Definition
A mutual fund (or open-end fund) is a pooled investment vehicle that collects money from many investors and invests it in a diversified portfolio of stocks. "Open-end" means the fund issues and redeems shares on demand based on its Net Asset Value (NAV).
NAV = (Total Value of Portfolio – Liabilities) / Shares Outstanding
Mechanism
Investors buy or redeem shares directly from the fund company, not from other investors. Shares are priced once per day at NAV, which is calculated after the market closes. A fund manager actively manages the portfolio based on a specific investment mandate.
Example
An investor buys $10,000 worth of the Fidelity Blue Chip Growth Fund. They receive shares at that day's closing NAV (e.g., $50/share = 200 shares). If the NAV rises to $55, their investment value becomes $11,000.
Index Funds
These are passive funds that aim to replicate the performance of a market index, like the S&P 500. They are low-cost, have low turnover, and their NAV is calculated daily like a mutual fund. An example is the Vanguard 500 Index Fund.
Exchange-Traded Funds (ETFs)
ETFs are typically index-tracking funds that are traded on stock exchanges, just like individual stocks. Unlike mutual funds, ETFs can be bought and sold intraday at market prices.
ETF Creation/Redemption Mechanism
Authorized Participants (APs) keep the ETF's market price aligned with its NAV through an arbitrage process:
- Creation: APs deliver a basket of the underlying securities to the ETF issuer in exchange for new ETF shares.
- Redemption: APs return ETF shares to the issuer in exchange for the underlying securities.
If an ETF trades above its NAV, APs will sell the ETF and buy the underlying stocks, pushing the ETF price down. If it trades below NAV, they do the opposite.
Tracking Error: This is the small difference between an ETF's returns and its underlying index's returns, caused by fees, cash drag, or sampling methods.
Definition
Hedge funds are private, actively managed investment vehicles for accredited or institutional investors. They aim for absolute returns using flexible strategies like leverage, short selling, and derivatives. They typically charge "2 and 20" fees (2% management fee, 20% performance fee).
Key Hedge Fund Strategies
| Strategy | Description | Example |
|---|---|---|
| Long/Short Equity | Go long undervalued stocks and short overvalued ones. | Long Apple, short Dell. |
| Market Neutral | Balance long and short positions to remove market beta. | +$100M in long positions, –$100M in short positions. |
| Event Driven | Trade corporate events like mergers or spinoffs. | Long the target company, short the acquirer in a merger. |
| Activist | Take significant stakes in companies to push for strategic changes. | Elliott Management's involvement in Twitter. |
| Quantitative | Use algorithmic and statistical models for trading. | Renaissance Technologies. |
Definition
These are large, long-term institutional investors managing public or corporate retirement assets (pension funds) or state reserves (SWFs). They focus on capital preservation, steady growth, and income over extremely long horizons.
Examples
- Pension Fund: CalPERS (California Public Employees’ Retirement System).
- SWF: Norway’s Government Pension Fund Global.
Role of Equity
Equities serve as the primary long-term growth driver in their asset allocation, often making up 40–70% of the portfolio.
Definition
Private equity involves investing in non-public companies or taking public companies private with the goal of improving operations and selling them for a profit later. These are long-term (5–10 years), illiquid, high-risk, and high-return investments.
Types of PE Investments
| Type | Description | Example |
|---|---|---|
| Venture Capital (VC) | Investing in early-stage, high-growth startups. | Sequoia investing in Stripe. |
| Growth Equity | Providing capital for mature firms that are scaling rapidly. | Tiger Global investing in Flipkart. |
| Buyouts / LBOs | Acquiring a controlling stake in a company, often using significant debt. | KKR buying Boots Alliance. |
| Mezzanine Financing | Hybrid debt-equity financing for expansion or pre-IPO funding. | Convertible debt + equity warrants. |
Definition
Equity strategies that focus on generating steady income through dividends or option premiums, rather than just capital appreciation.
Types of Income Strategies
| Strategy | Description | Example |
|---|---|---|
| Dividend Growth Funds | Focus on companies that consistently increase their dividends. | Procter & Gamble, Johnson & Johnson. |
| High-Dividend Funds | Target the highest-yielding stocks available. | Utility and REIT ETFs. |
| Covered Call ETFs | Enhance income by systematically selling call options on the fund's holdings. | Global X NASDAQ 100 Covered Call ETF (QYLD). |
Definition
Smart beta and factor investing systematically tilt portfolios toward certain characteristics (factors) that have been shown to deliver excess returns over time. It is a rules-based, quantitative approach.
Common Factors
| Factor | Description |
|---|---|
| Value | Cheap stocks (low P/E, P/B) tend to outperform. |
| Momentum | Stocks that have been trending higher tend to continue rising. |
| Quality | Companies with high ROE and stable earnings tend to perform well. |
| Size | Small-cap stocks have historically outperformed large-cap stocks over time. |
| Low Volatility | Lower-beta stocks tend to outperform on a risk-adjusted basis. |
Definition
Quant strategies use data science, statistics, and algorithms to identify and exploit market inefficiencies to generate alpha.
Key Quant Approaches
| Strategy | Description | Example |
|---|---|---|
| Statistical Arbitrage | Exploits short-term mispricings between correlated stocks. | Pair trading Coke vs. Pepsi. |
| Factor Models | Uses multi-factor models (e.g., Fama-French) to forecast returns. | Overweighting value, underweighting growth. |
| Pairs Trading | Long one stock and short a related one based on mean reversion. | Long Ford, short GM when their price ratio deviates. |
| ML-Driven Alpha | Uses machine learning to identify predictive signals from vast datasets. | Using NLP on news sentiment to trade earnings. |
Summary Comparison of Vehicles
| Vehicle / Strategy | Liquidity | Risk | Return Potential | Typical Investor |
|---|---|---|---|---|
| Mutual Fund | Daily | Medium | Moderate | Retail, Institutional |
| ETF / Index Fund | Intraday | Market-level | Moderate | Passive Investors |
| Hedge Fund | Quarterly/Annually | High | High | Accredited/Institutional |
| Pension Fund / SWF | Long-term | Low-Medium | Moderate | Governments, Retirees |
| Private Equity / VC | Illiquid (5-10 yrs) | High | Very High | Institutional, UHNW |
Final Interview Tips
Understand the ETF creation/redemption process, as it's a favorite interview question. Be ready to explain the key differences between hedge funds, mutual funds, and private equity. For factor investing, connect it to academic theory like the Fama-French factors.