Mutual Funds and Other Investment Companies

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B, K M Chapter 4

• Mutual Funds and Other Investment Companies

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Benefits of Investment Companies

• Administration record keeping
• Diversification divisibility
• Professional management
• Reduced transaction costs

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Net Asset Value

• Used as a basis for valuation of investment
  company shares
• Selling new shares
• Redeeming existing shares
• Calculation
• Market Value of Assets - Liabilities
• of Shares Outstanding

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Types of Investment Companies

• Unit Investment Trusts
• Pools of money invested in a portfolio that is
  fixed for the life of the fund
• Little active management involved
• Steadily lost market share to mutual funds in
  recently years

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Types of Investment Companies

• Managed Investment Companies
• Open-End fund stand ready to redeem or issue
  shares at their net asset value (NAV)
• Closed-End fund are traded much like shares of
  common stock. They do not issue or redeem shares
  at NAV, and often trade at a discount or surplus
  NAV.
• Key Differences
• Shares Outstanding
• Closed-end no change unless new stock is offered
• Open-end changes when new shares are sold or old
  shares are redeemed
• Pricing
• Open-end Net Asset Value (NAV)
• Closed-end Premium or discount to NAV

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Figure 4.1 Closed-End Mutual Funds
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Types of Investment Companies

• Other investment organizations
• Commingled funds
• Real Estate Investment Trusts (REITs)
• Hedge Funds

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Figure 4.2 Listing of Mutual Fund Quotations
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Investment Policies

• Money Market
• Equity
• Specialized Sector
• Bond
• Balance Income
• Asset Allocation
• Indexed
• International

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Table 4.1 Classification of U.S. Mutual Funds
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How Funds Are Sold

• Directly marketed
• Sales force distributed
• Revenue sharing on sales force distributed
• Potential conflicts of interest
• Financial supermarkets

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Potential Conflicts of Interest - Revenue Sharing

• Brokers put investors in funds that may that may
  not be the most appropriate
• Mutual funds could direct trading to higher cost
  brokers
• Revenue sharing is not illegal but it must be
  disclosed to the investor

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Costs of Investing in Mutual Funds

• Fee Structure
• Front-end load
• Back-end load
• Operating expenses
• 12 b-1 charges
• These fees are named after the SEC rule that
  permits funds to pay for distribution costs such
  as advertising, promotional literature and, most
  importantly, commissions to brokers out of fund
  assets
• Are deducted from the funds assets
• Fees can have an important impact on fund
  performance

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Taxes on Mutual Funds

• Investor directed portfolios can be structured to
  take advantage of taxes while mutual funds cannot
• High turnover leads to tax inefficiency
• More disclosure on taxes was required in 2000

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First Look at Mutual Fund Performance

• Evidence shows that average mutual fund
  performance is generally less than broad market
  performance
• Evidence suggests that over certain horizons some
  persistence in positive performance
• Evidence is not conclusive
• Some inconsistencies

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Figure 4.3 Percentage of Funds Below Wilshire
5000
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Sources of Information on Mutual Funds

• Wiesenbergers Investment Companies
• Morningstar (www.morningstar.com)
• Yahoo (biz.yahoo.com/funds)
• Investment Company Institute
• Popular press
• Investment services