1

Chapter 15 – Mutual Funds

• Pool money from investors with similar objectives and purchase a diversified portfolio run by a professional manager– Shares issued to investors– Fluctuate with value of portfolio– Investments broadly or narrowly diversified

• $7 trillion assets; ½ families own

2

Recent Issues

• Until last year “squeaky clean”

• 2003 Whole series of conflicts– Late trading favoring large investors– Soft dollars– Proxy voting– Fees

3

Advantages

• Diversification through pooling

• Professional management

• Minimum transaction costs

• Liquidity – open-end funds will buy back

• Flexibility – 8,600 funds; different goals

4

Disadvantages

• Lower performance than market – expenses

• Costs vary- load fees, management, 12-b1

• Risk – not all funds truly safe (junk bonds)

• Can't avoid market risk

• Trade frequently causing short-term gains

5

Open-End Funds

• Stand ready to issue new shares or buy back outstanding shares at Net Asset Value on a daily basis.

• NAV = value of all assets, less liabilities divided by number of shares– Current value of investments determine

value of each share– Open-end funds are largest type

6

7

Other Types of Funds

• Closed-end – has fixed number of shares– Traded between investors; not sold back to mgr– Value may be above or below NAV

• Unit trusts – fixed pool of investments, often bonds. – Passively managed; bonds held to maturity

• Real Estate Investment Trusts (REIT's)– Equity, mortgage, and hybrid funds

8

Costs of Mutual Funds

• Load charges – sales commissions on shares– 4% to 6% to 8.5% when you buy or– Back-end loads – paid when sold; sliding scale

• No-load funds – no sales charge– Deal directly with management company rather

than broker– No-load funds perform as well as load funds

9

Other Fees

• Management Fees – about 1% of assets– Paid to “pick the winners”; but low correlation

• Expenses – no limit but should = actual cost– For administrative, trading, shareholder service

– Affected by turnover ratios

• 12b-1 marketing fees – range from zero to 1%– Advertising and promotion expense paid by fund

10

11

Types of Funds and Objectives

• Money market mutual funds (MMMF's)• Stock funds – many types and objectives• Balanced funds – stocks and bonds for

steady income and moderate growth• Asset allocation – switch between stocks

and bonds depending on market outlook• Bond funds – income over growth

– High to low quality; municipal bond funds

12

13

Mutual Fund Services

• Automatic investment or withdrawals

• Reinvestment of dividends and interest

• Can wire transfer funds Phone switching between funds

• Check writing on MMMF's - $250 min

• Bookkeeping services and tax reporting

14

Buying a Mutual Fund

• Determine your goals

• Find fund to meet objectives; prospectus

• Evaluate fund's performance and costs– Past performance does not predict future– Fund doing well one year might not next

year

• Sources of info – Morningstar is best

15

Prospectus

• Goals and strategies

• Manager's experience

• Performance over last ten years

• Fees, expenses and turnover ratios

• Shows assets in portfolio