Running a mutual fund isn't a one-person job. It takes a team of specialized players, each with distinct responsibilities and regulatory obligations. Understanding who does what—and who pays whom—helps explain why fund expenses exist and where your money actually goes.
Fund Structure: Who Does What
| Party | Role | Compensation |
|---|---|---|
| Custodian Bank | Safeguards fund assets; may act as Transfer Agent and Paying Agent | Custodial fees |
| Investment Adviser | Manages fund within stated objectives; contract approved by shareholders | Management fees (% of AUM) |
| Fund Sponsor (Underwriter) | Creates and distributes the fund | Underwriting fees |
| Selling Group | Acts as agent selling shares at POP | Selling concession |
The custodian bank is like the vault keeper—they hold the actual securities and ensure they're properly safeguarded. The investment adviser makes the investment decisions. The selling group gets the fund into investors' hands.
The investment adviser's contract must be approved by shareholders. This gives investors a voice in who manages their money—and how much they're paid to do it.
Benefits of Mutual Funds
Why did mutual funds become the dominant investment vehicle for regular Americans? Three reasons:
- Professional Money Management — Someone else does the research
- Diversification — Own hundreds of securities with a single purchase
- Wide Variety of Fund Objectives — Whatever your goal, there's probably a fund for it
The 75-5-10 Rule: What Makes a "Diversified" Fund
The Investment Company Act defines a diversified fund using the 75-5-10 Rule:
| Requirement | Meaning |
|---|---|
| 75% | At least 75% of the fund's assets must be invested in securities |
| 5% | No more than 5% of the fund's assets can be invested in any one issuer |
| 10% | A maximum of 10% of the voting securities of one issuer is allowed |
Test Tip: The 75-5-10 rule only applies to 75% of the portfolio. The other 25% can be invested however the fund chooses—even entirely in one security.
Non-Diversified Funds
A fund that doesn't meet the 75-5-10 requirements is classified as non-diversified. This isn't necessarily bad—a fund that only invests in U.S. Treasuries would be non-diversified but hardly risky.
Types of Funds
| Fund Type | Description |
|---|---|
| Growth Funds | Invests in equities of rapidly growing companies for capital gains |
| Growth and Income Funds | Provides both dividend income and growth potential |
| Income Funds | Invests in fixed income securities like preferred stocks and bonds |
| Balanced Funds | Maintains a balance of stocks and bonds |
| Index Funds | Tracks the performance of an index like the S&P 500 |
| Specialized (Sector) Funds | Invests in a particular industry or geographic area |
| Target Date Funds | Automatically adjusts allocation as target date approaches |
These have become enormously popular in 401(k) plans because they automatically adjust asset allocation as retirement approaches. A "2050 Fund" holds mostly stocks today but will shift toward bonds as 2050 nears. It's professional management on autopilot.
Key Points to Remember
- Custodian bank holds the assets; investment adviser makes decisions
- 75-5-10 Rule: 75% in securities, max 5% per issuer, max 10% voting control
- Non-diversified doesn't mean high-risk—it means concentrated
- Target date funds automatically adjust allocation over time