Mutual Funds: What They Are and How They Work

Mutual funds are one of the most popular and accessible tools for those who want to enter the world of investments without necessarily having large amounts of capital. These are financial vehicles managed by Società di Gestione del Risparmio (SGR), which collect the money of numerous savers and invest it in a diversified portfolio of financial assets, such as stocks, bonds and government bonds.

In this complete guide we delve into the functioning, types, advantages and risks of mutual funds, providing clear and detailed answers for those who are approaching this tool for the first time or want to learn more.

What are mutual funds?

Mutual funds, also known as OICR (Organismi di Investimento Collettivo del Risparmio), are financial instruments that allow you to invest in capital markets through professional and collective management. Their structure requires that the money collected from savers flows into a "common fund", managed by an authorised SGR and supervised by the supervisory authorities.

Collective management allows you to:

• Diversify risk: thanks to a portfolio made up of numerous securities, any losses linked to the poor performance of a single financial instrument are mitigated.
• Access financial markets: even with relatively small sums, it is possible to invest in financial instruments that would otherwise require large amounts of capital.
• Take advantage of the professional expertise of experts: the fund is managed by industry experts, who operate according to transparent regulations.

Although they offer many advantages, mutual funds do not guarantee a predefined return: the results depend on the performance of the underlying financial instruments. In fact, by purchasing fund units, investors participate proportionally in the returns or losses generated by the investments made by the manager.

How mutual funds work

Asset management companies raise capital from a number of investors, often through a network of financial advisors. The sums raised are invested in a set of financial instruments, such as shares, bonds or raw materials, following a pre-established strategy defined in the prospectus.

This approach allows for diversification that would be difficult for a single investor to achieve, especially if they have limited resources. Management is entrusted to expert professionals, whose objective is to maximize returns compared to a reference benchmark, i.e. an index that measures the fund’s performance compared to the market to which it belongs.

The benchmark

The term benchmark refers to the reference parameter that allows you to recognize the profile of a financial product or fund and, in this case, also helps you understand the risk index of a fund. Through this indicator, you can understand the structure of the fund and understand what risks it is running on the current market. This parameter is of fundamental importance for choosing the mutual fund to rely on.

The benchmark consists of one or more indices that configure the performance of the markets in which the fund invests.

Shares and calculation of yield

The saver who buys fund shares can check their value daily in the press in the case of open-end mutual funds. In the case of closed-end funds, however, the value is calculated periodically (usually on a monthly basis).

In practice, the subscriber owns a portion of the assets, equal to the savings contributed plus or minus the capital gain/loss realized by the manager on all the securities in which the fund’s assets are invested.

The value of the shares is calculated with the Nav (Net Asset Value), an assessment of the performance of the portfolio of assets held by the portfolio and is calculated as follows:

Nav = asset assets - liabilities/shares in circulation

Classification of mutual funds

Mutual funds are classified based on the financial instruments used and the geographical or sectoral areas of intervention. Below are some of the main categories:

Based on financial instruments

• Liquidity funds: they allocate the entire portfolio to bonds and liquidity. Liquidity funds cannot invest in shares and unrated instruments. The instruments held must have a rating of at least A2 (Moody’s) and A (S&P). They are liquid and suitable for those who cannot invest in the long term. Their yield is in line with that of Treasury bills: therefore it is not high, but stable.
• Bond funds: they cannot invest in shares and therefore allocate their entire portfolio to bonds and liquidity. They are suitable for meeting the needs of those who want to grow their capital in the medium term (3-5 years). In this time frame their yield is higher than that of liquidity funds.
• Balanced funds: they invest in a mix of government bonds, bonds and shares, in Italy and abroad with a single constraint: the portion of the portfolio allocated to shares must be between 10 and 90%. They are suitable for those who want to grow their capital in the medium-long term (over 5 years), with a yield potentially higher than that of bonds.
• Equity funds: they invest at least 70% of the portfolio in shares and are suitable for meeting the needs of those who want to grow their capital in the long term (7-10 years and beyond). The riskiness of equity funds generally increases as specialization increases: funds diversified across multiple countries are the least volatile.

Based on geographical area or sector

Mutual funds classified based on the financial instruments in which they invest can be further subdivided based on the geographical area or sector. For example, a US equity fund invests mainly in shares of American companies, while a high yield bond fund focuses on high-yield bonds.

