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Investing in Mutual Funds


Company Size Managers specialize in small companies or large cos. Mutual Fund ... Montgomery Small Cap was up 98.8% in 1991, Oakmark was up 48.9% in 1992, DFA ... – PowerPoint PPT presentation

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Title: Investing in Mutual Funds

Investing in Mutual Funds
  • Topic 11

A. Pooled Diversification
  • 1. Professional Money Managers
  • 2. Combines the Funds of many people with
    similar investment goals
  • 3. Receive shares of stock in the mutual fund
    a pooled common investment.
  • 4. An indirect investment

B. Attractions and Drawbacks of Mutual Fund
  • 1. Diversification
  • 2. Full-time Professional Management
  • 3. Modest Capital Investment
  • 4. Services offered
  • a. Automatic reinvestment of dividends
  • b. Withdrawal plans
  • c. Exchange privileges
  • d. Check writing privileges

B. Attractions and Drawbacks of Mutual Fund
  • 5. Convenience
  • a. Easy to acquire
  • b. Paperwork and record keeping
  • c. Prices are widely quoted
  • 6. Lack of liquidity
  • a. Normally must be sold back to the fund
  • b. No brokerage commissions
  • 7. Consistently average to below average

C. Essential Characteristics
  • 1. Open-end Funds
  • a. Investors buy and sell shares back to the
    fund itself
  • b. There is no limit on the number of shares the
    fund can issue
  • Defined as the total market value of all
    securities held by the fund less liabilities,
    divided by the number of fund shares outstanding.

Net Asset Value Example
  • Example NAV
  • XYZ Mutual Fund owns assets totaling 10M and
    liabilities equal to 500,000 with 500,000 shares
  • Therefore, NAV is 10,000,000 - 500,000
    / 500,000
  • 19/share

C. Essential Characteristics (continued)
  • 2. Closed-end Funds
  • a. A fixed number of shares outstanding
  • b. 100 Closed-end funds
  • c. 8 billion market value
  • 3. Investment Trusts
  • a. Interest is an unmanaged pool of
  • b. Usually consist of corporate, government, or
    municipal bonds

C. Essential Characteristics (continued)
  • 4. Load or No Load
  • a. Load Fund
  • Charges a commission when shares are bought (7 -
    8 1/2 or more)
  • b. No Load Fund
  • No sales charges are levied
  • 5. Other fees and Costs
  • a. Professional Management Fee
  • .25 to 1.75 percent of the average dollar amount
    of assets under management

D. Types of Funds (Equity)
  • 1. Growth
  • Goal is capital appreciation
  • 2. Maximum Growth
  • Highly speculative, seeking large profits from
    capital gains
  • a. Often buy stocks of small, unseasoned
  • b. Highly speculative

D. Types of Funds (continued)
  • 3. Income
  • CURRENT income is main objective
  • a. Interest income
  • b. Dividend income
  • 4. Balanced Funds
  • Objective is to earn both capital gains and
    current income
  • a. High-grade common stocks (60 - 75)
  • b. Fixed income securities (25 - 40)

D. Types of Funds (continued)
  • 5. Small Company
  • Invest in small companies that usually have sales
    of 100 million or less.
  • 6. International
  • Can invest in one region or area of the world
  • Can invest in specific country

D. Types of Funds (continued)
  • Bond Funds
  • Objective is to invest in bonds
  • a. Income is primary objective
  • b. Two advantages
  • Liquidity
  • Diversification

D. Types of Funds (continued)
  • 6. Money Market Funds
  • Offers the individual investor access to
    high-yielding money market instruments without
    having to pay 100,000 denominations
  • a. Bank CDs
  • b. Treasury Bills
  • c. Commercial Paper

D. Types of Funds (continued)
  • 7. Dual Funds
  • Closed-end Funds with two types of shares
  • a. INCOME shares (Senior) which receive two
    times income as Junior
  • b. CAPITAL shares (Junior) which receive two
    times the capital gains as Senior

