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Mutual Funds


Lecture # 24 Mutual Funds Balanced Funds The basic objectives of balanced funds are to generate income as well as long-term growth of principal. – PowerPoint PPT presentation

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Title: Mutual Funds

Lecture 24
  • Mutual Funds

Balanced Funds
  • The basic objectives of balanced funds are to
    generate income as well as long-term growth of
    principal. These funds generally have portfolios
    consisting of bonds, preferred stocks, and common
    stocks. They have fairly limited price rise
    potential, but

  • do have a high degree of safety, and moderate to
    high income potential. Investors who desire a
    fund with a combination of securities in a single
    portfolio, and who seek some current income and
    moderate growth with low-level risk, would do
    well to invest in balanced mutual funds.

  • Balanced funds, by and large, do not differ
    greatly from the growth and income funds
    described above.

Growth Funds
  • Growth funds are offered by every investment
    company. The primary objective of such funds is
    to seek long-term appreciation (growth of
    capital). The secondary objective is to make
    one's capital investment grow faster than the
    rate of inflation. Dividend income is considered
    an incidental objective of growth funds.

  • Growth funds are best suited for investors
    interested primarily in seeing their principal
    grow and are therefore to be considered as
    long-term investments - held for at least three
    to five years. Jumping in and out of growth funds
    tends to defeat their purpose.

  • However, if the fund has not shown substantial
    growth over a three - to five-year period, sell
    it (redeem your shares) and seek a growth fund
    with another investment company.

  • Candidates likely to participate in growth funds
    are those willing to accept moderate to high risk
    in order to attain growth of their capital and
    those investors who characterize their investment
    temperament as "fairly aggressive.

Index Funds
  • The intent of an index fund is basically to track
    the performance of the stock market. If the
    overall market advances, a good index fund
    follows the rise. When the market declines, so
    will the index fund. Index funds' portfolios
    consist of securities listed on the popular stock
    market indices.

  • It is also the intent of an index fund to
    materially reduce expenses by eliminating the
    fund portfolio manager. Instead, the fund merely
    purchases a group of stocks that make up the
    particular index it deems the best to follow.

  • The stocks in an index fund portfolio rarely
    change and are weighted the same way as its
    particular market index. Thus, there is no need
    for a portfolio manager. The securities in an
    index mutual fund are identical to those listed
    by the index it tracks, thus, there is little or
    no need for any great turnover of the portfolio
    of securities.

  • The funds are "passively managed" in a fairly
    static portfolio. An index fund is always fully
    invested in the securities of the index it

  • An index mutual fund may never outperform the
    market but it should not lag far behind it
    either. The reduction of administrative cost in
    the management of an index fund also adds to its

Sector Funds
  • As was discussed earlier, most mutual funds have
    fairly broad-based, diversified portfolios. In
    the case of sector funds, however, the portfolios
    consist of investment from only one sector of the

  • Sector funds concentrate in one specific market
    segment for example, energy, transportation,
    precious metals, health sciences, utilities,
    leisure industries, etc. In other words, they are
    very narrowly based.

  • Investors in sector funds must be prepared to
    accept the rather high level of risk inherent in
    funds that are not particularly diversified. Any
    measure of diversification that may exist in
    sector funds is attained through a variety of
    securities, albeit in the same market sector.

  • Substantial profits are attainable by investors
    astute enough to identify which market sector is
    ripe for growth - not always an easy task.

Special Funds
  • Specialized funds resemble sector funds in most
    respects. The major difference is the type of
    securities that make up the fund's portfolio. For
    example, the portfolio may consist of common
    stocks only, foreign securities only, bonds only,
    new stock issues only, over - the - counter
    securities only, and so on.

  • Those who are still novices in the investment
    arena should avoid both specialized and sector
    funds or the time being and concentrate on the
    more traditional, diversified mutual funds

Islamic Funds
  • In case of Islamic Funds, the investment made in
    different instruments is to be in line with the
    Islamic Shairah Rules. The Fund is generally to
    be governed by an Islamic Shariah Board.

  • And then there is a purification process that
    needs to be followed, as some of the money lying
    in reserve may gain interest, which is not
    desirable in case of Islamic investments.

Risk Involving in Mutual Fund Investment
  • There is some degree of risk in every investment.
    Although it is reduced considerably in mutual
    fund investing. Do not let the specter of risk
    stop you from becoming a mutual fund investor.

  • However, it behaves all investors to determine
    for them the degree of risk they are willing to
    accept in order to meet their objectives before
    making a purchase. Knowing of potential risks in
    advance will help you avoid situations in which
    you would not be comfortable.

  • Understanding the risk levels of the various
    types of mutual funds at the outset will help you
    avoid the stress that might result from a
    thoughtless or a hasty purchase.
  • Let us now examine the risk levels of the
    various types of mutual funds.

  • Mutual funds characterized as low-level risks
    fall into here categories
  • Money market funds
  • Treasury bill funds
  • Insured bond funds

  • Mutual funds considered moderate-risk investments
    may be found in at least the eight types
    categorized below.
  • Income funds
  • Balanced funds
  • Growth and income funds
  • Growth funds

  1. Short-term bond funds (taxable and tax-free)
  2. Intermediate bond funds (taxable and tax-free)
  3. Insured government/municipal bond funds
  4. Index funds.

  • The types of funds listed below have the
    potential for high gain, but all have high risk
    levels as well.
  • Aggressive growth funds
  • International funds
  • Sector funds
  • Specialized funds

  1. Precious metals funds
  2. high-yield bond funds (taxable and tax-free)
  3. Commodity funds
  4. Option funds

  • As you become a more experienced investor, you
    may want to examine other, more technical,
    measures to determine risk factors in your choice
    of funds.

Beta Coefficient
  • Beta coefficient is a measure of the funds risk
    relative to the overall market. For example, a
    fund with a beta coefficient of 2.0 means that it
    is likely to move twice as fast as the general
    market both up and down. High beta coefficients
    and high risk go hand in hand.

Alpha Coefficient
  • Alpha coefficient is a comparison of a funds
    risk (beta) to its performance. A positive alpha
    is good. For example, an alpha of 10.5 means that
    the fund manager earned an average of 10.5 more
    each year than might be expected, given the
    funds beta.

Interest Rates
  • Interest rates and inflation rates are other
    factors that can be used to measure investment
    risks. For instance, when interest rates are
    going up, bond funds will usually be declining,
    and vice versa.

  • The rate of inflation has a decided effect on
    funds that are sensitive to inflation factors
    for example, funds that have large holdings in
    automaker stocks, real estate securities, and the
    like will be adversely affected by inflationary

R-Square Factor
  • R-Square factor is a measure of the funds risk
    as related to its degree of diversification.

  • The information is supplied here merely to
    acquaint you with the terminology in the event
    you should wish to delve more deeply into complex
    risk factors. The more common risk factors
    previously described are all you really need to
    know for now, and perhaps for years to come.

  • One caveat is in order, however. There is no such
    thing as an absolutely 100 risk-free investment.
    Even funds with excellent 10 year past
    performance records must include in their
    literature and prospectuses the following

  • Past performance is no guarantee of future
    results. However, by not exceeding your risk
    tolerance level, you can achieve a wide safety
    and comfort zone with mutual fund portfolios such
    as those shown.