Other classifications

• Harmonized and non-harmonized funds: harmonized funds comply with EU directives no. 611/85 and 220/88 (implemented in our legal system with Legislative Decree no. 83/92) and can be marketed in the European Union, while non-harmonized funds follow more flexible rules but with fewer protections.
• Open-ended and closed-ended funds: in open-ended funds, investors can buy or sell shares at any time, while in closed-ended funds, reimbursements are only possible at pre-established deadlines.
• Moveable and real estate funds: moveable funds invest in financial instruments such as shares and bonds, while real estate funds focus on real estate and real estate companies.

How to choose a mutual fund

Based on the investor’s investment characteristics, it will be possible to choose the funds in which to invest. Often, in fact, it is the set of several funds, with different characteristics, that can best respond to this purpose.

It is good to say that to choose funds you need to know them and compare them. For this reason, it is necessary to carefully read the information prospectus and the accounting documents, which contain all the information that allows you to understand in detail the functional and qualitative differences of the products and their ability to meet your investment needs.

In addition to these aspects, it is also important to evaluate the costs, both because they affect the overall return on the investment and because sometimes, individual funds offer multiple formulas (entry fees, exit fees, etc.) from which to choose the ones that best suit your needs.

Which funds to invest in in 2025?

In 2025, investors can count on a wide range of mutual funds to diversify their portfolios and maximize returns. Here is an overview of the most promising options:

1) Dividend funds, ideal for those seeking stability and returns. Some of the best funds in this category include:

• Invesco Global Equity Income Fund Class R Usd: three-year return of 11.27%, investing mainly in international stocks, with a strong exposure to the United States (52%) and Europe (17%).
• M&G (Lux) Global Dividend Fund Class A Eur Inc: return of 10% over the last three years, focused on global stocks with ESG criteria, with 43% invested in the US.
• Goldman Sachs Global Equity Income Class X Usd Acc: return of 9.04%, investing in stocks with high dividend rates, with a predominance of investments in the US (56%).

2) The most promising equity funds for 2025 are:

• Templeton Euroland A (Acc) EUR: YTD return of 12.87% with management costs of 1.5%.
• MS INVF Asia Opportunity A EUR: YTD return of 26.81%, representing one of the best funds for investing in Asia.
• Fidelity MSCI Japan Index Fund P-ACC-EUR (hedged), an index fund that has shown good performance in the Japanese market.

3) Among the bond and money market funds, more stable and low risk, we find:

• BlackRock Institutional Cash Series Sterling Ultra Short Bond Fund
• H2O Multi Emerging Debt Fund, focused on emerging debt

Advantages and risks of mutual funds

Mutual funds offer several advantages to investors, especially for those who do not have a lot of capital available, but it is also necessary to carefully evaluate some risks before investing.

Advantages

• Diversification, mutual funds allow you to reduce risk by investing in a large and diversified portfolio.
• Professional management, which allows you to entrust your capital to industry experts.
• Segregated assets of the fund, separate from that of the management company, in order to guarantee greater protection.
• Simplified access also for small savers.

Risks

• Costs: entry, management, performance and exit fees can affect returns.
• Risk profile: to avoid surprises, it is essential to choose a fund in line with your risk profile and objectives.
• Non-guaranteed returns: past performance does not guarantee future results.

Mutual Fund: Costs and Subscription Methods

The costs are linked to the entry fees charged to subscribers and the management fees, taken from the fund. The value of the share is always net of taxes. As for the subscription, however, it can be done in two ways:

• payment in a single solution (Pic);
• with a capital accumulation plan (Pac).

The latter, called accumulation plans or Pac, should represent the most natural investment method, because in families savings tend to be built up month after month, year after year.

Differences between mutual funds and SICAVs

An alternative to mutual funds are SICAVs (Variable Capital Investment Companies). Unlike mutual funds, in SICAVs the assets of the fund and those of the company that manages it are not separated. Investors become shareholders of the company, also acquiring voting rights in meetings.

Differences Between Mutual Funds and ETFs

Mutual funds and ETFs (Exchange Traded Funds) differ in several key ways. Mutual funds are actively or passively managed investment vehicles, with shares bought or sold directly from the management company at their net asset value (NAV), which is calculated once a day. In contrast, ETFs are traded on an exchange like stocks, with prices that fluctuate throughout the day based on market movements, providing greater flexibility for investors.

Costs are also a key difference: mutual funds tend to have high management fees, sometimes over 2% per year, while ETFs have lower costs, often around 0.3%. This structure makes ETFs more accessible to cost-conscious investors, while mutual funds may be more suitable for those looking for active, customized portfolio management.

Original article published on Money.it Italy. Original title: Fondi comuni di investimento, cosa sono e come funzionano