Transcript No Slide Title

Chapter Eighteen
Mutual Funds
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Mutual Funds Overview
• Mutual funds are financial intermediaries that pool the
financial resources of investors and invest those
resources in diversified portfolios of assets
• Enjoy economies of scale by incurring lower
transaction costs and commissions
• Shareholder services offered include free exchanges of
investments between a company’s funds, automatic
investing, check-writing, automatic reinvestment of
dividends, and automatic withdrawals
• At year-end 2001, more than 8,300 mutual funds held
total assets of $6.97 trillion
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Historical Trends
• First mutual fund established in 1924
• Advent of money market mutual funds in 1972
as investors looked for ways to earn market
rates on short-term funds
• Tax-exempt money market mutual funds
introduced in 1979
• Special-purpose equity, bond, emerging market,
and derivative funds exploded on the scene
during the 1990’s bull market
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Growth of the Mutual Fund Market
300000
9000
8000
250000
7000
200000
6000
5000
150000
4000
100000
3000
2000
50000
1000
0
0
1950
1960
1970
Shareholders (thou.'s)
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1980
1990
Assets ($ Bn.)
2000
2001
No. of Funds
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Types of Mutual Funds
• Long Term
– Equity funds - funds consisting of common and
preferred stock securities
– Bond funds - funds consisting of fixed-income
capital market debt securities
– Hybrid funds - funds consisting of stock and bond
securities
• Short Term
– Money market mutual funds – invest in taxable or
tax-exempt money market securities (with maturity
of less that one year)
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Mutual Fund Prospectuses and Objectives
• Regulations require mutual fund managers to
specify the investment objectives of their funds
in a prospectus available to potential investors
• The prospectus includes a list of the securities
that the fund holds and the investment objectives
(e.g., aggressive growth funds invest in the
equities of high-growth and high-risk firms)
• As of 1998, SEC requires key sections of a fund
prospectus to be written in ‘plain’ English
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Investor Returns from Mutual Fund
Ownership
• The return for the investor reflects three aspects of
the underlying portfolio of mutual fund assets
– portfolio earns income and dividends on those assets
– experiences capital gains sells an asset at a higher price
– capital appreciation in the underlying values of its existing
assets adds to the value of mutual fund shares
• Daily marking to market - asset and balance sheet
values are adjusted to reflect current market prices
• NAV - the net asset value of a mutual fund -- equal to
the market value of the assets in the mutual fund
portfolio divided by number of shares outstanding
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Calculation of NAV; Classes of Funds
Calculation of NAV on an Open-End Mutual Fund
NAV = Total market value of assets under management
Number of mutual fund shares outstanding
Open-end mutual fund - a fund for which the supply of
shares is not fixed but can increase or decrease daily with
purchases and redemptions of shares
Closed-end investment companies - specialized investment
companies that have a fixed supply of outstanding shares
but invest in the securities and assets of other firms
REIT - a closed-end investment company that specializes in
investing in mortgages, property, or real estate shares
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Mutual Fund Costs
• Mutual funds charge shareholders a price or
fee
• Two types of fees are incurred by investors
– Load versus No-load Funds
• Load fund - a mutual fund with an up-front sales or
commission charge that the investor must pay
• No-load fund - a mutual fund that does not charge up-front
sales or commission charges on the sale of mutual fund
shares to investors
– Fund Operating Costs
• annual fees charged to cover all fund level expenses
experienced as a percent of fund assets
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Assets in MMMFs, 2001 (in $B)
Total financial assets
Foreign deposits
Checkable deposits and
currency
Time and savings deposits
Security RPs
Credit and Market instruments
Open-market paper
U.S. government securities
Treasury
Agency
Municipal securities
Corporate and foreign bonds
Miscellaneous assets
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$2240.7
124.2
4.6
219.5
227.0
1,536.9
638.9
454.1
135.7
318.4
281.0
163.0
128.6
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Regulation
• This industry is heavily regulated to protect investors
• SEC is the primary regulator
– Securities Act of 1933 requires a mutual fund to file a registration
statement with the SEC
– Securities Exchange Act of 1934 makes the purchase and sale of mutual
fund shares subject to various antifraud provisions and appointed the
National Association of Securities Dealers (NASD) to supervise
– Investment Advisers Act and Investment Company Act of 1940
established rules to prevent conflicts of interest, fraud, and excessive fees
– Insider Trading and Securities Fraud Enforcement Act of 1988 requires
mutual funds to develop mechanisms and procedures to avoid insider
trading abuses
– Market Reform Act of 1990 allows the SEC to introduce circuit breakers
– NSMIA of 1996 also applies to mutual funds
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