D. Types of Funds (continued)
  • 8. Specialty Funds - Single Industry
  • a. Option trading
  • b. Commodity funds
  • c. Oil drilling
  • d. Cattle funds
  • e. Electronics
  • f. Gold
  • g. Chemicals
  • h. Health

E. Special Services
  • 1. Saving Plans
  • Investor adds funds on a regular basis
  • 2. Automatic Reinvestment Plans
  • Dividends and capital gains are reinvested in
    additional shares
  • 3. Regular Income
  • Through withdrawal plans, the investor can
    receive periodic repayment or income
  • Shares or Dollars

E. Special Services (continued)
  • 4. Conversion Privileges
  • Allows the investor the right to switch from one
    fund to another
  • a. Must confine switches within the same family
    of funds
  • b. Usually no transfer charges

E. Special Services (continued)
  • 5. Check Writing Privileges
  • a. Shareholders have the right to write checks
    drawn on the Mutual Fund account
  • b. Normally checks must be written for at least
  • c. Almost all Money Funds have this privilege

F. Risk
  • Because Mutual Funds are so well diversified
    (typically), the inherent risk is similar to that
    in the Market
  • However, Specialty Fund risk can vary
    significantly from overall Market risk

Analyzing Mutual Funds
  • Assessment of your risk tolerance
  • Importance of diversification
  • Should hold six mutual funds
  • Should be able to earn 16 plus with a beta
    equivalent to 1.0 or slightly less

Mutual Fund Analysis
  • Style Analysis Style analysis identifies the
    process of investing by fund managers that leads
    them to pick certain kinds of securities.
  • Three factors of style analysis
  • Growth
  • Value
  • Company Size

Mutual Fund Analysis
  • Growth Managers buy stocks in companies whose
    earnings are growing rapidly.
  • Value Managers are bargain hunters seeking stocks
    with low prices compared to intrinsic value.
  • Company Size Managers specialize in small
    companies or large cos.

Mutual Fund Style Analysis
  • Style determines 85-90 of a fund portfolios
  • The technique looks at the way funds perform on a
    monthly basis against one of 12 different
    indexes. The mix of indexes that are most highly
    correlated determines the style of the mutual
    fund manager.

Mutual Fund Style Analysis
  • The mutual fund universe can be divided into six
    basic styles
  • Small cap growth funds
  • Large cap growth funds
  • Small cap value
  • Large cap value
  • Foreign funds
  • Fixed income funds

Mutual Fund Style Analysis
  • Source of Information
  • Advisor Software
  • Style Data
  • 1-800-738-6369
  • http//

Mutual Fund Annual Reports
  • Two Reports a Year Mutual funds typically issue
    two financial reports a year - the semiannual
    report, which is often dated June 30 or April 30,
    and the year-end or annual report, which is often
    dated December 31 or October 31.
  • Shareholder Letter A shareholder letter is
    usually written by the funds president or
    investment manager and reviews the funds
    investment objectives and performance for the
    current period.
  • Top 10 By looking at a mutual funds top 10
    holdings, you will get a sense of the type of
    investments in the portfolio and the degree to
    which the fund meets your investment objectives.
    Similarly, study the industry composition of the
    portfolio - the percent of the funds asset that
    is invested in a particular industry.

Mutual Fund Annual Reports
  • Investment Portfolio An investment portfolio
    comprises the assets (securities) held within a
    mutual fund.
  • Portfolio Turnover Portfolio turnover is the
    percentage of the portfolios investment that are
    bought and sold in one year. A fund with a
    portfolio turnover rate of 100 percent means they
    effectively bought and sold every security in the
    portfolio. High portfolio turnover increases
    transaction expenses and often reduces your rate
    of return.
  • Charts and Graphs Many mutual fund reports
    include charts and graphs. A line graph may
    compare the growth of a 10,000 investment in the
    fund to the growth of similar investments over
    five years, ten years, or over the life of the
    fund. Pie charts are used to show the of each
    type of investment in the fund C.S., bonds, and

