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Less Popular Types of Mutual Funds – Part 1

By: , dated January 25th, 2013

The mutual funds in this section cannot be classified as either stock funds or bond funds. Some, like lifecycle funds and balanced funds, invest in both stocks and bonds, while others, like money market funds, invest in neither.

Money Market Funds 

Money market funds are among the safest and most stable of all the different types of mutual funds. These funds invest in short term (one day to one year) debt obligations such as Treasury bills, certificates of deposit, and commercial paper . The main goal is the preservation of principal, accompanied by modest dividends. These funds are in no way guaranteed or insured by the federal government or any other institution. Although money market mutual funds are among the safest types of mutual funds, it still is possible for money market funds to fail. But given the conservative nature of their investments, such scenarios are highly unlikely. In fact, the biggest risk involved in investing in money market funds is the risk that inflation will outpace the funds’ returns, thereby eroding the purchasing power of the investor’s money .

Income Funds

Income funds focus on providing investors with a steady stream of fixed income. In order to achieve this, they might invest in bonds, government securities, or preferred stocks that pay high dividends . They are considered to be conservative investments, since they stay away from volatile growth stocks. Income funds are popular with retirees and other investors who are looking for a steady cash flow without assuming too much risk.

Balanced Funds

The purpose of balanced funds (also sometimes referred to as “hybrid funds”) is to provide investors with a single mutual fund that combines both growth and income objectives. In order to achieve this goal, balanced funds invest in both stocks (for growth) and bonds (for income). Balanced funds typically invest no more than 50% of their money in stocks, with the rest allocated to debt instruments. Such diversified holdings ensure that these funds will manage downturns in the stock market without too much of a loss; the flip side, of course, is that balanced funds will usually enjoy fewer gains than an all-stock fund during a bull market.

Asset Allocation Funds

Asset allocation funds are a type of balanced fund that invest in a number of different asset classes, such as stocks, bonds and cash. They are similar to balanced funds, except they invest in many other types of asset classes in addition to stocks and bonds (e.g. money market accounts).

International, Global, Regional, and Emerging Markets Funds

If one of the goals in mutual fund investing is diversification, then what better way to achieve that goal than by investing in assets from all over the world? That is the logic underlying global mutual funds (also sometimes called world funds). Such funds invest throughout the world, including in the U.S. Global mutual funds can provide more opportunities for diversification than domestic funds alone. You should take into account, however, that there can be additional risks associated with global funds involving currency fluctuations and political and economic instability abroad.

International funds (sometimes referred to as foreign funds) are similar to global funds but with one major exception: they do not invest in any domestic assets. International funds therefore do not offer as great an opportunity for diversification as global funds, but they are useful for investors who want to concentrate their holdings in foreign assets only, or who already have significant domestic investments in their portfolio. As with global funds, international funds can involve risks associated with currency fluctuations and political and economic instability abroad.

Regional funds can be thought of as a particular type of international fund that focuses on only one particular region — for example, Western Europe or Latin America. Even more specific are emerging markets funds that invest only in the capital markets of foreign countries that are undergoing dramatic economic transitions, such as those economies that are transforming from an agricultural economy to an industrialized one (as in the case of many third world countries) or those that are transforming from a state-run economy to a free-market one (as in the case of many former Eastern bloc countries). Emerging markets funds offer potentially higher-than-normal returns due to these economic transitions, but they can also involve a significant amount of risk if the economic transition fails or if there is instability in the country or its currency.

Mortgage-Backed Securities Funds

Mortgage-backed securities funds invest in home mortgage securities that are offered through several government agencies. These agencies, such as “Ginnie Mae” (the Government National Mortgage Association) and “Freddie Mac” (the Federal National Mortgage Association), purchase and then pool together groups of home mortgage loans, which they then later resell to investors (such as mutual funds) as a single security. Mortgage-backed securities funds receive interest payments on the mortgages, which they pass on to shareholders, as well as principal payments, which they use to reinvest in more securities . These funds are considered to be very safe since mortgage-backed securities from the aforementioned agencies are either backed by the federal government or they have very high credit ratings. However, these funds may suffer from prepayment risks (in which case the mortgagor may pay off the principal earlier than anticipated) and interest rate fluctuations (which could cause the value of the fund to go up and down).

Hedge Funds

Hedge funds are funds that use a variety of aggressive investing strategies (such as short selling, investing in derivatives, and leverage) to seek higher returns. Hedge funds are exempt from many of the rules and regulations governing other mutual funds, which allows them to accomplish aggressive investing goals. They are restricted by law to no more than 100 investors per fund, and as a result most hedge funds set exceptionally high minimum investment amounts, ranging anywhere from $250,000 to over $1 million. As with traditional mutual funds, investors in hedge funds pay a management fee; however, hedge funds also collect a percentage of the profits (usually 20%).

For Part 2 of this article, please click here.

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