The Characteristics of Close-Ended Mutual Fund - Essay Example

Introduction Mutual Fund is a term, meaning joint venture. As the human minds evolve more civilized, it also has undergone many evolutionary postures. Formerly it was practiced as close ended mutual fund in which combined investment had limits. Simply in those funds a restricted number of investors were allowed to play. As a result they used to have limited profit. While following the same pattern some innovative thoughts were put together along with the basic ingredients of the recipe of mutual funds to make it more reproductive. The consequences resulted in the body of open ended mutual funds. These open ended funds are still hailing the demanding curse of present age. Using the mutual fund scheme was more beneficial for the investors and was less fruitful for the manager or the body managing and investing the funds. Therefore to make more money from limited funds a newer system was stemmed into the fabric of trade. That system was to engage poor into this business by investing money in the form of blocks. This trick helped the managing body to withdraw more money out of the flow in the form of commission. On the contrary it involved less investment share which was easy to contribute by an average investors. Hence it had the characteristics of close ended mutual fund accompanied by replication of index. This system was easy to manipulate and friendly to the traders. In a nut shell the trade of funds took place in exchange of securities. It was a simple game that could be played without time limit. It had small shares than mutual funds, was more idealized and encouraged by majority of traders and investors. This scheme of investing the funds was given the name of exchange trade funds. It is the combination of index fund and close ended fund. Exchange trade system is more efficient than mutual fund system because it is easy to trade on fewer expanses and trade does not have time limits, buying and selling can be performed in same day. “ETFs have very low expense ratios, are traded intraday and are purchased from the secondary market through a broker who receives a commission”. (Rogers 108) History The idea of joint or combined investment is centuries old even when there was no concept of currency. This fashion of mutual investment was started by the merchants particularly in Europe. While peeping into the past, the merchants of 17th century practiced to take their goods to the far areas where they were able to earn a handsome interest on their investment. But the urge to gain more profit forced their minds to seek some new trends in order to improve their profits. “Comfort with an investment vehicle is not a luxury but rather a necessity” (Wiandt and McClatchy 26). Hence to calm this curse of earning more they started to invest the money of other people into the business. In return these merchants promised to give them profit according to share. So this was the beginning of mutual fund practice. The investment shares incorporated by merchants did not have any limits that mean it was an open ended trade. The profits yielded were divided on the total shares and after subtracting the commission of trading agent distributed among the share holders. Till that time no legal frame work was existed to look after this innovative business. The people were getting more money and the government was not involved. In other words profit was there earning was there but no concept of tax existed. Hence, in 18th century this business was in its optimum youth and acquired the attention of the whole world. The custom of combined investment took its roots in U.K, U.S in 18th century but the trend of investment was close ended. This trend of close ended investment remained in exercise till early 19th century. After the crash of stock market investors started discouraging the close ended investment and once again open ended investment was in top gear. The major issue of concern was that there did not exist any system which can resolve the conflicts of interest. To regulate this business properly, regulatory bodies like securities act of 1933 and securities exchange act of 1934 were established. In the light of these acts mutual funds need to be registered with the Security Exchange Commission in order to resolve interest conflict. But these acts still had some loop holes and were not able to govern the mutual interests properly. As a result mutual fund investment could not pick up that pace what it could have if provided with complete set of regulations. In short to resolve the remaining issues of conflict in 1940 investment company act was born. After the formulation of legal frame work the mutual fund investment took the position of world’s one of largest growing industry. In the late 19th century hundreds of new investors invested their money to kill the appetite of this industry and earned money with profits. For the open ended mutual investment the investors had to pay a big share to the investing manager to earn profit, it was a quite expansive and time consuming process. Moreover, the poor and standard class of investors had high risks of investment particularly after the stock market crash. To overcome this problem in the late 19th century a new tool of trading was introduced. This tool was purely to encourage the poor and standard class investors had small investments and was less expansive than mutual fund investment. The way this tool works