Mutual Funds

1
Mutual Funds

• Definition Financial intermediary through which
  savers pool their monies for collective
  investment, primarily in publicly trades
  securities.
• A fund is mutual in the sense that all of its
  returns minus its expenses, are shared by its
  shareholders.
• Returns consist of dividends, realized and
  unrealized capital gains (losses)
• Expenses consist of advisory fee for servicing
  the shareholders, annual fee for distribution
  (12b-1)

2
Mutual Funds Vs. Individual Securities

• Objective is to maximize return with minimum
  risk
• Efficient Market hypothesis and undervalued
  securities
• Mean reversion in the equity market
• Individual securities have two main sources of
  risk alpha and beta.
• Alpha - company specific risk usually accounts
  for 50-70 of securitys price volatility
• Beta - market risk accounts for 30-50 of price
  volatility.

3
Recent Trends Between Funds and Securities

• Review household purchases of equities data
• Anecdotal evidence - investors are shifting
  toward equity
• Increase in Nasdaq trading volume in 1999-
  technology stocks
• Increase in online trading
• Increase in Separate Accounts or wrap
  accounts.
• Accounts offered by trust bank/trust dept of a
  commercial bank. Minimum balance was 1m now as
  low as 50,000.

4
Bond Funds Vs. Individual Bonds

• Investors are focused on income stream
• To receive income, investors can buy individual
  bonds - T-bonds, agency bonds, corp. bonds,
  municipal bonds, and hold to their maturity.
  Receive periodic fixed interest payment and
  principal at maturity.
• Alternatively, receive income stream by buying a
  diversified bond mutual fund. No fixed interest
  payment nor an obligation to pay principal at
  maturity.

5
Bond Funds Vs. Individual Bonds

• Higher minimum requirements for individual bonds
  (usually 25,000 T-bonds 1,000). Lot size is
  usually 100,000. One 25,000 bond lacks
  diversification.
• Cost 2 - 4 of value.
• Bond mutual fund minimum As low as 1,000. Can
  redeem fund on any business day. Do not have to
  hold till maturity.
• Fund offers more diversification. Offer
  convenient services, such as monthly income
  payments, compared to quarterly or semi-annually
  for individual bonds

6
Benefits of Investing in Mutual Funds

• Diversification Typically lowers ? global fund
  may also lower ?
• Professional Management Professional
  qualifications (CFA) access to company
  executives in house research team, wall street
  research.
• Lower Transaction Costs Lower admn. cost,
  savings on record keeping, better execution of
  securities.
• Convenience Automatic deposits/ withdrawal, tax
  reporting, retirement planning, educational
  materials.

7
Disadvantages of Investing in Mutual Funds

• Need to pay fees/expenses even when fund performs
  poorly
• Increased diversification may prevent the chance
  of hitting the jackpot from one security
• Online trading and security research on the
  internet have reduced the advantage of cost and
  research access
• Less control over securities portfolio and
  therefore timing of realized capital gains for
  tax purposes.

8
What Investors Need to Know?

• Structure and working of a typical fund
• Roles of various entities involved in operating a
  fund
• Fund Manager, Custodian, distributor, etc.
• Minimum investment requirement
• Fees and Expenses
• Services provided to the shareholders
• Performance measurements