Transcript Document

Measurement of Mutual Funds
• By Total Return
Income + Capital Gain +/- Price Change
Initial Investment
• Versus Return of Peer Groups
– By broad or narrow categories of fund investments
– By investment objective
– By investment style based on historical holdings (general
equity funds)
• Versus Return of an Index
– May be broad or focus on particular region or country
– “Theoretical” index return does not include expenses that
would be involved if an actual portfolio
2–0
Types of Mutual Funds
Types of Funds
Money market
Equity
Bond
Hybrid
(Stock & Bond)
Index
Taxable
Taxable
Equity
Tax Exempt
Tax Exampt
Bond
Fund of Fund
2–1
Distribution of Mutual Funds
by Assets, July 2007
Hybrid funds
6%
Bond funds
14%
Money
market funds
23%
Stock funds
57%
Source: Investment Company Institute (ICI)
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Money Market Fund
• MONEY MARKET FUNDS: Invests in high
quality, low risk, short-term debt securities (T-bills,
banker’s acceptance, negotiable CD’s, etc.).
•Low risk of default and high liquidity. Managers
are limited to buying short-term securities rated
investment grade by Moody’s and S&P.
•Attempts to maintain NAV of the fund at $1 per
share; achieve this by purchasing debt securities
that are trading at a discount to their face value.
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Money Market Fund
• Interest accrues daily
• Money market funds are neither insured nor
guaranteed by the U.S. Government. Funds are
not insured by the FDIC.
• Like other securities, MMF are insured by
Securities Investor Protection Corporation (SIPC).
SIPC is a government sponsored private
corporation that provides limited protection (up to
$100,000) for customer if their broker/dealer goes
bankrupt.
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Money Market Fund
• Five Basic Types Of Money Market Funds:
1.GOV’T SECURITIES MONEY MARKET FUNDS
• Invests in T-bills, T-notes, and agency securities;
• 90 days or less to maturity;
• Income earned is subject to federal income tax
but may be exempt from state and local taxes;
•Considered to be the safest type of MMF.
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Money Market Fund
2. U.S. TREASURY MONEY MARKET FUND
• Invests only in U.S. government securities
issued directly by the U.S. Treasury with short
term maturity;
•Agency securities are not included;
• Income earned is subject to federal taxes, but
exempt from state and local taxes.
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Money Market Fund
3. TAXABLE MONEY MARKET FUND
• Invests in bank obligations such as,
negotiable CDs, short-term debt obligations
traded between institutions. Agency securities
are not included;
• Income earned is subject to federal , state
and local taxes.
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Money Market Fund
4. NATIONAL TAX EXEMPT MONEY MARKET
FUND
• 75% of its assets is invested in high quality debt
securities issued by municipality.
• 90 days or less to maturity;
• Income earned is exempt from federal income
taxes, but is subject to state and local taxes;
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Money Market Fund
5. SINGLE STAT, DOUBLE TAX EXEMPT
MONEY MARKET FUND
• Invests in municipal securities issued by a
single state;
•Income earned is exempt from federal and
state taxes, but may be subject to local taxes.
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Bond Funds
• Definition: Bond funds invest primarily in debt
securities with maturities of different lengths
(generally >1 year)
• Taxable bond funds
–
–
–
–
–
U.S. Treasury or government agency
High-grade corporate
High-yield (sometimes called “junk”)
Asset-backed
Global or foreign
• Tax-free bond funds
– National municipal
– State municipal
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Types of Bond Funds
Taxable Bond Funds
Corportate
Bond Fund
Government
Bond Fund
General
Adjustable
Rate Mortage
High Quality
General
High Yield
(Junk Bonds)
MortgageBacked
Securities
International
Bond Fund
Multi-Sector
Bond Fund
World
Bond Fund
U.S.
Treasury
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Types of Bond Funds
Tax Exempt
Bond Funds
National Tax Exempt
Bond Fund
Single State TaxExempt Bond Fund
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Stock Funds
• Definition: Stock funds invest primarily in equities
(common and preferred stock)
• Domestic (U.S.) funds
–
–
–
–
From value to growth
From micro-cap to large-cap
Sector
Theme
• International/World funds
– Global
– International (non-U.S.)
– Regional and country
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Equity Fund Objectives
Equit Fund Objectives
Aggressive Capital Equity
Growth Appreciation Income
Growth
Growth International/ Sector/ Small World/
and Income Foreign Specialty Comapany Global
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Competitive Universes
for Stock Funds
• For all equity funds
– Morningstar sets broad categories and assigns
star ratings within categories
– Morningstar sets narrower peer groups and
assigns category ratings within each group
– Lipper categorizes fund around standard
investment objectives for return comparisons
• Primarily for U.S. general equity funds—
based on historical holdings
– Morningstar uses style boxes to rank funds
– Lipper uses style classifications to rank funds
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U.S. General Equity Funds Investment
Style Classification Schemes
Morningstar StyleMapSM
Lipper Style Box Classifications
Reprinted with permission.
