Mutual funds may not have the same pizazz as choosing your own stocks but they do allow average investors to take advantage of low costs, diversification, and access to professional management. There is no legal definition of “mutual fund” but the term is most commonly applied to investment funds regulated and sold to the public.

The four most often referred to mutual funds are: Open-end funds (OEF), Closed-end funds (CEF), Unit Investment Trusts (UIT) and Exchange traded funds (ETF).

Open-end funds $17.1 trillion in holdings are currently the most popular choice for Americans followed by ETF’s $1.7 trillion, Closed-end funds $279 billion, and UIT’s $87 billion. UITs are the least purchased and the only type that does not allow for active management.

The bundle of securities underlying UIT are fixed at the initial offering. ETF’s traditionally have also been passively managed but in 2008 the SEC began authorizing the creation of actively managed funds.

Another difference between each type is how their shares or units are priced and traded.  Open-ended funds buy back their shares at the underlying securities calculated net asset value (NAV) at the end of each business day.

Purchasing back shares or units at NAV is similar to how UITs function when the sponsor buys back units from the investor. UITs may also be traded in a secondary market driven by supply and demand similar to Closed-end funds.

Once a CEF is issued, it trades like a stock on an exchange. This adds a layer of complexity due to the CEF’s ability to trade at a premium or more commonly a discount to NAV. ETF’s are also listed on exchanges and trade like stocks but unlike CEF’s are more commonly priced close to NAV.

UIT’s unique requirement for its underlying assets to be fixed is not alone as UIT’s are also required to have a termination date.  Although having a fixed set of underlying securities may not be a disadvantage the termination date may be as it forces a potentially taxable event.

In conclusion, Unit Investment Trusts do not allow for active management and may not be right in taxable accounts.  If the largest number of holdings/choices is important to try the most popular type, Open-ended funds. If you prefer your investment to trade like a stock, Exchange traded funds or Closed-end funds may be a good option.  Everyone’s situation is different and each type of fund is unique.  Try to match your goals with the type of mutual fund most suited for you.

Mutual Fund Advantages and Disadvantages

(A) Advantage, (D) Disadvantage, (N) Neutral

Open-end Fund (OEF)

• (A) Active or passively managed
• (A) No specified termination date
• (A) Few or no broker fees
• (N) Buyback shares at NAV
• (D) May have to hold extra cash to enable the purchase of shares at NAV
• (D) The potential for front and/or back-end load fees

Exchange Traded Funds (ETF)

• (A) Active or passively managed
• (A) No specified termination date
• (A) Trades like a stock
• (N) Listed on exchanges, valuations close or at NAV
• (D) Potential for trade/brokerage fees

Closed-end Funds (CEF)

• (A) Active or passively managed
• (A) No specified termination date
• (A) Trades like a stock
• (N) Listed on exchanges, introduces valuations at a premium or discount to NAV
• (N) Set the number of shares
• (D) Potential for trade/brokerage fees

Unit Investment Trusts (UIT)

• (A) Owners can sell back shares at NAV or on the secondary market
• (N) Underlying securities are fixed at the start
• (N) Set the number of shares
• (D) Termination date (causes a taxable event)

The information above will help you decide which mutual funds to invest in.

References:

Exchange-Traded Funds, SEC Release Nos. 33-8901, IC-28193, 73 Fed. Reg. 14618 (March 11, 2008).

2014 Investment Company Fact Book – Investment Company Institute