was very simple, the procedure of its working was to own a representative collection of securities. This collection was based on tracking the current market index at that time. The tracking of index was done by statistical sampling of the market trend. By this tool investor had an idea that what could he earn by looking the previous market history or index. This tool was given the name of Index fund. Index fund was less expansive more realistic less time consuming but had fewer profits. “Index funds has much lower operating expanses than actively managed funds because they are passively managed”. (Jones 150) Therefore search for an intermediate tool could not come to an end. By keeping the index fund under observation some characteristics of close ended fund was incorporated into it. This merger of two trading systems gave rise to a new fund in which exchange of index fund securities took place. This system was more efficient than solitary mutual fund and index fund system and became popular at more speed than either of the aforementioned funds. This new system was given the name of Exchange Trade Fund. It was not as expansive as open ended mutual trade fund was, not as risky as index fund that was purely based on the previous market fashion. So by the present time two major systems of trading are in practice and they are mutual funds and exchange trade funds. There is a lot of controversy among the traders regarding the weight of either of the systems but exchange trade fund has found to be more favorite by the investors. The reason could be again that it is the human psychic that they want to play safe with least risks and desirable profits. How one should choose the mutual fund or the ETF As a matter of fact both of the funds are working to earn money. But the debate on their selection is very sarcastic and controversial. As all of the individual investors do not belong to the same financial background, hence the first thing to consider is the amount or money one has to perform trade with. This is important because it is obvious from the past experiences that money is the thing that can be earned only by dealing sensible investments., “Today’s financial advisors say that their investment clients seem to be comfortable with ETFs”. (Wiandt and McClatchy 26) Let us talk about the mutual funds first, these funds are more suitable for the investors having a big amount to play the trade at their own. Because the expanses for playing mutual fund trade are higher, suppose, if someone has to invest a big amount then the percentage of commission would be negligible but on the contrary on small amounts it counts a lot where someone is spending fewer money. So in case of small investments exchange trade fund is more favorable. “as the end of 2001, the assets of all ETFs totaled some, $83 billion, up from $58 billion at the beginning of the year.” (Jones 150) The game of earning money by trading requires a lot of skills and a sense of capturing the market trends. In other words, a new comer in this game has very small chances to win unless he has a big amount to invest. This shows that mutual fund investment would be more paying to new comers with large capitals. On the other hand a new comer with small investment would go for the exchange trade fund but that require a lot of practice in order to become more sensitive to market trends. Nevertheless market sense would not be there chances of winning exchange trade are narrow. But, in present time this problem has been over come by the involvement of agents that do have particular knowledge about market trend. “reason for relatively low index fund costs is that managers in this fund hold broadly diversified portfolios designed to match the investment returns of the overall market”. (Feldstein 29) These agents invest the small amounts of other people having no or least knowledge of trade into exchange trade and give them short term profits. Here again the ball is in the court of exchange trade due to the reason that majority of the investors belong to a standard class rather than big investors. This is why the exchange trade is gaining fame around the globe. Evidence that goes in favor of the exchange funds is that they are exempt of the taxes or have to subject little taxes because they are traded as stock. On the other hand mutual funds comprise big amounts and are liable to taxes heavily comparatively than exchange trade funds. Therefore exchange trade fund is the subject of choice for the players with less money. Effect of time spectrum on Mutual funds and ETFs Though the present time is entitled to the exchange trade funds but they are only effective for a short period of time. But one of the back draws of exchange trade funds is that one has to follow the index of the market. And most of the exchange trading takes place on the previous market fashion. Market is a very volatile subject and no one can portrait the hundred percent trend of market. “ETFs may simplify the process of building a portfolio that corresponds to a specific asset allocation model”. (Morris 109) Therefore, it is good to do exchange trade but not in long terms. The ease of this trade is one can sell the stock before it goes to decline. But if he missed the case the results could be catastrophic. Mutual funds on the other hand are safe investments and do not subject to sudden decline. Because they do not have as much liquidity as shown by exchange trade funds. If one has large