Quick Answer
Mutual funds are categorized by asset class (equity, fixed-income, money market, interval) and investment objective (value, growth, income, balanced, international, global, sector, life-cycle). Retail and government money market funds may use a stable
Quick Answer: Mutual funds are categorized by asset class (equity, fixed-income, money market, interval) and investment objective (value, growth, income, balanced, international, global, sector, life-cycle). Retail and government money market funds may use a stable $1 NAV; institutional prime and institutional tax-exempt funds use a floating NAV. Target-date funds automatically become more conservative over time.
NAV; institutional prime and institutional tax-exempt funds use a floating NAV. Target-date funds automatically become more conservative over time.With the structural framework in place, you can now look at the flavors of mutual funds offered to retail customers. The categorization has two layers: the asset class the fund holds, and the investment objective the fund pursues.
What are the main asset class categories of mutual funds?
Mutual funds are typically sorted first by what they hold.
Equity funds:
- Invest primarily in stocks
- Subtypes include growth, value, index, sector, international, global
- Higher volatility, higher long-term return potential
Fixed-income (bond) funds:
- Invest in bonds
- Subtypes include government, corporate, high-yield, municipal, international
- Further divided by duration: short, intermediate, long
- Lower volatility than equity funds; sensitive to interest-rate changes
Money market funds:
- Invest in short-term debt: Treasury bills, commercial paper, banker's acceptances, brokered certificates of deposit (CDs)
- Retail and government funds may maintain a stable $1.00 Net Asset Value (NAV)
- Institutional prime and institutional tax-exempt funds must use a floating NAV
Interval funds:
- A specialized closed-end fund structure
- Offers to repurchase shares from investors at stated intervals (typically quarterly) at NAV
- Less liquid than open-end funds but can hold less-liquid assets
Exam Tip: Gotchas
- Interval funds are a closed-end structure despite the periodic repurchase feature. They are not open-end funds and do not offer daily redemption at NAV.
- Money market funds hold only short-term debt by rule. A "money market" label on a fund holding longer-dated bonds is a misnomer; the exam expects you to recognize the label's constraint.
How do retail and institutional money market funds differ?
The money-market-fund rule under the Investment Company Act (ICA) applies different pricing requirements to retail, government, and institutional prime or tax-exempt funds.
| Fund Type | Eligible Investor | NAV Method |
|---|---|---|
| Retail prime or tax-exempt | Natural persons only | May use amortized cost / penny rounding for a stable $1.00 NAV |
| Institutional prime or tax-exempt | Includes non-natural persons | Floating NAV required |
| Government | Retail or institutional | May use amortized cost / penny rounding for a stable $1.00 NAV |
Think of it this way: A stable $1.00 NAV is a pricing method, not a guarantee. Retail and government funds may use it. Institutional prime and institutional tax-exempt funds price to market with a floating NAV, so their share price may be $0.9999 or $1.0001.
Exam Tip: Gotchas
- Retail money market funds can still break the buck. The $1.00 NAV is a target, not a guarantee. If the fund's amortized-cost price deviates from its market-based value by more than one half of one percent, the board may adjust the share price below $1.00. Famous example: the Reserve Primary Fund broke the buck during the 2008 financial crisis.
- Institutional prime and institutional tax-exempt money market funds use floating NAV. Retail and government money market funds may keep a stable $1.00 NAV.
- There are no longer redemption gates. The SEC removed them in the 2023 reforms. Only liquidity fees remain, and the mandatory liquidity fee applies only to a fund that is neither a government nor a retail money market fund. A retail fund therefore faces only a discretionary fee. An answer choice offering a gate is offering a repealed tool.
What investment objectives do mutual funds pursue?
The second layer of categorization is the fund's investment objective (what the portfolio manager is trying to achieve).
| Objective | Portfolio Focus | Risk Profile |
|---|---|---|
| Value | Undervalued securities (low Price/Earnings (P/E), high dividend yield); contrarian approach | Moderate |
| Growth | Companies with above-average earnings growth; typically low or no dividends | Higher volatility |
| Income | Dividend-paying stocks and/or bonds; focus on current yield | Lower to moderate |
| Balanced | Mix of stocks and bonds (commonly 60/40); income + moderate growth | Moderate |
| International | Non-U.S. securities | Higher (currency + political risk) |
| Global | U.S. + non-U.S. securities | Moderate to higher |
| Sector | Concentrated in a specific industry (technology, healthcare, energy) | Higher (concentration risk) |
| Life-cycle (target-date) | Asset allocation adjusts toward more conservative as the target date approaches | Glide path declines with age |
International vs. global:
- International funds exclude U.S. securities
- Global funds include both U.S. and non-U.S. securities
Life-cycle (target-date) funds:
- Single-fund retirement solution
- Glide path automatically becomes more conservative over time
- Target date is typically the customer's expected retirement year (e.g., a "Target Date" fund named for the year of expected retirement)
- Often used as Qualified Default Investment Alternative (QDIA) in 401(k) plans
Exam Tip: Gotchas
- A life-cycle (target-date) fund's glide path automatically rebalances. The customer does not need to reallocate manually. This is why target-date funds work as 401(k) default options.
- Global includes U.S.; international excludes U.S. A client who wants only foreign exposure needs an international fund, not a global one.
- Sector funds carry concentration risk. A sector fund is less diversified than a broad equity fund and is typically recommended as a satellite holding, not a core holding.
What Should You Check on Exam Day?
- Do you know interval funds are a closed-end structure, even though they repurchase shares from investors at stated intervals?
- Can you explain why a retail money market fund can still break the buck, since the $1.00 NAV is a target, not a guarantee?
- Do you know redemption gates were removed in 2023, so only liquidity fees remain, and the mandatory fee excludes government and retail funds?
- Can you state the difference between international funds, which exclude U.S. securities, and global funds, which include both U.S. and non-U.S. securities?
- Do you know a life-cycle (target-date) fund's glide path automatically becomes more conservative as the target date approaches?