A mutual fund is a financial instrument that enables joint investment in securities through an investment portfolio managed jointly for all investors in the fund by a fund management company ("Fund Manager"). The mutual fund itself is not traded on the stock exchange. It is the responsibility of the fund manager to report to investors about the performance of the mutual fund on an ongoing basis.
Investment in a mutual fund is made by purchasing participation units, which entitle their holders to a relative portion of the portfolio. The Fund's investment in securities is carried out in accordance with a prospectus and the fund's trust agreement. The fund's investment portfolio is managed by professional managers who charge management fees.
The fund operates according to the "Fund Agreement". The Fund Agreement is signed between the Fund Manager and the Trustee (who in fact represents the unit holders and holds the fund's assets), and includes the details regarding the fund's establishment and its management. The Fund Agreement is published to the public upon the establishment of the Fund.
The Fund Manager makes decisions regarding the manner in which the investments in the mutual fund are managed. The Fund Manager's aim is to achieve maximum profits by investing in the capital market: he buys and sells securities and operates through financial instruments in accordance with the fund's investment policy.
Distributor - A member of the stock exchange who can submit orders for the purchase or redemption of units (usually banks, but also investment brokers). The distributor transfers to the Fund Manager, through the TASE Clearing House, the total number of orders for units received and the total instructions for the redemption of units received.
The Israel Securities Authority
supervises mutual funds under the Joint Investment Trust Law, 5721-1961, which established the legal framework for the establishment and operation of mutual funds. The mutual fund is not a legal entity, and its operations are based on a trust agreement that was signed between the fund's trustee and the fund manager.
In comparison with direct investment in securities, a mutual fund allows an investment with a wider dispersion, which usually reduces the risk involved in the investment, even by relatively small amounts. The value of the fund is determined by the value of the fund's assets.
How Does It Work?
Each mutual fund is composed of units, each of which grants equal rights to the fund's assets and profits. When an investor buys fund units, the Fund Manager creates new units, and when the investor redeems the units, the units are deleted.
The units are redeemable on any day that is a trading day in the fund. At the end of the trading day, the unit price is set according to the value of the Fund's assets and the number of units therein, with the deduction of the expenses involved in the realization of the Fund's assets and the remuneration of the Fund Manager and the Trustee.
Mutual Fund Types
Mutual funds are classified according to various parameters:
- Investment policy in the various products traded on the stock exchange (indexed bonds, unlinked bonds, government bonds, stocks, options, cash and other financial assets)
- Dividend distribution policy (accrual fund, profit-sharing fund)
An aggregate mutual fund does not distribute its profits to the participation unit holders as a dividend. The fund accumulates its profits and reinvests them in additional assets. In contrast, a profit-sharing fund does not accumulate its profits and distributes them as dividends to the holders of the participation units.
- Nature of incorporation (open and closed funds)
An open-end fund constantly offers units to the public according to a prospectus it publishes, except during temporary closure. A closed fund offers a limited number of units, and the price of a participation unit is determined according to supply and demand of the fund.
- High-Tech fund: A special closed-end mutual fund - a high-tech fund, is currently traded on the TASE. The fund is a closed-end, tax-exempt, profit sharing fund, which operates under special regulations enabling it to invest up to 75% of its assets in private high-tech companies that are not traded on the stock exchange. The fund enjoys government guarantees for some of its investments.
- Tax status (liable and exempt)
Classification of Mutual Funds
There are two tax classifications for mutual funds: liable or exempt. The classification affects the tax paid by the mutual fund and by the investor.
- A Liable Mutual Fund (L) pays tax directly to the tax authorities according to the tax rates applicable to individuals. As a result, the capital gain to the investor generated at the time of redemption of the unit is exempt from capital gains tax, as is the dividend. A capital loss suffered in the redemption of a liable mutual fund does not allow for offsetting capital gains on other securities.
- An Exempt Mutual Fund (E) does not pay tax on its income, and therefore the investor in the fund will pay tax on real capital gains. A capital loss arising from the redemption of a unit in an exempt fund may be offset against capital gains tax on the sale of Israeli negotiable securities or on the redemption of units in exempt mutual funds.