amounts to invest for a long term investment mutual funds are the choice of trade. Here again the problem of generating profits arises. Mutual funds are safer but exchange trade funds can generate more profits and returns in a very short time. Hence if we talk about the time spectrum mutual funds are less effective in earning profits than exchange trade funds. Effect of fee on trading mutually or exchange trading As mutual funds are safe and allow the investors to sit back and relax but they have very complex fee structures. For example there is load fee in the beginning, then transaction fee and if someone wants to liquidate his shares before the prescribed time frame he has to pay a redemption fee. This shows that it is a very hectic job especially for the investors with limited investments. While in case of exchange trade funds the only fee is the stock commission and an expense ratio which is approximately negligible as compared to mutual funds. “ETFs expanse ratios are lower than traditional mutual funds.” (Christine 168) “it is out of convenience that many mutual fund managers pay their brokers to make the purchase.” (Wiandt and McClatchy 13) Hence the chances of misconception are more in case of mutual fund investments. Because in this case manager has all the liability to look after the amount of investors. It is the liability of manager to play and win or lose. According to some analysts managers may earn more commission which is good on their behalf but usually it hurts the investors. But this is not in case of exchange trade funds. Factors effecting the selection of Mutual funds and exchange trade funds Both of the funds are not bad if used in a proper technical manner. The thing one should keep in mind before going for either of the investment system is that he should consider his current asset value. Because this is the game one can never win without a real insight of the market, mental clarity, and ego satisfaction. The most important thing to consider is people usually lose this game just because of the curse of getting more. Hence it is hard to say that what one should go for, whether for the mutual fund or for the exchange trade, unless, future concerns capital in hand and mental peace are not there decision making is impossible. This can be clear that if someone has enough time and quite good capital in hand then the selection of mutual funds is effective. But the person having less time or needs money in a short time no matter he has large capital would go for the exchange trade fund. And for those having less time and less money exchange trade is the only choice. That means the weight age of exchange trade fund is more than the mutual funds. Particularly in the current human race it is the dream of every body to earn effective money in short time. So the favorite choice is always the exchange trade fund. The second factor that counts a lot towards the selection of either of the systems is the tolerance capacity of any individual. As a matter of fact the game of exchange trade is more risky because in it chances of decline and incline are equal and very rapid. So before selecting the choice one should gage the resilience of his personality and then jump into the flow of trade. Here in this point mutual fund is the trade of choice for the least tolerates. Mutual funds can give them mental relief and personal satisfaction but cannot provide rapid money in short time. “There is a strong component of the tolerance for risk taking that simply depends on the preferences of the individual” (Litterman 25). Benefits of exchange trade funds over Mutual funds Broadly speaking there are many benefits of exchange trade funds over the mutual funds like, in case of exchange trades small amounts are involved in trading if for the instance trade goes in loss the monitory loss of investors would be tolerable. On the other hand in case of mutual funds big investments results in big loses. Although more risk is there in case of exchange trade because if the good is not sell at proper time interval then chance of another attempt is very rare. This can be explained by considering that if one good’s prices were high and the investor holding that stock waited further in a hope that its rates may increase further then there are chances that he may lose the game because rather than increase in rates there could be a sudden decline which could be catastrophic. “All of the standardized ETFs are ranked highly because trading in the composite share should be more efficient than in the underlying positions separately” (Fabozzi, Markowitz 759). Another advantage of exchange trade is that it can be liquefied at any time. In case of mutual funds they can not be liquefied at any particular moment. This can be understandable by considering that suppose the oil rates are very high then an investor performing the exchange trade can sell the stock immediately. While on the contrary the investor performing mutual fund trade has to wait the end of the business day and after the approximation of his net asset value he would be able to buy that share on next day no matter the price retain its youth till that time. Another but not the least advantage of exchange trade is that it do not require that the investor put all of its eggs in the same basket like mutual funds. It is more diversified and the investor can split its capital according to the risks he can tolerate. By doing so there are more chances to win the