Types of investment funds
Introduction
An investment fund is a legal structure that allow investors to pool their money together to make investments. In the United States, there are 9 investment fund types:
- Mutual funds
- Closed-end funds
- Business development companies, or BDCs
- Unit investment trusts
- Interval funds
- Exchange traded funds or ETFs
- Exchange traded notes or ETNs
- NextShares
- Hedge funds
Mutual funds
Mutual funds have historically been the most popular way that U.S. investors pooled their money to make investments. According to the Investment Company Institute, as of Q2 2024, mutual funds had assets under management totaling around $32 trillion dollars.
Mutual fund shares are not traded on stock exchanges. Instead, an investor buys and sells shares in a mutual fund by directly interacting with the mutual fund company. But most investors actually buy mutual fund shares through an intermediary, such as a broker. Most online brokers such as Schwab or Etrade allow you to buy mutual funds using their platforms, but you can't necessarily buy all available mutual funds. Instead, they typically let you buy from a choice of thousands of funds that they support. Most corporate 401k retirement plans are built around mutual funds, where the 401k plan administrator will buy and sell shares on your behalf.
By rule, mutual fund shares are bought and sold at the fund's net asset value ("NAV") - the value of all of its investments, less liabilities and expenses, as calculated at the end of the day. When you purchase or sell mutual funds, the mutual fund issues or redeems those shares directly, which means the number of outstanding shares in the mutual fund is constantly changing. That's why they are often referred to as "open ended" funds.
Most mutual funds are "actively managed" mutual funds, where investment decisions are made by a portfolio manager, but at the same time there are also a lot of "index" mutual funds.
One feature that is unique to mutual funds is that mutual funds have "share classes". As mentioned above, we have 34,167 mutual fund symbols in our database. But that number is somewhat misleading. There are actually only about 10,000 mutual funds, because most mutual funds have multiple classes of stock in the fund. Each class of stock is given a unique ticker symbol.
Why are there different share classes? The different share classes are designed so that the mutual fund company can charge different fees to different types of investors. Mutual funds often include all kinds of rules about when and how you can invest in them, such as a minimum investment requirement, or a rule as to what type of investor is allowed to purchase the fund. And they often charge different types of fees when you buy or sell shares in a fund. All the rules and fees are different for each different share class in a fund.
Because the rules and fees for each share class are different, the performance of each share class is different (i.e. higher fees equals less returns). That's why each share class has to have its own symbol. Most funds don't have 19 share classes, but many have 5-10 share classes.
Over the past few years, exchange traded funds have started to become more and more popular with investors, who are increasingly favoring ETFs over mutual funds. There are lots of reasons why, but probably one small reason is that the share class system of mutual funds creates too much unnecessary complexity.
For more detail about mutual funds, read our article what is a mutual fund?
Closed-end funds
A closed-end fund is an investment fund whose shares are listed on a stock exchange and traded just like a stock. The market price of a closed-end fund share fluctuates throughout the day like that of other publicly traded securities and is determined by supply and demand in the marketplace. So the market price may or may not be equal to the fund's net asset value per share.
The term "closed-end" refers to the fact that the fund does not issue additional shares of the fund in the normal course of business. A mutual fund issues and redeems shares of the fund every day, as investors buy in or sell out of the fund. So the number of shares in a mutual fund is "open ended". By contrast, a closed-end fund does a one time initial public offering of shares and then those shares are traded between investors on a stock exchange.
Although there is no reason that they could not be setup as an index fund, all closed-end funds today are actively managed by a portfolio manager. One feature that makes closed-end funds unique is that closed-end funds are allowed to borrow money at a fund level, and they can issue preferred stock. The idea is to borrow at a 4% interest rate, or issue preferred stock with a 4% dividend rate, and invest the money in an asset that will return 6%, thus generating an extra 2% return for common fund holders. This type of leverage is called "structural leverage". There are no other fund types, with the exception of hedge funds, that are allowed to use structural leverage. There are leveraged mutual funds and ETFs, but they achieve leverage using derivatives like swaps rather than using structural leverage. Currently, a majority of closed-end funds use structural leverage to try to enhance common shareholder returns.
For more detail, read our article what is a closed-end fund?
Business development companies
A business development company is a special type of closed-end fund that specializes in making debt and equity investments in small and medium sized business, similar to a venture capital firm. They otherwise operate like a closed-end fund, so they can borrow money and issue preferred stock. Also like a closed-end fund, the shares of a BDC trade on a stock exchange at market prices, so the market price may or may not be close to the net asset value of the BDC. For more detail, read our article what is a BDC?
Unit investment trusts
Unit investment trusts (UITs) are an investment fund that has a preset termination date based on the portfolio’s investments and the UIT’s investment goals. Federal law requires that UITs have a largely fixed portfolio—one that is not actively managed or traded. Once the trust’s portfolio has been selected, its composition may change only in very limited circumstances. Unit investment trusts are bought and sold by interacting with the fund company (typically via a broker). Similar to mutual funds, UIT shares are required by law to be bought and sold at the fund's end of day net asset value (NAV).
