Transcript Diapositive 1

CHAPTER 4 FUNDAMENTALS
OF INVESTMENT MANAGEMENT
Zoubida SAMLAL - MBA , CFA
Member, PHD candidate for HBS
program
MUTUAL FUNDS
Our goal in this chapter is to understand the
different types of mutual funds, their risks, and
returns.
Investors added $363 billion in net new funds to
mutual funds in 1999, and by the end of the year,
mutual fund assets totaled $6.85 trillion. These
were estimated to be 83 million Americans.
MUTUAL FUNDS
• Mutual funds are simply a means of
combining or pooling the funds of a large
group of investors.
• The buy and sell decisions for the resulting
pool are then made by a fund manager, who is
compensated for the service provided.
• Like commercial banks and life insurance
companies, mutual funds are a form of
financial intermediary.
INVESTMENT COMPANIES AND FUND
TYPES
Investment company
A business that specializes in pooling funds from
individual investors and investing them.
Open-end fund
An investment company that stands ready to buy
and sell shares at any time.
Closed-end fund
An investment company with a fixed number of
shares that are bought and sold only in the open
stock market.
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INVESTMENT COMPANIES AND FUND
TYPES
McGraw Hill / Irwin
@2002 by the McGraw- Hill Companies Inc.All rights reserved.
INVESTMENT COMPANIES AND FUND
TYPES
Net asset value
The value of the assets held by a mutual fund,
divided by the number of shares. Abbreviated
NAV.
• Shares in an open-end fund are worth their
NAV, because the fund stands ready to
redeem their shares at any time.
• In contrast, the shares of closed-end funds
may or may not be equal to their NAV.
WORK THE WEB
For mutual fund facts and figures, visit:
http://www.ici.org
MUTUAL FUND OPERATIONS
Organization and Creation
• A mutual fund is simply a corporation. It is owned
by shareholders, who elect a board of directors.
• Most mutual funds are created by investment
advisory firms (such as Fidelity Investments), or
brokerage firms with investment advisory
operations (such as Merrill Lynch).
• These firms wish to manage the funds to earn
fees.
WORK THE WEB
All the major fund families have
websites. Try, for example:
http://www.vanguard.com
MUTUAL FUND OPERATIONS
Taxation of Investment Companies
• An investment company that
 holds almost all its assets as investments
in stocks,
bonds, and other securities,
 uses no more than 5% of its assets when acquiring
a particular security, and
 passes through all realized investment income to
fund shareholders,
is treated as a “regulated investment
company” for tax purposes and does not need
to pay taxes on its investment income.
MUTUAL FUND OPERATIONS
The Fund Prospectus and Annual Report
• Mutual funds are required by law to supply a
prospectus to any investor who wishes to
purchase shares.
• Mutual funds must also provide an annual
report to their shareholders.
MUTUAL FUND COSTS AND FEES
Types of Expenses and Fees
 Sales charges or “loads.” Front-end loads are
charges levied on purchases, while back-end
loads are charges levied on redemptions.
 12b-1 fees. SEC Rule 12b-1 allows funds to
spend up to 1% of fund assets annually to
cover distribution and marketing costs.
 Management fees. Usually based on fund size,
performance, etc.
MUTUAL FUND COSTS AND FEES
Types of Expenses and Fees …continued
 Trading costs. This is related to the fund’s turnover.
WORK THE WEB
Prospectuses are increasingly available
online. To see some examples, visit:
http://www.fidelity.com
To see a fund that really discloses
information, try:
http://www.ipsfunds.com
Check out the “plain language” risk
disclosure!
MUTUAL FUND COSTS AND FEES
Why Pay Loads and Fees?
• You may want a fund run by a particular
manager, and all such funds are load funds.
• You want a specialized type of fund. Loads and
fees for such funds tend to be higher as there
is little competition among them.
SHORT-TERM FUNDS
Money market mutual fund
A mutual fund specializing in money market
instruments.
• Short-term funds are collectively known as
money market mutual funds, or MMMFs.
• MMMFs always maintain a $1 net asset value to
make them resemble bank accounts.
