We are very often presented with a variety of financial funds to invest without really knowing what the difference among them is. In this article, we will make a quick review of three fund types to have a better understanding of how they work.
Open-Ended Mutual Funds
Open-Ended Mutual Funds are regulated by the SEC (Securities and Exchange Commission). These funds are open to the public, easily accessible for investment and are constantly marketed, which result in these type of funds to be able to get new investors and also to loose investors on a daily basis. These funds don't have a restriction on a number of shares that can be issued, but usually when the manager sees the fund has become too big to be managed and to meet it's objective the manager will close the fund to new investors.
In terms of how the fund is structured, for these funds, the Manager always keeps a percentage of their assets in Cash in case an investor would like the Manager to buy their share back. At the end of the day when the market closes and the NAV (Net Asset Value) is calculated, they can trade shares based on the NAV, the fund can either loose or win investors, this is the reason why they are called open-ended. The manager of these funds usually gets a management fee of the percentage of the assets the fund holds, usually, the percentage of the management fee is around 2% and is calculated based on the NAV of the fund.
Closed-End Mutual Funds
Closed-End funds are regulated by the SEC (Securities and Exchange Commission). They are run by a Manager like the Open-End funds, but these funds are only marketed when the fund is getting created, issued shares are fixed to a number of initial investors that decide to invest during the initial public offering. These funds don't have cash allocated as part of the fund structure since the fund is closed to new investors and there is no possibility for the different investors to ask the Manager to buy their shares back.
If an investor wants to trade a share that was invested in a closed-end fund this has to be done in the secondary market (example: New York Stock Exchange, NASDAQ), the secondary market allows the investors to trade their shares at any given time of day in comparison to the open-ended funds where only shares can be traded at the end of they day. The price defined for the shares of Closed-End funds are determined by the market forces like the supply and demand, not by the NAV as the open-end fund does. The price is usually defined at either the Premium or Discount to the NAV.
Hedge Funds are not regulated by the SEC (Securities and Exchange Commission). These funds cannot market themselves and cannot take money from the public. they are reserved for accredited investors. These investors are accredited through their net-worth, income, asset size and other requirements; they are often called sophisticated investors since they can usually take big risks when investing. These funds have a larger management fee than the types of funds previously mentioned, their fee is around 20% of the annual profits of the fund.
Hedge Funds are commonly known for their secrecy and high risk on investments, the management team usually don't communicate what they are investing in to keep the investment plans closed to other managers/investors who might copy their investing strategies. The manager of the Hedge Fund usually has a big percentage of their money relative to their net worth invested in the fund, which gives the investors some confidence that the manager will have a big comprehension on risks involved and will manage the assets measuring the risks accordingly.