Fund supermarkets are analogous to grocery supermarkets: they allow consumers to buy a variety of goods from different producers at one central location. In the case of fund supermarkets, the consumers are investors, the producers are mutual fund families, and the central location is a brokerage firm. The primary benefit of such an arrangement is simplicity: you get to buy funds from different families and receive all their statements in a single report. Fund supermarkets are also supposed to save on costs, since the funds are usually traded with no commissions and no transaction fees. In reality, however, the supermarkets charge the fund families a stiff fee, which is then passed off to investors through the form of expense fees or reduced distributions.
Funds of Funds
“Funds of funds” (FOFs) are meta-mutual funds; that is, they are mutual funds that invest in other mutual funds. Just as a normal mutual fund invests in a number of different securities, so an FOF buys shares of many different mutual funds. These funds were designed to achieve even greater diversification than normal mutual funds; however, they suffer from several drawbacks. Expense fees on FOFs are typically higher than those on regular funds because they include part of the expense fees charged by the underlying funds. But even FOFs with low fees may suffer from another disadvantage: duplication. Since FOFs buy many different funds which themselves invest in many different stocks, it is possible for the FOF to own the same stock through several different funds. Most experts say that FOFs are not terribly useful, given that one or a few mutual funds can provide adequate diversification without the second level of fees.
Starting in the early 1990s, many mutual fund families began offering “lifecycle” funds designed to carry investors from one stage of life to the next. The idea is to offer investors three types of funds — high growth, average growth, and low growth — that they can switch between as their risk tolerance changes once they move from youth to middle age to retirement. Although lifecycle funds all share the common goal of first growing and then later preserving principal, they can contain any mix of stocks, bonds, and cash.
Institutional funds are mutual funds that target pension funds, endowments, the wealthy, and other multi-million dollar investors. Their main objective is to reduce risk, so they invest in hundreds of different securities, which makes these funds among the most diversified funds available. They also do not tend to trade securities very often, so they are able to keep operating costs to a minimum. Although in the past investors typically needed at least $1 million in order to invest in an institutional fund, nowadays some discount brokers offer access to these funds for more modest sums of money, such as $1,000-$5,000.
Socially Responsible Funds
Perhaps the most subjective of all the types of mutual funds, socially responsible funds aim to invest only in companies that adhere to certain ethical and moral principles. Exactly what this means obviously varies from fund to fund, but some examples include: funds that only invest in environmentally conscious companies (“green funds”), funds that invest in hospitals and health care centers, and funds that avoid investing in alcohol or tobacco companies. Socially responsible funds try to maximize returns while staying within these self-imposed boundaries.
Contrarian funds seek to make a profit by investing in the opposite direction of the prevailing market sentiment. During the extended bull market of the 1990s this term actually came to be equated with bear market investing, but really it just means investing in the opposing direction . Contrarian funds will invest in bonds when the stock market is high (in anticipation that it will fall) and stocks when the stock market is low (in anticipation it will rise).
GIC funds are mutual funds that invest solely in guaranteed investment contracts (GICs). GICs are fixed income debt instruments sold by insurance companies to pensions and other types of retirement plans. They pay a fixed interest rate over a short period of time, usually about 5 years, and they are guaranteed by the insurance agency that issues them, not by the government. As with other mutual funds that invest in debt instruments, GIC funds are generally considered to be conservative investments.
Unit Investment Trusts (UITs)
Unit Investment Trusts (UITs) technically are not a type of mutual fund, but they behave similarly to them. Like mutual funds, UITs pool together money from a group of investors and then use that money to purchase a basket of securities (usually bonds but occasionally stocks). Unlike mutual funds, however, UITs do not later buy and sell more securities for their portfolio — in other words, a UIT’s portfolio is frozen after the initial securities are bought. And unlike mutual funds, UITs have expiration dates (usually anywhere from one to five years); after a UIT expires, investors may choose to receive their investment in cash (minus operating costs and sales charges) or they can roll over their investment into a new UIT. Some investors prefer UITs to mutual funds because UITs typically incur lower annual operating expenses (since they are not buying and selling shares); however, UITs often have steep sales charges and entrance/exit fees that could end up costing more than the fees paid to a mutual fund. The other problem with UITs is that they can only be purchased through the investment houses that created the trust and not on the open market. This can make it difficult for investors to find pricing information for the UIT, and so it can be quite difficult for investors to compare prices across UITs before deciding which one to purchase.
Market Neutral Funds
Neutral funds attempt to provide a higher return than the risk-free rate (the rate on Treasury bills) while neutralizing their risk to zero. They try to accomplish this by fully hedging their portfolios through a series of long and short positions aimed at balancing off any risks to equal zero. Leveraging is used to earn a higher rate of return than the risk-free rate.
Option and Futures Funds
Option and futures funds are among the most risky mutual funds available. This is because the fund does not own the securities underlying the options or the futures; it only owns the right or the obligation to buy or sell those securities at a certain date in the future . The goal of option and futures funds is primarily capital appreciation, although sometimes they are used to hedge against prevailing market conditions. Most option and futures funds have minimum net worth requirements and are not appropriate investments for inexperienced investors (just as options and futures aren’t appropriate for beginners).