Mutual Fund Annual Reports
  • Portfolio Some mutual fund financial reports
    include a more in-depth discussion of the funds
    performance for the period than the shareholders
  • Statement of Assets and Liabilities A mutual
    funds statement of assets and liabilities
    reflects the funds financial position at the
    stock or bond markets close on the date of the
    report. Assets typically include investments
    that are valued at market on the financial
    statement date. Other assets include collateral
    held for securities loaned and receivables. Two
    examples are dividends and interest income
    receivable, which represent income earned by the
    fund but not yet collected in cash. Liabilities
    primarily represent amounts the fund owes for the
    purchase of new securities.

Mutual Fund Annual Reports
  • Footnotes to the Financial Statements Mutual
    fund financial reports include footnotes similar
    to those found in other annual reports.
    Footnotes include significant accounting
    policies, and related party and affiliate
  • Significant Accounting Policies Related party
    and affiliate transactions typically include
    three types of transactions. The first occurs
    when payment of fees is made to portfolio
    managers and financial advisors. The second
    occurs when a mutual fund accumulates an
    ownership stake of a least 5 of the company.
    The third occurs when one mutual fund sells some
    of its investments to another mutual fund
    sponsored by the same mutual fund family.

Deadly Mutual Fund Myths - The Conventional
Wisdom Myth
  • 1. The Conventional Wisdom Myth
  • This is the number one mistake most investors
    make. Investors look at historic trends reported
    by Forbes, Kiplingers Business Week and others
    tend to recommend funds that have already made
    big gains rather than identify funds that are
    positioned to make profits in the future.

The Diversification Myth
  • 2. If you own at least 10 different mutual funds
    youll have a diversified portfolio.
  • Owning 10 mutual funds wont assure you of
    anything but a lot of work trying to stay on top
    of them all. In fact, you can have a well
    diversified portfolio with just 4 to 6 funds or
    you can have a portfolio of 15 funds with very
    little diversification.

The Momentum Myth
  • 3. The easiest way to beat the market is to buy
    last years top-performing funds.
  • The fact is that last years best funds are just
    as likely to be this years dogs. Blindly
    following this strategy is very dangerous for
    most investors. The very top-performing funds
    are usually those that took a lot of risk and
    happened to bet on the right market sector at the
    right time.

The Five-Star Myth
  • 4. The best funds to buy are those rated 4 or 5
    Stars by Morningstar.
  • The star system tells you which funds were good,
    not which ones will be good. Even Morningstar
    will tell you that their ratings are a measure of
    past (risk-adjusted) performance, not the
    potential for future profits. Relying on
    statistical ratings is no substitute for a
    thorough examination and analysis of what a fund
    is doing today.

The Market Timing Myth
  • 5. The safest strategy is to move everything
    into money market funds when the market is
    declining and switch everything back into stock
    funds when the market is rising.
  • This is a losers game. It has been proven over
    and over that investors are incapable of timing
    the market or identifying major bull or bear

The Long-Term Performance Myth
  • 6. The best measure of a funds quality is its
    long-term performance.
  • There is a fair amount of truth to this
    statement, but too many investors follow some
    brokers advice to buy this fund, it has a great
    10-year record, without asking some key
    questions. Who earned that record? Is the
    manager responsible for its returns still at the
    helm? If not, the record could be meaningless.

The New fund Myth
  • 7. You should wait until a fund has at least a
    3-year track record before investing.
  • The fact is that brand new funds often enjoy
    superior gains. New funds from top fund families
    often show explosive gains in their rookie year.
    Montgomery Small Cap was up 98.8 in 1991,
    Oakmark was up 48.9 in 1992, DFA Pacific Rim
    Small Company was up 92.6 in 1993, and Janus
    Olympus was up 30 the first 9 months of 1996.