a presentation on mutual funds
TRANSCRIPT
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A Presentation on Mutual Funds
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Questions to start with
What is a mutual fund?
How does one compute the net asset value
(NAV)? What expenses and charges might a mutual
fund investor face?
What does research on mutual fundperformance tell about fund expenses,portfolio turnover, and returns?
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Questions to start with
What is a good procedure for determining
which mutual funds to purchase?
When might it be appropriate to sell sharesin a mutual fund?
What are the similarities between mutual
funds and some other managedinvestments?
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Mutual Fund Growth
Mutual funds havebecome very popularinvestment vehicles.
Nearly $7 trillion intotal assets in 2000 vs$13 trillion in NYSEin 2002.
Total assets havegrown 600% since1990.
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What is a mutual fund?
Mutual funds are open-end investment
companies.
The fund sells shares to the public andinvests the proceeds in a pool of funds,
which are jointly owned by the funds
investors.
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Computing Net Asset Value For investors, the performance of their investment
depends on what happens to the funds per sharevalue, or net asset value (NAV).
NAV= Market Value of AssetsLiabilities
Number of Shares OutstandingNAV
1=NAV
0+All Incomes-All Distributed
Example: NAV0=Rs.100, Distributed 1) Net
Realized Gains=Rs.2 and 2) Net InvestmentIncome=Re.1.
NAV1= Rs.100-Rs.2-Re.1=Rs.97
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Mutual Fund Management
Most funds are started by investment managementcompanies who hire the fund manager to makeinvestment decisions. Fidelity, Vanguard, etc.
Usually offer many different funds and allowinvestors to switch between funds.
Funds (open-end) sell additional shares to thosewho want to invest, redeem shares at the NAV(less any fees) to those who want to sell theirshares.
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Why invest with mutual funds?
Liquidity
Funds buy and sell their own shares quickly, even if
fund investments are illiquid Diversification
Small minimum investment buys a typically well-
diversified investment
Professional management and record-keeping Expertise and services
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Why invest with mutual funds?
Choice and flexibility
Families of funds offer a variety of investments
to match investor needs
Indexing
Some funds track a broad market index which
insures that investors will earn the marketreturn
Increasingly popular mutual fund alternative
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Mutual Fund Drawbacks
Active trading contributes to high costs
which lower fund returns
Tax consequences can be a disadvantage
Tax impacts of asset trading are passed through
to investors
Tax bill can be large even when the NAV falls
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Mutual Fund Returns
Three sources of return:
Income distributions (ID)
Bond interest, stock dividends
Capital gain distributions (CGD)
Realized gains/losses from selling assets
Changes in NAV (DNAV)
From unrealized gains/losses from assets
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Mutual Fund Returns
Return = (ID + CGDPayments +DNAV)/Beg.NAV
Ex. NAV0=Rs.35,NAV1=Rs.35.2, Net RealizedGain Rs.2, Net Investment Income =Rs..5.Return= (2+.5+35.2-35)/35=7.714%
Most mutual funds allow investors to eitherreceive distributions in cash or to reinvest inadditional shares.
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Types of Mutual Funds
Funds can be classified according to the
type of security in which they invest
Stock Funds
Taxable Bond Funds
Municipal Bond Funds
Stock and Bond FundsMoney Market Funds
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Common Stock Funds
Most popular type of fund
Wide variety with different objectives and
levels of riskGrowth
Industry or sector funds
Geographic areasInternational or Global
Equity Index funds
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Taxable Bond Funds
Generally seek to generate current income withlimited risk
Can vary by maturity Short-term, Intermediate-term, Long-term
Can vary by type of bond Government
Corporate Mortgage-backed
International/Global
Bond Index funds
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Municipal Bond Funds
Provide investors with
income exempt from
Federal taxation Often concentrate on
single states to avoid
state income taxation
as well
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Stock and Bond Funds Seek to provide a combination of income and
value appreciation.
Different namesBalanced funds (60% equity+40% of debt securities)
Goal: to conserve principal, by maintaining abalanced portfolio of both stocks and bonds
Blended funds: Mutipurpose funds(e.g., balancedtarget maturity, convertible securities that invest in
both stocks and bondsFlexible funds: Flexible income, flexible portfolio,
global flexible and income funds, that invest in bothstocks and bonds
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Money Market Funds
Provide safe, current income with highliquidity
Invest in money market securitiesT-bills, Bank CDs, Commercial paper, etc.