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Morningstar StyleMap
• Market Cap – weighted median market cap of
fund’s holdings
• Styles are based on: P/E, P/Book and
dividend yield (D/P)
• Growth : High P/E, high P/B, and low D/P.
• Value : Low P/E, low P/B, and high D/P
• Blend : Mix of growth and value; falls middle
of growth/value scale
• Historical Vs. Current style.
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Lipper Style Box
• “Old” system: Investment objective and market
cap measured at the time fund purchased
securities
• “New” System: considers actual fund holding
regardless of objectives
• Classifies funds by analyzing financial characteristics of fund’s holdings at 3 different dates
– Most recent portfolio (weighted 60%)
– One year prior fiscal year (weighted 30%)
– Two year prior fiscal year (weighted 10%)
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Lipper Style Box
• Classifies funds as Value, Growth and Core
• Examines P/E, P/B, and Sales growth
• “Supper group”: all styles for a particular
capitalization
• Differences between Morningstar and Lipper
– Multi cap and supergroup in Lipper
– Market cap – Morning star uses 5000 stock index;
Lipper S&P SuperComposite 1500 index
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Hybrid Funds
Hybrid Funds:
• Invest in both stocks and bonds,
• May also invest in convertible bonds and
preferred stocks,
• Generally less risky than the stock funds; may
provide better return than the bond funds
• The level of risk depends on the mix of stocks
and bonds,
• Appropriate for conservative investors.
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Hybrid Funds
Three types of Hybrid Funds:
Hybrid Funds
Asset Allocation Funds
Balanced Funds
Convertible Securities Fund
Fixed
Preferred Stock
Flexible
Corporate Bond
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Asset Allocation
Asset Allocation: Purpose is to put assets
together in such a way as to maximize return
at a level of risk consistent with investor’s
objectives.
Process involves 4 key elements:
1) Investors need to determine the assets that
are eligible for the portfolio.
2) Necessary to determine E(R) for these
eligible assets over a holding period.
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Asset Allocation
3) Once returns have been estimated and
risk accessed, optimization technique is
used.
4) Choose portfolio from efficient frontier,
provides maximum return, minimal risk.
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Approaches to Asset Allocation
Fixed Weight: Fixed percentage of the portfolio
to each asset category – 3 to 5 in total. Fixed
does not mean equal weight.
Common Stock
Bonds
Foreign Securities
Short term Securities
30%
50
15
5
Allocation does not change over time, may be
adjusted after a major market move to keep the
desired fixed allocation
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Asset Allocation
Flexible Weight - also known as strategic asset
allocation: Weight changes on the basis of market
analysis. Favorable domestic inflation forecast
compared to foreign may result in revised
allocation.
Common Stock
30% to 45%
Bonds
50 to
40
Foreign Securities
15 to
10
Short term Securities 5
to
5
Weights are changed to capture greater returns
in changing market.
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Asset Allocation
Tactical Asset Allocation: Form of market
timing that uses stock index futures and
bond futures to change a portfolio’s asset
allocation.
Stocks are forecasted to be less attractive
than bonds, sell stock index futures and
buy bond futures.
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Asset Allocation
Bonds are forecasted to be less attractive
than stocks, buy stock index futures and
sell bond futures.
Requires sophisticated technique, large
portfolio, quantitative modeling.
Appropriate for large institutional
investors.
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Balanced Fund
Balanced fund: Preservation of capital is the
main objective
• Each fund sets its own fixed allocation
percentage and discloses them in the
investment objective,
• Traditional balanced fund allocation:
– 60 % stock; 40% bond bond;
– Other allocations scheme may be: 555% stock;
35% bond; and 10% cash equivalent.
• Rarely the leading performers not the worst
performer.
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Convertible Securities Fund
Invests in corporate bonds and preferred stocks
that can be converted into common stocks
• The majority of the bond and preferred stock
are investment grade securities
• Small percentage may be invested in
nonconvertible corporate bonds, U. S.
government securities, foreign securities, and
common stocks,
• Fund is not well known or popular; difficult to
understand how the underlying instruments
work.
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Active versus Passive Management
• Actively managed funds
– Goal is to outperform a benchmark index
– Managers attempt to add value through
security selection and/or sector weighting
• Passively managed funds
– Goal is to match the return of an index
– Managers may purchase all component
securities of an index or a representative
sample
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Active versus Passive
Management (cont.)
• Which is better?
– There is much academic debate, with evidence on
both sides
– EMH adherents and some studies argue that
active managers do not outperform over the longterm and that higher fees wipe out any difference
– Supporters of active management and some
studies argue better success over shorter time
periods, in less liquid markets, in “broad” markets,
and with very talented fund managers
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Alternatives to Mutual Funds
• Alternatives to equity index funds
– Unit investment trusts (UITs)
– Exchange-traded funds
• Pooled vehicles primarily for high-networth clients
– Hedge funds
– Common trust funds
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