According to the Investment Company Institute, as of September 30, 2024, unit investment trusts had assets under management totaling around $90 billion. For more detail, read our article what is a unit investment trust?Interval funds
An interval fund is technically a closed-end fund but with attributes of both a closed-end fund and a mutual fund. Unlike closed-end funds, interval funds do not trade on a stock exchange. Interval fund shares are bought and sold by interacting with the fund company (typically via a broker). Similar to mutual funds, interval fund shares are required by law to be bought and sold at the fund's end of day net asset value (NAV). What makes an interval fund unique is that an investor can buy shares in an interval fund at any time, similar to a mutual fund, but an investor cannot sell the shares back to the interval fund at any time. Instead, an interval fund will only repurchase shares from investors under a formal repurchase program, which is normally conducted quarterly. An interval fund will announce that they are willing to repurchase 5% of their outstanding shares, and that's it. So if investors want to sell back more than 5% of the outstanding shares, each investor is limited to selling his prorata share of the 5% cap. For more detail, read our article what is an interval fund?
Exchange traded funds
Exchange traded funds, or ETFs, are the second most popular fund type, after mutual funds, and over the past twenty years have been growing in popularity.
Shares of an exchange traded fund are traded on the stock market, just like a closed-end fund. Once the initial issuance of shares happens, from that point on investors are buying and selling shares from other investors. But the big difference between a closed-end fund and an exchange traded fund is that ETFs have a built in mechanism to keep the market price of the ETF fairly close to the ETF's net asset value, as fully explained in what is an ETF.
ETFs have grown in popularity because ETFs are synonymous with "index" investing. Unlike most other fund types, most ETFs are index funds - they seek to track an index rather than having a portfolio manager make investment decisions. Over the past twenty years, investors have increasingly realized that it is very difficult for a portfolio manager to actively pick stocks in a way that will outperform the market as a whole, net of fees - see more in our article active versus passive investing. Because they primarily track indexes, most ETFs also have very low fees compared to a mutual fund or closed-end fund.
Exchange traded notes
An exchange traded note, or "ETN", is technically not an "investment fund", but to an investor an ETN is similar to a fund. An exchange traded note is a subordinated note issued by a large investment bank like Barclays Bank or UBS Bank that is traded on the stock market, just like an ETF. An ETN is a subordinated note - the bank is borrowing money from investors, and paying "interest" on the debt based on the interest or dividends of a stock market index. When the bank eventually settles the note, the settlement price is based on the return of the stock market index it is tied to. For more detail, read our article what is an ETN?
NextShares
A NextShares is a new type of investment fund that is traded on a stock exchange that was invented by Eaton Vance. It is a hybrid type of investment fund with elements of a closed-end fund and elements of an ETF. For more detail, read our article what is a NextShares?
Hedge funds
A hedge fund is an investment fund that is not regulated by the S.E.C. A hedge fund avoids S.E.C. regulation because hedge fund shares can only be owned by "accredited investors" - basically someone with a significant amount of wealth. There are approximately 2,500+ hedge funds in the U.S. There is a website that tracks hedge fund activity called BarclayHedge. According to BarclayHedge, the hedge fund industry has around $5.2 trillion of assets under management.
Virtually all hedge funds are actively managed by a portfolio manager. The perception is that hedge funds use all kinds of complicated investing techniques that "most people" wouldn't understand, or they pursue investment strategies that aren't available through other investment fund types. Although there is probably some truth to that statement, with the advent of smart beta ETFs that are pursuing more and more complex investing strategies, the number of strategies available only through a hedge fund is probably shrinking.
Hedge funds often gain a large amount of publicity because certain hedge funds make large bets on individual securities, which often gains them a lot of press. And it is true that many of the people that own a hedge fund have become extremely wealthy, which also garners the industry a lot of press. But as a group, the performance of most hedge funds is not that great, net of fees. Many hedge funds charge very high fees. A 2% management fee is common, and many hedge funds also take an incentive fee of anywhere between 10-20% of fund profits. We don't currently have hedge funds in our database.
Summary
Here's a quick summary of the above information. These numbers are approximations, and are changing all the time, but this gives you a rough idea of the relative size and popularity of each fund type:
| Fund Type | Assets Under Management |
|---|---|
| Mutual funds | $32 trillion |
| Closed-end funds | $207.78 billion |
| BDCs | $50.16 billion |
| Unit investment trusts | $90 billion |
| Interval funds | ??? |
| ETFs | $10 trillion |
| ETNs | $735.06 billion |
| NextShares | $3.43 million |
| Hedge funds | $5.2 trillion |