Mutual Funds

1
Chapter 15

• Mutual Funds

2
Introduction to Mutual Funds

• Mutual funds are open-end investment companies
  that sell shares of stock to the public and use
  the proceeds to invest in a portfolio of
  securities on behalf of its shareholders
• Mutual funds are actually a subcategory of what
  is referred to as regulated investment companies

3
Types of Investment Companies

• Unit Investment Trust (UIT)
• Exchange Traded Funds (ETFs)
• Closed-end Investment Company
• Open-end Investment Company (mutual funds)

4
Mutual Fund Fees

• Loads or Sales Charges
• Front-end load
• Back-end load
• Other Mutual Fund Fees
• 12b-1 fees
• Management fees
• Expense ratio

5
Mutual Fund Classification

• Load vs. No-Load Funds
• Classes of Load Fund Shares
• Class A shares
• Class B shares
• Class C shares

6
How Do Fund Expenses Impact Performance?

• High quality performance funds may have high or
  low expense ratios
• However, the higher the expenses of the mutual
  fund, the more the fund manager will have to
  overcome to achieve strong return performance

7
Advantages of Mutual Funds

• Low initial investment
• Diversification
• Ease of access
• Professional management
• Tax efficiency of fees
• Liquidity
• Transaction cost efficiency
• Variety
• Services

8
Disadvantages of Mutual Funds

• Performance
• Fees, Loads, and Expenses
• The abundance of choices
• Liquidity
• Execution
• Classification system (misclassification)
• Built-in gains

9
Types and Objectives of Mutual Funds

• Money Market Mutual Funds provide investors the
  opportunity to earn competitive money market
  returns with the added benefits of ease of access
  and liquidity.
• Fixed-Income Mutual Funds diversify the
  investment portfolio and provide investors with
  current income.

10
Types and Objectives of Mutual Funds (cont.)

• Equity Mutual Funds provide investors easy,
  efficient access to common stock securities.
• Hybrid or Balanced Funds invest in a balanced
  fashion, such that a portion of the portfolio is
  invested in cash, fixed- income securities, and
  equity securities.

11
How Do Investment Advisers Select Mutual Funds?

• Prospectus
• Fund objective
• Investment policy/strategy
• Manager tenure
• Historical performance
• Portfolio turnover
• Fees and expenses
• Buying and selling shares
• Minimum initial investment
• Investor services

12
How Do Investment Advisers Select Mutual Funds?
(cont.)

• MPT statistics and performance measures
• Coefficient of determination (R2)
• Beta
• Jensens Alpha
• Sharpe ratio
• Treynor ratio

13
MPT Statistics

• R2 change in portfolio explained by changes
  in a market index
• Beta Indicates volatility of portfolio as
  compared to the market
• ? Rp- Rf B (Rm Rf)

14
MPT Statistics (cont.)

• Sp Rp Rf
• ?p
• Tp Rp Rf
• ?

15
Managing Mutual Fund Portfolios

• Issues to look for
• Changing asset size
• Style shift
• Manager changes
• Capital gain exposures