Chapter 18 - PPT


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Chapter 18 - PPT

  1. 1. Chapter Eighteen Mutual Funds McGraw-Hill/Irwin © 2006 The McGraw-Hill Companies, Inc., All Rights Reserved.
  2. 2. Mutual Fund <ul><li>Definition - </li></ul><ul><li>Security that gives small investors access to a well diversified portfolio of </li></ul><ul><ul><li>Equities </li></ul></ul><ul><ul><li>Bonds </li></ul></ul><ul><ul><li>Other securities </li></ul></ul><ul><li>Shareholders participates in gain/loss of fund </li></ul><ul><li>Shares issued & redeemed as needed </li></ul>
  3. 3. Mutual Fund cont. <ul><li>Net asset value (NAV) determined each day </li></ul><ul><li>Portfolio objective stated in prospectus </li></ul><ul><li>Majority of mutual funds fail to beat the market </li></ul>Past performance is no guarantee of future results
  4. 4. Advantages and Disadvantages of Mutual Funds <ul><li>Diversification </li></ul><ul><li>Professional Management </li></ul><ul><li>Time Savings </li></ul><ul><li>Performance </li></ul><ul><li>Expenses </li></ul><ul><li>Selection problems </li></ul>
  5. 5. Diversification <ul><li>Chose securities from different industries </li></ul><ul><li>Economy does not affect companies equally </li></ul>
  6. 6. Advantages and Disadvantages of Mutual Funds <ul><li>Alternatively diversify portfolio in different kinds of assets such as </li></ul><ul><ul><li>Bonds </li></ul></ul><ul><ul><li>Preferred stock </li></ul></ul><ul><ul><li>Convertible securities </li></ul></ul><ul><ul><li>International securities </li></ul></ul><ul><ul><li>Real estate </li></ul></ul>
  7. 7. Mutual Funds cont. <ul><li>Buy different types of mutual funds to achieve </li></ul><ul><li>diversification, e.g. </li></ul><ul><li>Corporate </li></ul><ul><li>U.S. government bond fund </li></ul><ul><li>Domestic equity fund </li></ul><ul><li>International equity fund </li></ul><ul><li>Real estate investment trust </li></ul><ul><li>Municipal bond fund </li></ul><ul><li>Short-term money market fund </li></ul>Correlation <1 with each other
  8. 8. Closed-End versus Open-End Funds <ul><li>Close & Open refer to distribution & redemption </li></ul><ul><li>Closed-end fund </li></ul><ul><li>Fixed number of shares </li></ul><ul><li>Cannot buy the shares directly from the fund </li></ul><ul><li>(except at the inception of the fund) </li></ul><ul><li>Limitation on shares outstanding </li></ul><ul><li>Fund does not stand ready to buy shares back </li></ul><ul><li>Purchasers/sellers must trade with each other </li></ul>
  9. 9. Closed-End versus Open-End Funds <ul><li>Open-end fund </li></ul><ul><li>Represents opposite of closed-end fund </li></ul><ul><li>Always ready to sell new shares </li></ul><ul><li>Always ready to buy back old shares </li></ul><ul><li>Shares of closed-end funds trade on security </li></ul><ul><li>exchanges or over-the-counter just as any other stock might </li></ul>
  10. 10. Example Total value of securities ……. $140 million Liabilities ……………………… $5 million Shares outstanding ………….. 10 million
  11. 11. Exchange Traded Funds (ETFs) <ul><li>Passively managed </li></ul><ul><li>Low-cost </li></ul><ul><li>Tax-efficient baskets of stocks </li></ul><ul><li>Focus on </li></ul><ul><ul><li>Countries </li></ul></ul><ul><ul><li>Sectors </li></ul></ul><ul><ul><li>Regions </li></ul></ul><ul><ul><li>Indices </li></ul></ul>
  12. 12. Exchange Traded Funds (ETFs) <ul><li>Best advancement for individual investors in the past decade </li></ul><ul><li>No other development, with the possible exception of the rise of Eliot Spitzer, New York attorney-general, has inflicted greater damage to the mutual fund industry that has monopolized the investor market for the past 50 years </li></ul>