NAV stays at Re.1; income either paid out
or reinvested daily Provide an alternative to bank deposits, butnot FDIC insured
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Mutual Fund Innovations
Life-stage funds
Offer different mixes of securities based on the
age of the investor
Supermarket funds
Offer a wide variety of funds with one-stop
fund shoppingTransfer services between funds
Expenses/fees can be high
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Mutual Fund Prospectus
Must be available to investors and should be
review by investors.
Contains: Funds investment objective
Investment strategy
Principal risks faced by investors
Recent investment performance
Expenses and fees
Lots of other detailed information
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Mutual Fund Expenses and
Considerations
Loads Commission to the broker to financial advisor who sold
the fund to the investor
For load funds, the offer price is the funds NAV plus
the load (while no-load funds are sold at their NAV) Ex. 4% load with NAV Rs.96, buy at Rs.100
Load range from around 3% (low-load) to 8.5%
12b-1 Fees: pay to the distributor (.25%-.75% )+
.25% servicing charge in some cases) Fees deducted from the asset value of the fund to cover
marketing expenses
An alternative to loads
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Offering Price= NAV/(1-load %).Investing Rs.1,000 in a load MF with 7% and
expected return of 10%,
Rs.value=1000(1-.07)(1.10)=1023 (2.3%growth)
Investing Rs.1,000 no load MF with 8% returnand 2% redemption fee,
Rs.value=1000(1-0)(1.08)(1-.02)= 1058.4(5.84% growth)
Rs.35.4 Difference
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Mutual Fund Expenses and
Considerations Deferred Sales Loads
Redemption charges when fund shares are sold (ratherthan when purchased)
Often high (5-7%) if shares are sold within the firstyear, but then fall over time, perhaps even disappearingeventually
Share Classes
Many funds offer several different classes of shares (A-B-C) with different fee structures
Best choice usually depends of investment horizon
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Mutual Fund Expenses and
Considerations Management Fees
Fees deducted from the funds asset value to
compensate the fund managers Some adjust fees according to the funds
performance
Expense ratioAdding all fees and calculating expenses as a
percentage of the funds asset
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*Mutual Fund Expenses and
Considerations Portfolio Turnover
Not an explicit cost, but very important determinant ofshareholder returns
Trading costs rise with turnover
In order for high turnover to pay off, fund managersmust be successful in their active trading strategies
Sources of Information Wall Street Journal, Business Week
Morningstar Fund history, tax efficiency, risk analysis
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Holding Period for a Portfolio
Portfolio Turnover
Holding Period = 12 months/(Portfolio
Turnover%)
Ex Turnover 125%=>12/1.25=9.6 month
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Mutual Fund Return and Risk
PerformanceReturn Performance
On a risk-adjusted basis, the average stock fundunder-performs market averages
While portfolio managers seem to out-perform themarket before expenses, net returns are below themarket index
Some above-average performers over short timehorizons, but such performance is not generallysustained (just luck?)
These results help to explain the growing
popularity of index funds
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Mutual Fund Return and Risk
PerformanceRisk Performance
While returns are not consistent, risk is
Objectives lead to strategies that lead to
varying degrees of investment risks
Return is positively related to the level of
risk
Risk is therefore an important consideration
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Mutual Fund Return and Risk
PerformanceFees and expenses: Do higher fees pay off?
Investment performance is no better (and perhapsworse) for load funds vs. no-load
Expenses lower returns in predictable wayslower expense funds give better returns
Turnover affects returns in several ways, including
taxeshigh turnover means more short-termrealized gains
Tax efficiency is an important considerationafter-tax returns may be 30-40% less than pre-tax
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Mutual Fund Investment
Strategies Choose in funds consistent with your objectives,
constraints, and tax situation.
Consider index funds for a large portion of yourfund portfolio.
When possible, invest in no-load funds withbelow-average expense and turnover ratios.
Invest at least 10-20% in international or globalfunds.
Own funds in different asset classes andconsider life-cycle investing.
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Mutual Fund Investment
Strategies If you actively manage your portfolio, consider
the past years hot funds.
Do not attempt to time the market; timingstrategies add little except costs and risk.
Use dollar cost averaging by investing a setdollar amount each month.
Avoid investing money shortly before the capitalgain distribution dates (prospectus).
Do not own too many funds. You will getaverage returns with high expenses.
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When should you sell a mutual
fund? Personal considerations
Portfolio rebalancing points due to life cycleconsiderations
Be aware of the quick trigger, selling on the first dip in NAV;think long-term
Be aware of capital gains with selling fund shares
Fund considerations
Change in portfolio manager Change in investment style
Fund is growing too large or too fast
Persistent bad performance.