Understand Retail Funds

Retail Funds, such as mutual funds, offshore funds, and unit trusts, pool the investments of multiple individual participants and invest the proceeds in a portfolio of securities. Retail funds and other commingled pools provide diversification and the benefits of professional investment management to investors. Shareholders receive a proportionate share of the capital gains and income earned on the fund's holdings.

Investors buy shares of open-end funds directly from the investment company at the Net Asset Value (NAV) per share. The NAV per share is calculated each day by first calculating the gross assets of the fund, which is the sum of the market value of each of the securities and the cash holdings of the fund. The net asset value of the fund is then calculated by taking the gross assets and subtracting accrued liabilities to the fund including the fee payable to the management company and other expenses such as custody and transfer agency fees.

The following figure illustrates the calculation of the fund's NAV per share. At the end of each day, the net asset value per share is calculated by dividing the net asset value of the fund by the shares outstanding, including new shares purchased using new contributions into the fund that day. The new contributions are added to the equity capital of the fund.

 When an investor makes a contribution into a mutual fund, the fund company creates new shares with a value equal to the NAV at the end of the day the contribution was made. Mutual funds employ forward pricing, where the contribution is made at the NAV struck at the end of the day the contribution was made. This has a beneficial impact on the return measurement process in that the NAV per share does not have to be adjusted by cash flows in order to calculate a time weighted return.

You can calculate a time weighted return on a mutual fund without knowing the total market value of the fund or the size and timing of cash flows. The cash flow impact was netted out of the return because additional shares are issued proportional to each contribution. For example, suppose you have a fund where a shareholder contribution is received on Day 1 for $10. The shareholder receives shares equal to the contribution divided by the Day 1 NAV of $10, or 1 share. The money is made available to the fund manager the next day, and the additional share is included in the next day's NAV calculation. The following figure demonstrates the calculation of the NAV per share and return when there are contributions into the portfolio.

 To calculate the returns for mutual funds, you first create mutual fund entities.