  13. 13. Exchange Traded Funds (ETFs) <ul><li>Index-based funds imitate market indexes e.g. </li></ul><ul><ul><li>S&P 500 Index (SPDRs) </li></ul></ul><ul><ul><li>Dow Jones Index (called DIAMONDS) </li></ul></ul><ul><li>Major advantage of ETFs: </li></ul>Investor can buy “the market” or “ an industry” just like buying a common stock ETFs discussed more fully in the next chapter
  14. 14. Investing in Open-Ended Funds <ul><li>Load versus No-Load Funds </li></ul><ul><li>No-Load Funds </li></ul><ul><li>Information on Mutual Funds </li></ul>
  15. 15. More than 95% of the investment funds in U.S. are open-ended
  16. 16. Load versus No-Load Funds Exit fee 2 to 3% may decline with time Back-end load Zero No Load 2 to 3% Low-load funds 7.25% or higher Load funds Commission in % Fund type
  17. 17. No-Load Funds <ul><li>Do not charge commissions </li></ul><ul><li>Sold directly by investment company through </li></ul><ul><ul><li>Advertisements </li></ul></ul><ul><ul><li>Prospectuses </li></ul></ul><ul><ul><li>800-number telephone orders </li></ul></ul><ul><li>About 50% of all mutual fund assets are no-load funds </li></ul><ul><li>Account for approx. 50% of new sales </li></ul><ul><li>Why buy load funds when you can buy no-load funds? (HOPE for a better return!) </li></ul>
  18. 18. No-Load Funds <ul><li>How do no-load funds justify their existence? </li></ul><ul><li>Answer: charge assets management fee plus expenses (12b-1 fees) - 0.75 to 1.25% </li></ul><ul><li>Load funds have similar management fees </li></ul><ul><li>Fund with a 12b-1 fee of .25% or less is still considered a no-load fund </li></ul>
  19. 19. <ul><li>Invest $1,000 in a load mutual fund </li></ul><ul><li>Pay a 7.25% commission </li></ul><ul><li>Only 92.75% go toward purchasing shares </li></ul><ul><li>$1,000 investment becomes $927.50 </li></ul><ul><li>Fund must go up by $72.50 or 7.82% just to break even </li></ul>
  20. 20. Figure 18-2 Load and No-Load Fund Assets as a Share of Fund Assets, 1984 -2003
  21. 21. Figure 18-2 Load and No-Load Fund Assets as a Share of Fund Assets, 1984 -2003
  22. 22. Differing Objectives and the Diversity of Mutual Funds <ul><li>Matching Investment Objectives with Fund Types </li></ul><ul><li>Money Market Funds </li></ul><ul><li>Growth Funds </li></ul><ul><li>Growth with Income </li></ul><ul><li>Balanced Funds </li></ul><ul><li>Index Funds </li></ul><ul><li>Bond Funds </li></ul><ul><li>Sector Funds </li></ul>
  23. 23. Differing Objectives and the Diversity of Mutual Funds <ul><li>Sector Funds (riskier) </li></ul><ul><ul><li>Energy </li></ul></ul><ul><ul><li>Medical Technology </li></ul></ul><ul><ul><li>Computer Technology </li></ul></ul><ul><ul><li>Leisure </li></ul></ul><ul><ul><li>Defense </li></ul></ul><ul><li>Foreign Funds </li></ul>
  24. 24. Differing Objectives and the Diversity of Mutual Funds <ul><li>Specialty Funds - investing primarily in the securities of a particular </li></ul><ul><ul><li>Industry </li></ul></ul><ul><ul><li>Sector </li></ul></ul><ul><ul><li>Type of security </li></ul></ul><ul><ul><li>Geographic region </li></ul></ul>www. sbs . gov . uk /phoenix www. calvertgroup .com www. usfunds .com Examples: Underlined hyperlinks
  25. 25. Differing Objectives and the Diversity of Mutual Funds <ul><li>Hedge Funds </li></ul><ul><ul><li>The name is misleading </li></ul></ul><ul><ul><li>Not restricted to hedging/reducing risk </li></ul></ul><ul><ul><li>Neither bullish or bearish </li></ul></ul><ul><ul><li>Highly leveraged </li></ul></ul>
