I’ve saved the best for last in this ongoing series describing the practical fundamentals of investing in Mutual Funds. You can check out my first three articles in this series here (1, 2, 3). By taking the time to understand how it is that Income-Oriented Mutual Funds create value for you as a cash-flow generating security, you can really begin to harness your portfolio towards meeting your short-term lifestyle goals in a way that you’d never be able to realize on your own.
Income Generating Funds can be broadly categorized into three main categories for our purposes:
Global Macro-Fundamental
Funds associated with “Global-Macro” strategies generally pursue a diverse portfolio of income from around the world. That being said, the strategy may become particularly nuanced, depending on the fund. A more aggressive fund, for example, may choose to pursue leverage from low-interest countries (caution: Leverage involves a risk of Contango against the interest rate carried), and apply it towards maximizing returns in countries that provide investors with the most lucrative coupons. A more moderate fund might focus instead of laddering strategies that provide monthly cash flow (as opposed to semi-annually or quarterly). Lastly, funds may engage in varying levels of exposure to currency risks.
While it may seem as though this category is far too broad for practical usage, they remain particularly appealing in the way that they provide investors with access to diversified, high-yield bond portfolios, which reflect the movements of the global market as a whole. Additionally, they provide smaller investors with extremely simple diversification. Compared to the time and money required to put together your own diversified global income portfolio, these securities are invaluable.
Balanced Income
A balanced income fund is the lazy-man’s excuse for not having a personal investment advisor. These funds operate under the assumption that many investors are generally pursuing the same investment goals, and can therefore benefit from scale if they are all grouped into the same fund. While generally fairly conservative instruments, these funds provide generally predictable returns that index to high quality securities.
They also generally provide a diversification across asset classes, allowing investors access to dividends, interest payments, and capital gains all at once. If you’re looking for something to anchor down your portfolio risk with risk and returns that are slightly better than that of simply tracking an index, this is your solution. As a reasonably safe investment, these funds are structured to avoid attracting situations of Contango, surprise tax expenses, and structure their distributions in a predictable schedule.
Specialty (Junk) Bond
Investors have all sorts of nasty names of High Yield Bonds. However, the Mutual Funds industry has made a commendable effort to restoring some good faith in the practice of independently studying ‘Specialty’ (aka. Junk) bonds to find value. By actively researching the securities in question, diversifying throughout a portfolio, and sometimes even actively supporting the prices of High Yield Bonds, a Specialty fund is able to fortify the integrity of the returns against the underlying systemic risks that are generally associated with the lower grades of bonds. Usually keeping to BBB-grade securities, Specialty Bond funds usually invest in mid-level companies that are issuing debt to finance fixed assets, and to prevent the dilution of existing equity.
Similar to Global Macro Fundamental Funds, Specialty Funds provide smaller investors with access to very lucrative distributions, with the added benefit of using diversification and research techniques not available to smaller retail clients. However, even though many of these funds simply invest in bonds until maturity, changing interest rate and market growth rates will create the perception of an opportunity loss, and may cause other investors to flee the fund in pursuit of other gains. Once again, there is a tangible risk of Contango further eroding your position.
That’s it, you now understand the basics of investing in Mutual Funds. Take some time to digest the massive amount of information you’ve taken in over the course of this series, and remember to keep checking in for more. With the fundamentals out of the way, I look forward to providing increasingly specific information to help you with understanding and applying the various types of mutual funds in existence.
