Mutual Fund Holding Rules

The sum of all the securities and assets in a fund's portfolio are commonly called the mutual fund holding. As a mutual fund, the investment vehicle is limited to certain types of transactions and holdings by the Securities and Exchange Commission (SEC). Mutual funds fall into a class of investment advisers, and this class determines the types of holdings the fund can have. For example, a hedge fund can engage in different strategies than a mutual fund. In response to the market meltdown of 2007, the SEC changed the rules for mutual fund holdings. 

Reasons for New Rules

The new rules for mutual fund holdings arose because there was a "run on the bank" in 2007 and the years following. Many mutual funds invest in bonds for long-term returns and stable growth. These bonds are relatively safe, but they can be compromised in the case of default. Typically, defaults occur only in a limited scope, meaning the integrity of the fund as a whole is not compromised. In the late 2000s, these defaults occurred on a large scale, preventing the funds from delivering the promised principal amount to their investors. While loss of interest is generally accepted in the short-run, loss of principal holdings can be detrimental to investors. 

Cash or Liquid Holding Requirements

One major change taking place in some funds is the requirement to hold a portion of all investments in cash or in securities that can be liquidated into cash within a certain period of time. The most regulated funds, money market funds, must maintain 10 percent of holdings in cash. An additional 30 percent of the holdings must be able to be transferred into cash within one week. This prevents the possibility the fund simply cannot return a principal sum to an investor. 

Quality of Holding Requirements

Securities and bond ratings factor into mutual fund investments. If a security is below a certain rating, it is no longer investment grade. Within the investment grade rating, though, there are several other levels of quality. In the crash of 2007 and on, mutual funds were discovered to be holding multiple credit default swaps and mortgage backed securities. These instruments were not of the highest quality on the market, and the risk to mutual funds was exponential. Now, the SEC mandates only a certain level of holdings can be of the highest risk level on certain types of mutual funds. For example, money market funds must have no more than three percent of holdings in high-risk securities. 

Protection for the Investor

Ultimately, these holding rules are designed to offer more investor protection. They limit the amount of speculating the average mutual fund can engage in. Speculating is very much a part of investing, but most individual investors agree it should not be a part of most mutual funds. Mutual funds pool together investors to qualify for an institutional status, allowing them more market freedom. At the same time, their investors are often the most inexperienced on the market. Addressing this dichotomy meant setting new rules for the types of holdings in a mutual fund. 

blog comments powered by Disqus
Scottrade