• Depending on the type of securities purchased,
MMMFs can be either taxable or tax-exempt.
SHORT-TERM FUNDS
• Most banks offer what are called “money
market” deposit accounts, or MMDAs, which
are much like MMMFs.
• The distinction is that a bank money market
account is a bank deposit and offers FDIC
protection.
WORK THE WEB
For information on thousands of funds,
including MMMFs, visit:
http://www.mfea.com
LONG-TERM FUNDS
• A fund’s objective is the major determinant of
the fund type.
• Historically, mutual funds were classified as
stock, bond, or income funds. However, it is
becoming increasingly difficult to do so.
STOCK FUNDS
• Some stock funds trade off capital appreciation
and dividend income.
– Capital appreciation, growth, growth and income,
equity income.
• Some stock funds focus on companies in a
particular size range.
– Small company, midcap.
• Some fund groups invest internationally.
– Global, international, region, country, emerging
markets.
STOCK FUNDS
• Sector funds specialize in specific sectors of
the economy.
• Other fund types include index funds, social
conscience funds, and tax-managed funds.
BOND FUNDS
• Bond funds may be distinguished by their
 maturity range ,  credit quality,
 taxability,  bond type, and  issuing country.
• Bond fund types include short-term and
intermediate-term funds, general funds, highyield funds, mortgage funds, world funds, insured
funds, single-state municipal funds.
STOCK AND BOND FUNDS
• Funds that do not invest exclusively in either
stocks or bonds are often called “blended” or
“hybrid” funds.
• Examples include balanced funds, asset
allocation funds, convertible funds, income
funds.
MUTUAL FUND OBJECTIVES: RECENT
DEVELOPMENTS
• In recent years, there has been a trend toward
classifying a mutual fund’s objective based on
its actual holdings.
• For example, the Wall Street Journal classifies
most general purpose funds based on the
market “cap” of the stocks they hold, and also
on whether the fund tends to invest in
“growth” or “value” stocks (or both).
MUTUAL FUND PERFORMANCE
• Mutual fund performance is very closely
tracked by a number of organizations.
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Mutual Fund Performance
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Mutual Fund Performance
MUTUAL FUND PERFORMANCE
• While looking at historical returns, the
riskiness of the various fund categories should
also be considered.
• Whether historical performance is useful in
predicting future performance is a subject of
ongoing debate.
• Some of the poorest-performing funds are
those with very high costs.
CLOSED-END FUNDS & EXCHANGE
TRADED FUNDS
• Most closed-end funds sell at a discount
relative to their net asset values, and the
discount is sometimes substantial. The typical
discount also fluctuates over time
• Despite a great deal of research, the closedend fund discount phenomenon remains
largely unexplained.
CLOSED-END FUNDS & EXCHANGE
TRADED FUNDS
• An exchange traded fund, or ETF, is basically
an index fund, except that it trades like a
closed-end fund (without the discount
phenomenon).
• An area where ETFs seem to have an edge
over the more traditional index funds is the
more specialized indexes.
CHAPTER REVIEW
• Investment Companies and Fund Types
– Open-End versus Closed-End Funds
– Net Asset Value
• Mutual Fund Operations
– Mutual Fund Organization and Creation
– Taxation of Investment Companies
– The Fund Prospectus and Annual Report
CHAPTER REVIEW
• Mutual Fund Costs and Fees
– Types of Expenses and Fees
– Expense Reporting
– Why Pay Loads and Fees?
• Short-Term Funds
– Money Market Mutual Funds
– Money Market Deposit Accounts
CHAPTER REVIEW
• Long-Term Funds
– Stock Funds
– Taxable and Municipal Bond Funds
– Stock and Bond Funds
– Mutual Fund Objectives: Recent Developments
• Mutual Fund Performance
– Mutual Fund Performance Information
– How Useful are Fund Performance Ratings?
CHAPTER REVIEW
• Closed-End Funds and Exchange Traded Funds
– Closed-End Funds Performance Information
– The Closed-End Fund Discount Mystery
– Exchange Traded Funds