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Understanding Fund Categories Will Result In Better Returns

By Cory Bowman

Republish: EasyPublish™ Published: 23Dec2011 Word count: 519 Viewed: 43 time(s) Get Free Content For Your Site

Ever wonder how to become a financial advisor? A key part in advisor training is to complete a mutual fund education which provides a clear understanding of the thought processes of fund managers. Since the relationship between advisors and managers is very important, understanding this psychological maneuvering helps advisors to accurately plan their connections with managers. Investors dealing with fund managers must be aware that some funds come with incentive fees, which are offered to the manager of a mutual fund based upon performance.

In theory, incentive fees for active fund managers should result in better fund returns. While some studies reflect this belief, others indicate that such incentives lead to additional risk. For those learning how to become a financial advisor, an incentive fee might encourage the manager to take more risks than he or she otherwise would in pursuit of maximum return. The backward-looking nature of performance fees is one reason many investors object to them, as they are unsure of how daring the manager will be in his or her choices. As of mid-2011, less than 5% of all open and closed-end funds had incentive fees.

A second advantage of a mutual fund education is that advisors are informed on the specifics of various fund categories. One popular type is managed-payout funds, where the main objective is to provide a steady income stream without incurring the costs of variable annuities with living benefits. Some managed-payout funds tie their distributions to market interest rates, while others determine payouts based on historical returns. A large number of these funds make distributions from income and principal. Managed-payout funds generally invest in a sampling of the sponsoring firm's mutual funds. Some advisors view a managed-payout fund as just one of several building blocks that make up a client's retirement income (i.e., annuities, pensions, Social Security, etc.).

In addition to managed-payout funds, funds known as "go-anywhere" are also popular among advisors. These funds contain investments that can be spread throughout the world among various asset classes. One concern surrounding "go-anywhere" funds is that investors have no idea how the portfolio will change if the market suddenly changes, which means advisors do not know if such a fund will complement other investments in the client's portfolio. Some of these flexible funds focus on stocks; others shift between stocks, bonds, and cash, and some invest in assets ranging from private transactions and commodities to real estate, emerging markets and derivatives. By July 2011, there were over 250 go-anywhere funds, which are often compared to world allocation and moderate allocation funds.

Relations between investors, advisors, and managers can be tricky. As of February 2011, new rules for money market funds have been put into effect. This means that the SEC releases monthly snapshots of money market funds' "shadow" prices that reflect the actual market value of fund holdings as opposed to the $1 NAV at which investors buy and sell shares. It is always a good idea for financial advisors to complete a mutual fund education in order to retain strong relationships with both investors and fund managers.

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