This is a very basic question, I'm surprised I haven't thought of it
before. The market price of a mutual fund, is it determined by the
demand of those wanting to buy it (as is a stock)? Or is determined
by the cost of the individual stocks within it (some sort of
mathematical additon/division/formula reflecting the actual value of
the stocks in the fund)?
That's the case for a "closed-end mutual fund". The CEF has a
fixed number of shares outstanding and the market forces of
supply and demand keeps the sum value of all those shares
somewhere in the area of the value of the underlying portfolio,
but not exactly at it - which is why they trade at a discount
"open ended mutual funds" (what most folks mean when they refer
to a mutual fund) go through a calculation every night - figuring
out the value of the portfolio and dividing by the number of
shares outstanding to come up with a "NAV" ("Net Asset Value")
per share. After they do that, any share purchases and sales
from that day are processed at that NAV price. Suppose there
are a million shares outstanding and the portfolio is worth
$80million dollars. The NAV is now $80/sh. Now, suppose that
Bob sent in a check for $8000 and Sam conctacted the fund and
asked for a redemption of 50 shares. The fund goes and creates
100 new shares out of thin air for Bob (and the $8000 gets
incorporated into the portfolio). Then the fund takes back
those 50 shares that Sam redeemed and sends Sam his $4000.
Now, the portfolio is worth $80,004,000 and there are
1,000,050 shares outstanding. All the open-ended funds
go through this computation, sale and redemption process
every night and the number of shares outstanding changes
every day. That way, open-ended funds always "trade" (they
don't really trade) at NAV.
Closed end funds also compute a NAV every day, but since
they don't issue or redeem shares nightly, whatever the NAV
is when it trades (in the secondary market), it trades at
whatever folks are willing to trade at, sometimes more and
most often for less than NAV.
[Some quirks to all that which are ignored above: multiple
share classes, extraction of management fees and trading
costs, possible sales loads front-end, ongoing, or back-end,
the IPO of a CEF, etc. etc. But that's the very simple version]
Plain Bread alone for e-mail, thanks. The rest gets trashed.
No HTML in E-Mail! -- http://www.expita.com/nomime.html
Excellently concise answer by Bread.
Just wanted to point out to Iarwain that even in open ended funds the
portfolio value is determined by the underlying stocks held in the
fund. The value of those stocks is controlled by demand.
So one could say that ALL mutual fund pricing is controlled by
investor demand, but not necessarily directly.
BeanSmart.com is a site by and for consumers of financial services and advice. We are not affiliated with any of the banks, financial services or software manufacturers discussed here.
All logos and trade names are the property of their respective owners.
Tax and financial advice you come across on this site is freely given by your peers and professionals on their own time and out of the kindness of their hearts. We can guarantee
neither accuracy of such advice nor its applicability for your situation. Simply put, you are fully responsible for the results of using information from this site in real life situations.