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Mutual funds


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Title: Mutual funds

  • Mutual funds
  • (see Ch. 16 Hirschey and Nofsinger)

Investment Companies
An investment company invests a pool of funds
belonging to many individuals in a portfolio of
individual investments such as stocks and
bonds Benefits
  • Diversification
  • Professional management
  • Low capital requirement
  • Reduced transaction costs
  • Access to illiquid markets
  • Access to non-traditional trading strategies

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
  • 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.
  • Open end fund of shares issued solely depends
    on investor demand
  • Bought and sold directly through the investment
    company (not an exchange)

Net Asset Value
  • Used as a basis for valuation of mutual funds.
  • Selling new shares
  • Redeeming existing shares
  • Calculation
  • Market Value of Assets Fund Expenses -
  • Shares Outstanding
  • 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

Sources of Information
  • Lipper Inc. leading provider of data and
    analysis on the investment company business ( )
  • provide unbiased data and
    analysis and candid editorial commentary
  • Vanguard Group providing competitive investment
    performance and lowest operating expenses ( )

Mutual Funds Investment Policies
  • Money Market
  • Fixed Income
  • Equity
  • Balance Income
  • Asset Allocation
  • Indexed
  • Specialized Sector

Mutual Fund Organization
  • Mutual fund shareholders own mutual funds, elect
    the board of directors
  • Majority of the directors must be independent
  • Investment advisor manages the day-to-day
  • Principal underwriter, administrator, transfer
    agent, custodian, and independent public

Types of Investment Organizations
  • Mutual funds
  • Open-End
  • Closed-End
  • (Stock trades on secondary market Net
    asset value (NAV) is determined daily, but market
    price determined by supply and demand)
  • - ETFs (Exchange Traded Funds)
  • Hedge Funds
  • Private equity/venture capital funds

Costs of Investing in Mutual Funds
  • Fee Structure
  • Front-end load
  • Back-end load
  • Operating expenses
  • 12 b-1 charges
  • distribution costs paid by the fund
  • Alternative to a load
  • Fees and performance

Mutual funds Performance
  • Its not conclusive
  • Most of the studies suggest that the average MF
    underperforms its benchmark
  • There is some evidence of short-term performance
  • The evidence show that its not easy to find
    funds that outperform
  • for a long period of time
  • Nonetheless, hot funds receive a
    disproportionately amount of
  • new money

Closed-End Funds
  • Issues a fixed number of shares at a given point
    in time
  • Collect money from investors through and IPO and
    use this money to invest in securities.
  • of securities are fixed at the time of IPO.
  • When the market price exceeds its NAV, selling at
    a premium, otherwise, selling at a discount
    (closed-end funds typically sell at a discount)
  • Suited to specialized investing in small or
    illiquid markets

Exchange Traded Funds
  • Are similar to closed-end funds traded
    securities entails commission costs
  • Each ETF is a claim on a trust that holds a
    specified pool of assets (e.g. SP500 index
  • ExamplesSPDRS,ishares,HOLDERS
  • Advantages
  • Liquidity
  • Taxes
  • Can be purchased on margin or sell short
  • ETF are appropriate for short-term investors and
    the ones who buy in large lots

  • Alpha mutual fund return benchmark return
  • Higher the Alpha better the fund performance

Morningstar rating
  • Created in 1984 to provide comprehensive
    assessment of mutual funds
  • The star system was not meant to predict future
  • 5 - the top 20 of the funds 1 the bottom

Hedge Funds
  • Considerable confusion exists concerning hedge
  • what they are (and are not) and how they work
  • Hedge funds are privately organized, pooled
    investment vehicle with no restrictions in terms
    of investment strategies, asset classes and use
    of leverage
  • Many of them registered off-shore for tax and
    regulatory reasons
  • Cant have more than 100 accredited investors
    or 500 super-accredited investors
  • Accredited investor net worth gt 1 million or
    income of 200,000 in each of the past two years
  • Super-Accredited investor net worth gt 5 million

Hedge Funds
  • Are not allowed to advertise broadly and engage
  • general solicitation to the investing public
  • Charge 1-2 of assets under management and
    20-25 of profits
  • First hedge fund on record, Jones Hedge Fund,
    was established in 1949
  • He hedged the US equity market risk and focused
    on stock selection
  • By 2001, more than 5,000 funds in existence
  • Common features
  • - shorting
  • - leverage
  • - concentration
  • Do they all hedge?

Hedge Fund Strategies
  • Long-short equity
  • Equity market neutral
  • Fixed-income arbitrage
  • Convertible arbitrage
  • Merger arbitrage
  • Global macro
  • Special situations

Learning objectives
  • Discuss the advantages and disadvantages of
    mutual funds
  • Know how to calculate NAV
  • Define and Discuss the differences between open
    end, closed end and ETFs
  • Briefly discuss the costs, loads and fees of
    investing in mutual funds
  • Morningstar and Style boxes
  • Discuss the governance structure, Mutual Funds as
    Tournaments, and Performance (p. 513-516)
  • Discuss what the hedge funds are, and how do
    they differ from traditional professionally
    managed investment products
  • End of chapter questions 16.2, 16.3, 16.4,16.6,
    16.7, 16.11