Date post: | 02-Apr-2015 |
Category: |
Documents |
Upload: | kristina-pippin |
View: | 213 times |
Download: | 0 times |
Investments: Analysis and Behavior
Chapter 16- Mutual Funds
©2008 McGraw-Hill/Irwin
16-2
Learning Objectives
Understand the structure and pricing of mutual funds Remember the differences between open-end, closed-
end and exchange traded funds Recognize the impact of expenses and taxes on fund
returns Assess mutual fund performance Know various types of mutual funds
16-3
Mutual Funds An investment company that issues its portfolio shares to investors.
Money from shareholders are pooled and invested in a wide range of stocks, bonds, or money market securities. Managed by professional managers
Each investor shares proportionately in the income and investment gains and losses, as well as the brokerage expenses and management fees.
16-4
1. Types of Mutual Funds
Open-end Funds Closed-end Funds Exchange Traded Funds (ETF)
16-5
Open-End Funds
An open-end investment company is commonly called an open-end fund.
A mutual fund has no limit on the size of the fund or the number of shares outstanding.
Mutual fund shares are not sold to other investors. Instead, they are redeemed by the fund management.
The value of a mutual fund share is called its net asset value.
16-6
Open-End Investment Companies
Insert Figure 21-1 here.
16-7
Closed-End Funds
A closed-end fund has a fixed number of shares.When the market price exceeds its NAV, selling
at a premium, otherwise, selling at a discount Buy and sell like a stock.The pricing of closed-end fund shares is a
financial puzzle - they usually sell at a discount to their net asset value (NAV).
16-8
Exchange Traded Funds (ETFs)
Exchange traded fund (ETF) is a form of closed-end fund, embedded with some features of an open-end fundTraded like a stock at stock exchangesShare price is very close to its NAVShares are redeemable!!
16-9
2. Important mutual fund terms
Net Asset Value (NAV) Fees
Load: Expense ratio: 12b-1 fee:
Alpha Beta
16-10
Net asset Value NAV: per share value of a mutual fund’s investment
holding.
Example
A mutual fund has $100 mil in assets and $3 mil in short term liabilities. 10.765 mil shares outstanding. What is the NAV?
Solution
($100 mil - $3 mil) / 10.765 mil = $9.0107 per share
gOutstandin Shares of #
sLiabilitie Portfolio Assets of ValueMarket NAV
16-11
Types of Mutual Funds Objective Funds Hold Growth Potential Income Potential Stability
Money Market Funds
Taxable money market Current income stability of principal
Cash investments None Moderate Very high
Tax-exempt money market
Tax-free income, stability of principal
Municipal cash investments None Moderate Very high
Bond Funds
Taxable bond Current income Wide range of government and/or corporate bonds
None Moderate to high Low to moderate
Tax-exempt bond Tax-free income Wide range of municipal bonds None Moderate to high Low to moderate
Common Stock Funds
Balanced Current income capital growth
Stocks and bonds Moderate Moderate to high Low to moderate
Equity income High-yielding stocks, convertible bonds
Moderate to high Moderate Low to moderate
Value funds Low P/E, P/B stocks Moderate to high Low to moderate Low to moderate
Growth and income Dividend-paying stocks Moderate to high Low to moderate Low to moderate
Domestic growth Capital growth U.S. stocks with high potential for growth
High Very low Low
International growth Stocks of companies outside U.S.
High Very low to low Very low
Aggressive growth Aggressive growth of capital
Stocks with very high potential for growth
Very high Very low Very low
Small cap Stocks of small companies Very high Very low Very low
Specialized Stocks of industry sectors High to very high Very low to moderate
Very low to low
16-12
1) Load and No-Load Load funds is a sales charge.
If paid at the time of purchase, the fee is a front-end load.
If levied when shares are sold, the fee is a back-end load, or contingent deferred sales charge.
A no-load fund charges no sales commission.
Fees
Most mutual funds separate their charges into a number of categories.
16-13
The Investment Company Industry : Fees
Insert Figure 21-2 here.
16-14
Expense Ratio
Annual fee charges are calculated by a fund’s expense ratio, which is the fund’s total expenses expressed as a percentage of the fund’s assets. (range from 0.2% to 2%)management fee : includes salaries and
bonus paid to fund managers 12-b fees: advertising costs on to the
accountholders Other fees
16-15
Expense Ratio
A mutual fund could have several classes of shares with different fee combinations.
Studies indicate thatExpense ratio is normally lowest for money
market mutual funds and highest for international stock funds
Tend to be lowest for large, liquid fundsThe lower the expense ratio, the better the
fund performance.
16-16
The Investment Company Industry : Fees
Insert Figure 21-3 here.
