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Lecture 18
Mutual Funds
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Net Asset Value
NSOLMVA
NAV
NAV = net asset value MVA = market value of assets L = funds liabilities NSO = number of shares outstanding
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Sales Charges
“Front-end” load—commission paid when shares are purchased.
Load fees range from 0% to 8.5%. Some funds charge load fees on
reinvested dividends! The fund’s prospectus may say
“Dividend reinvested at offering price.”
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Sales Charges
“Back-end” load—a contingent deferred sales charge. Starts at 5 or 6%. Decreases by 1% per year.
Load charges are ignored when a fund’s performance is reported.
Historical performance of load and no-load funds.
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Sales Charges
12b-1 charges. Covers distribution costs and
commissions paid to brokers. Annual charge of 0.25% to 1.00%
of fund’s assets. Some funds that are closed to new
investors continue to charge 12b-1 fees!
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Sales Charges Comparison of three funds.
Fund A—6% “front-end” load fee. Fund B—6% “back-end” load fee
that decreases by 1% per year. Fund C—No “front-end” load fee, a
1% annual 12b-1 fee and a “back-end” load fee that starts at 5% and decreases by 1% per month.
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Sales Charges
Some mutual funds have several classes of stock. Class A may have a “front-end”
load fee of 5%. Class B may have a 12b-1 fee of
1% per year and a back-end load fee that begins at 5% and decreases by 1% per year.
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Sales Charges
Transaction and redemption charges. Paid when fund shares are
purchased, liquidated, or exchanged into shares of another fund.
Usually 1% of net asset value. Paid to fund rather than fund’s
sponsors or sales representative.
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Expense Ratios
Investment advisory fees. Administrative expenses. Other operating expenses. 12b-1 fees. What counts is fund’s expense ratio
which vary from 0.2% to 2.5%. A fund’s expense ratio is a key
determinant of performance.
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Invisible Costs
Transaction costs associated with the fund buying and selling securities. Commissions: 0.1% to 0.5% Bid-Ask spreads: 0.125% to 6.0%. Price impact of a large block trade. Average transaction cost is
estimated to be about 0.6%.
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Invisible Costs
A fund’s annual portfolio turnover is
assets sfund' of valueAveragesalesor purchases of Minimum
A fund’s transaction cost can be estimated by multiplying the fund’s annual portfolio turnover by 2 and then multiplying by the average transaction cost of 0.6%.
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Taxes
To maintain a tax-free status a fund must distribute at least 90% of its dividends and realized capital gains each year.
Funds with high annual portfolio turnover realize more capital gains.
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Taxes
If you purchase a mutual fund just prior to the distribution of dividends or capital gains, you will pay taxes on income that you did not earn.
Unrealized capital gains are a potential tax liability.
Unrealized capital loses are a potential tax savings.
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Performance
Annual geometric rates of return from 1970 to 1996. Wilshire 5000 index 12.36% S&P500 index 12.42% Lipper General Equity
Fund Average 11.08%
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Performance
Returns on market indexes ignore expenses.
Expense ratio of Vanguard’s Wilshire 5000 Index Fund is about 0.25%.
The turnover ratio is about 3%. The overall costs would be about
0.30%.
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Performance
Malkiel’s estimates of Jensen’s alpha.
ri – rf = + (rM - rf) + e
Wilshire 5000 p-value Net return -0.93% 7.5% Gross return 0.18% 71.1%S&P500 p-value Net return -3.20% 0.0% Gross return -2.03% 0.1%
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Performance
Elton, Gruber, Das and Hlavka ri – rf = + (rM - rf) + S(rS – rf)
+ D(rD – rf) + e
rM—return on S&P500 index.
rS—return on a small stock index.
rD—return on a bond index. is negative, though generally not
statistically significant.
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Performance
About 60% of above average funds in one year remain above average over the next 3 years.
About 75% of below average funds in one year remain below average over the next 3 years.
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Performance
Persistence in relative performance across fund managers is: Mainly due to expenses and
transaction costs, Concentrated at the extremes of
best and worst performers.