend on her investment. So, she gets immediate diversification together with one concentrated and substantial return on her investment.
Cost of entry is quite low for mutual fund investments. Some of the best managed mutual funds in Nigeria require a minimum investment of just five thousand naira. This grants unparalleled economies-of-scale to the investor.
Mutual funds are able to easily buy and sell investments to take advantage of emerging opportunities in the market and so return higher margins to their subscribers. If an individual investor was to trade her shares that often, the commissions payable could wipe out any supposed benefits. This implies that even bigger investors would benefit from an investment in mutual funds.
Mutual funds are also categorized as either closed-ended or open-ended. A closed-ended fund sells a specified number of units during the new fund offer (NFO) and then concentrates on investing that amount alone. On the other hand, open-ended funds continue to accept additional subscribers and the pool of funds continues to grow. Some open-ended funds give subscribers the choice to either collect cash dividends or reinvest their dividends in more units of the fund. This stress-free reinvestment helps us to grow our investment without making additional investment decisions or even doing additional documentation.
Like all investments in the stock market, the value of an equities-focused mutual fund fluctuates, because the components of the fund (equities) fluctuate. Money market funds do not fluctuate like this. However, a well-managed equities fund is able to return higher returns than the market average. In Nigeria, whilst the stock market shrunk in 2018, some funds grew by as much as 10%. So, we must do due diligence on the fund managers. How well do they perform in comparison to their peers? How professional and ethical are they? How safe are the funds? What are their fees? Are they compliant with Securities and Exchange Commission (SEC) regulations? Our DD must confirm that there are no additional or hidden fees. How about “ease of exit”? Are their buying and selling prices publicly displayed? How easily would I get all or some of my money if I have a dire need? Some Nigerian fund managers promise to pay sales proceeds within 48 hours.
Mutual funds have many benefits, investors are well advised to consider this investment vehicle.