profits from the volatile market goods having trend of sudden rise and fall. All what an exchange trader require is the knowledge of the crusts and troughs of the market value line. Current position of ETFs and Mutual funds If we give a glance to the past few years the mania of exchange trade fund is becoming more popular day by day. As this trade business is very rapid in sense of making money, hence, more poor and standard class individuals are getting involved into it. The choice of trade more often is exchange trade fund rather than Mutual funds. The possible reason could be the low expanses, intraday trade, short term buying and selling and use of less money in order to perform trade. Investors around the globe prefer the exchange trade because it is approximately free of tax and also there are less chances of loss. The money gain is just as it was assumed in the old ages where barter system was in practice. As it represents from its name that it is simply the exchange of securities In terms of money or other services. Another reason of its fame is, this trade can be liquefy easily at any time as compared to mutual funds and no charges are supposed to be paid for liquefaction. Future of trade It is very unpredictable question to answer that what would be the future of the mutual fund and exchange trade fund. Keeping in view the history of market it can not be analyzed that in future which of the aforementioned trades would be in fashion. Market is always experiencing the change in its working in 18th and early 19th century the trend of close ended trade was there but now it has been changed to ETFs. Also evolution does exist which means that present things are always in constant change in their physical structures. As the demands of society alter the need for some new system take place. As ETFs are the evolution of index funds and close ended trades similarly it can be assumed in future some new tools would be there to fulfill the needs of that specific age. Now what would be the future if assumed on the basis of current situation, it is obvious that exchange trade fund would be prevailing. As this fund is helping for the poor, majority of the population will intervene with this fund to kill their poverty. Another manifestation could be if more rapid ways of making money in slight time are there then no one would prefer to plunge into lengthy procedures like mutual funds. Hence, on the basis current justifications it can be predicted that future trade would be ETF or some evolutionary face of Exchange trade fund. Conclusion It has been clear form all the above discussion that ETFs are more reliable than mutual funds. If the present situation of the world is analyzed most of the trading is taking place on barter system. Individuals having one particular good wait for the proper time by analyzing the market trend and then sale it in exchange of the money or other goods. Majority of the world’s population do not hold precious assets what they can invest into the business. Rather majority belongs to subclass or poor community which has to earn money rapidly to meet their basic needs. Keeping all these aspects in mind Exchange is the better option rather than availing the mutual funds which are more expensive and more time consuming. While considering the managers of mutual funds investments, there are more chances that managers may exploit the interests of investors by not letting them know properly about their current status. Also in case of mutual funds there always are conflicts of interests, the reason behind could be it is very hard to manage a big investment than managing the small investments as is in the case of exchange trade funds. There are few things necessary to observe before on enter into the exchange trade. Exchange trade is the derivative of index fund that totally operate on the basis of previous market values and trends. Before investing it should be clear in one’s mind that he knows all the steeps and slops of market values or if some trading agent got to be involved he should have tremendous grip on the market flow and twists. By considering all the above mentioned facts it is obvious that exchange trade is the most appropriate trade as it bears less expenses have more risks but less loses. Also it is friendly to the traders having less capital in hand. Exchange trade follows the market trends the money of investors can be liquefied according to desires whenever there is need to buy or sell the stock. Hence the easiest and convenient way of making money through trade is the exchange trade fund and is gaining the popularity due to its flexible mode of operation. Works Cited Bob Litterman. Modern Investment Management: An Equilibrium Approach. John Wiley and Sons, 2004. Charles Parker Jones. Mutual Funds: Your Money, Your Choice ... Take Control Now and Build Wealth Wisely. Financial Times Prentice Hall, 2002. Christine Brentani. Portfolio Management in Practice. Elsevier, 2003. Douglas S. Rogers. Tax-Aware Investment Management: The Essential Guide. Bloomberg Press, 2006. Frank J. Fabozzi , Harry M. Markowitz. The Theory and Practice of Investment Management. John Wiley and Sons, 2002. Jim Wiandt, William McClatchy. Exchange Traded Funds. John Wiley and Sons, 2002. Martin Feldstein. Privatizing Social Security. University of Chicago Press, 2000. Virginia B. Morris, Kenneth M. Morris. Standard and Poors Guide to Money and Investing. Lightbulb Press, Inc., 2005. Read More