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Mutual Funds

Mutual Funds

30.03.2021

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A mutual investment fund (MIF) is a property complex, without the formation of a legal entity, based on the trust management of the fund’s property by a specialized management company in order to increase the value of the fund’s property. Thus, such a fund is formed from the money of investors (shareholders), each of which owns a certain number of shares.

The purpose of creating a mutual fund is to make a profit on the assets combined into the fund and distribute the profit received between investors (shareholders) in proportion to the number of shares. An investment share (share) is registered security that certifies the right of its owner to a part of the fund’s property, as well as the repayment (redemption) of the share belonging to it in accordance with the rules of the fund. Investment shares, thus, certify the investor’s share in the fund’s property and the investor’s right to receive from the mutual investment fund the funds corresponding to this share, that is, to redeem the shares at their current value. Each investment share grants its owner the same amount of rights. The account of the rights of the owners of investment shares (register) is maintained by an independent organization that maintains the register of shareholders.

Benefits of mutual funds

A mutual fund provides the following advantages to investors over investing through a broker:

  • availability, since the amount of investment, can start from 1-3 thousand rubles;
  • diversification of investment risks even for minimal investments;
  • strict control over activities by the state;
  • transparent infrastructure: shareholders’ funds are separated from the funds of the management company and are stored in a specialized depository;
  • no taxation of the fund’s current operations (including no income tax), payment of income tax, or income tax is made only by the investor and only when the share is sold. According to the current legislation, the tax is paid by the shareholders themselves in case of income, that is, at the time of the sale of the share. No tax payments are made during the ownership of the share;
  • professional management;
  • high share liquidity (for open-ended funds);
  • the possibility of a phased payment of shares when working according to the capital call scheme.

Disadvantages of mutual funds

Higher risk compared to instruments with fixed income and legally guaranteed return of funds – deposits, high-rating bonds. However, there are mutual funds that invest only in high-rated bonds and bank deposits (money market funds), which, due to diversification, can serve as a tool to further increase reliability (reduce risks).

Additional costs for registration and storage of investment certificates.

Permanently paid remuneration to the management company, even when the fund suffers losses. The amount of remuneration ranges from 0.5% to 5% of the fund’s net asset value.

Often, for open-ended mutual funds, legislation imposes restrictions on which stocks and bonds a fund manager can buy. The private investor does not have such restrictions.

To reimburse the costs associated with the issuance and redemption of investment shares, management companies introduce discounts and surcharges.

A surcharge is money required by the management company or agent in addition to the value of the units upon the issue. The amount of the premium cannot exceed 1.5% of the value of the share.

A discount is a money held by the management company or agent from the value of the units upon redemption. The amount of the discount cannot exceed 3% of the value of the share.

The same fund may have different discounts and surcharges, depending on the agent through which the operations are carried out.

If a protracted fall in prices begins on the stock market, then the management companies of mutual funds do not sell all the shares, but only a part of the assets. On the one hand, the Central Bank of the Russian Federation requires strict adherence to the asset structure specified in the fund’s investment declaration (which does not allow transferring all assets into the monetary form), and on the other hand, such requirements support the liquidity of the stock market. This situation will not protect the shareholder’s capital in the event of a market crash. Private investors and trustees have the right to act more aggressively, getting rid of all the falling securities, since their hands are not tied by such legislative norms. This is driving an even bigger market crash.

Expected return on mutual funds

Funds are legally prohibited from guaranteeing or advertising expected returns; they can only show past achievements. In this regard, one of the heads of the Federal Financial Markets Service of Russia unequivocally pointed to the similarity of the exchange game and mutual funds, arguing that the shareholders of mutual funds should be able to withstand a 50 percent drop without panic, other analysts found similarities in the costs charged by managers of mutual funds with brokerage fees, however, the broker receives a percentage per transaction once, and not annually, as the managers of mutual funds.

To assess the effectiveness of fund management, the achieved return is usually compared with the potential return that an investor could receive if he bought a certain reference asset (comparison with a financial benchmark). Most often, national stock indices are considered benchmarks (standards). In Russia, this is the RTS index or the MICEX index. For the United States, the Dow Jones, S&P 500 and NASDAQ indices serve as benchmarks.

It is believed that the return on investment in actively managed mutual funds is on average slightly lower than when using some types of passive strategies at the expense of the costs of managing the mutual fund. The legislator limits the costs of managing a mutual fund to 10% of its assets, these are the costs – discounts and premiums, services of infrastructure organizations (special depository, auditor, and registrar), which will have to be paid from the entire value of the share, and not only from income, in addition, the income itself taxed. However, such an assessment does not take into account the additional profitability that a mutual fund can bring due to tax benefits of income, in particular, in accordance with the Tax Code of Russia, a domestic investor is entitled to an investment tax deduction when selling securities.

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