16-17
Fund A Fund B Fund C
Shareholder Transaction Expenses
Sales load imposed on purchases None None 4.75%
Sales load imposed on reinvested dividends None None 4.75
Redemption fees None None None
Exchange fees None None None
Annual Fund Operating Expenses
Management and administrative expenses 0.22% 0.60% 0.70%
Investment advisory expenses 0.02 — —
12b-1 marketing fees — 0.30 —
Marketing and distribution costs 0.02 — —
Miscellaneous expenses 0.03 0.32 0.26
Total Operating Expenses 0.29% 1.22% 0.96%
Expenses on a $10,000 Investment
1 year $ 30 $ 124 $ 587
3 years 93 387 823
5 years 163 670 1,077
10 years 368 1,477 1,805
Table 16.4A. Typical fee tables found in three different mutual fund prospectuses
16-18
B. The impact of equity mutual fund costs on long-term investor returns.
Fund A Fund B Fund C
Initial investment $ 10,000 $10,000 $10,000
Day 1 10,000 10,000 9,525
5 years 18,189 17,451 16,186
10 years 33,084 30,565 29,689
15 years 60,178 53,145 52,416
20 years 109,458 92,743 92,539
Gross return 13.00% 13.00% 13.00%
Operating expenses 0.29% 1.22% 0.96%
Net return 12.71% 11.78% 12.04%
Fund A : typical cost efficient index fundFund B : conventional no-load stock mutual fundFund C : low-load stock mutual fund with less than typical annual operating expenses
16-19
Figure 16.2 Impact of Costs and Taxes on 10% Return
$0
$500
$1,000
$1,500
$2,000
$2,500
$3,000
$3,500
$4,000
$4,500
$5,000
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40
Years
En
din
g V
alu
e
10% Return, no cost
10% Return, 1% cost
10% Return, 1% cost, 30% taxes
$4,526
$3,141
$1,152
Begin w ith $100
16-20
Sources of Investment Returns
Total Return: dividend and interest income and realized and unrealized appreciation Income distribution: interest and dividend income after
expenses. Capital gains unrealized until the fund sells the shares
(Unrealized capital gains) The realized capital gains are paid out to shareholders at the
end of the year (capital gains distributions)
16-21
Taxes
Shareholders pay taxes due once income dividends and capital gains distributions are received.
All income and capital gains distributions are generally subject to income taxes. Municipal bond or US T-securities interest income exempt
from federal taxes, but capital gains are taxable.
Turnover rate: expressed as a percentage of the fund’s average assets (average turnover rate for stock mutual fund: 79%)
16-22
Selecting A Mutual Fund
before-load(gross) return
change innet asset
value
capital gainsdistributions
incomedistributions
beginning net asset value
+ +
=
after-load(net) return
change innet asset
value
capital gainsdistributions
incomedistributions
beginning net asset value
+ + -
=
loadfee
With a mutual fund, return comes from the change in net asset value, capital gains distributions, and income distributions.
16-23
16-24
3. Fund Performance
Using ranking tools or portfolio evaluation tools (alpha, Sharp ratio, and Treynor measure)
16-25
Style boxes
Value Strategy(Score <1.75)
Blend(1.75 Score
2.25)
Growth Strategy(Score > 2.25)
Large-cap (Top 5%)
S & P 500Benchmark
Mid-cap(Next 15%)
Wilshire 4500Benchmark
Small-cap(Bottom 80%)
Russell 2000Benchmark
• Characterize mutual funds by market capitalization (large, mid, and small cap)• Next, determine how cheap or expensive portfolio holdings are relative to the overall market using P/E and P/B ratios (Value, Blend and Growth)
16-26
4. Selecting A Mutual Fund : Types of Funds
Insert Figure 21-4 here.
16-27
Money market funds invest in short-term government securities and sometimes in short-term corporate securities. They are used primarily as a temporary cash haven.
Bond funds invest in fixed income securities. They vary widely, and have no common maturity date to simultaneously return the components to their par value.
Stock funds vary widely in their risk and price behavior. They are classified as growth or value, and as large-cap or small-cap.
16-28
A balanced fund is a mixture of stocks and fixed income securities. It forces discipline on the fund manager.
An international fund is limited to buying securities registered outside the country where it is sold, while a global fund can invest anywhere in the world.
A fund of funds invests only in other mutual funds. Its diversification is good, but its expense ratio tends to be higher than that of the typical mutual fund.
16-29
Sector : Such funds invest in specific market sectors, such as physical commodities or stocks closely tied to natural resources e.g. oil, forest products, and gold.
An index fund may be a stock or bond fund that tries to behave exactly like the market. A stock index fund, for instance, may seek to mirror the performance of the Standard & Poor’s 500 stock index.
Investors should determine their investment objective first, and then choose an appropriate fund or group of funds.
16-30
Insert Table 21-2 here.
16-31
Information Sources : Company Information The prospectus is a legal document
describing the operation of the fund, its management, and the fees accountholders must pay.
One important item in the prospectus is the fund’s portfolio turnover rate. A higher rate usually means higher expenses.
The Statement of Additional Information is required by the SEC, although it is generally only sent to accountholders upon their request. It is a more detailed version of the prospectus.
16-32
Review
ConceptsOpen-end fund, closed-end fund, ETF load charge, NAV, 12-b fees, expense ratio,
alpha
16-33
Sources of Information Lipper Inc.: leading provider of data and
analysis on the investment company business ( www.lipperweb.com )
Morningstar.com: provide unbiased data and analysis and candid editorial commentary (www.morningstar.com)
Vanguard Group: providing competitive investment performance and lowest operating expenses ( www.vanguard.com )