  26. 26. Differing Objectives and the Diversity of Mutual Funds <ul><li>Hedge Funds continued </li></ul><ul><ul><li>Engage in wide range of activities for superior return: </li></ul></ul><ul><ul><ul><li>Buying (long) </li></ul></ul></ul><ul><ul><ul><li>Short selling </li></ul></ul></ul><ul><ul><ul><li>Buy/sell puts and calls at the same time in the attempt to gain an edge </li></ul></ul></ul><ul><ul><li>Limited partnership </li></ul></ul><ul><ul><li>Charge management fees only on profits (20%) </li></ul></ul>
  27. 27. Matching Investment Objectives with Fund Types <ul><li>Volatility of return </li></ul><ul><li>Safety of principal </li></ul><ul><ul><li>Little deviation of returns </li></ul></ul><ul><ul><li>Choose money market funds </li></ul></ul><ul><ul><li>Intermediate-term bond funds </li></ul></ul><ul><ul><li>Expect lower returns </li></ul></ul><ul><li>Aggressive growth stock funds </li></ul><ul><ul><li>Provide the highest expected return </li></ul></ul><ul><ul><li>Biggest risk </li></ul></ul>
  28. 28. Matching <ul><li>Balanced funds </li></ul>Growth-Income <ul><li>Bond funds provide </li></ul><ul><li>highest annual current yield </li></ul><ul><li>Aggressive growth </li></ul><ul><li>funds the lowest yield </li></ul>Income <ul><li>Almost all mutual funds allow </li></ul><ul><li>redemption at any time </li></ul>Liquidity FUND TYPES OBJECTIVES
  29. 29. Example- Diversify by Fund Type Money Market Funds 10% International Stock Fund 5% Bonds 35% U.S. Common Stocks 50% Type of Fund % Weight
  30. 30. The Prospectus <ul><li>Investment Objectives and Policies </li></ul><ul><li>Portfolio (or “Investment Holdings”) </li></ul><ul><li>Management Fees and Expenses </li></ul><ul><li>Turnover Rate </li></ul><ul><li>Expense ratio </li></ul><ul><li>Per share income </li></ul><ul><li>Capital changes </li></ul>
  31. 31. Shareholder Services <ul><li>Automatic reinvestment </li></ul><ul><li>Safekeeping </li></ul><ul><li>Exchange privilege </li></ul><ul><li>Preauthorized check plan </li></ul><ul><li>Systematic withdrawal plan </li></ul><ul><li>Checking privileges </li></ul>
  32. 32. Dollar Averaging <ul><li>Investor buys </li></ul><ul><li>Fixed dollar’s worth </li></ul><ul><li>Given security </li></ul><ul><li>Regular intervals </li></ul><ul><li>Regardless of security’s price </li></ul><ul><li>Ignores current market outlook </li></ul>
  33. 33. <ul><li>In January, low price $12, purchased </li></ul><ul><li>large numbers: 16.66 shares </li></ul><ul><li>In April, high price $19, purchased </li></ul><ul><li>low numbers: 10.52 shares </li></ul>
  34. 34. Computing Total Return on Your Investment <ul><li>Assume invested in a fund for one year </li></ul><ul><li>Three potential sources of return: </li></ul><ul><li>Change in net asset value (NAV) </li></ul><ul><li>Dividends distributed </li></ul><ul><li>Capital gains distributed </li></ul>
  35. 35. Permits tracking of mutual funds in portfolios Provides mutual fund data & quotes along with portfolio tracking & financial planning information Basic site containing detailed information about mutual funds, portfolio tracking, & analysis Comments Websites
  36. 36. Provides information about mutual funds Investment Company Institute www. ici .org Comments Websites
  37. 37. Summary <ul><li>Investment funds allow investors to pool their resources under professional managers </li></ul><ul><li>Closed-end a fixed number of shares, and purchasers and sellers of shares must deal with each other (via brokers) </li></ul><ul><li>Open-end fund are more prevalent </li></ul><ul><ul><li>Ready to sell new shares or buy back old shares </li></ul></ul><ul><ul><li>Load fund up to 7.25% sales commissions </li></ul></ul><ul><ul><li>No-Load fund </li></ul></ul>
  38. 38. Summary <ul><li>Mutual funds specialize: </li></ul><ul><li>Money market management </li></ul><ul><li>Growth in common stocks </li></ul><ul><li>Bond portfolio management </li></ul><ul><li>Special sectors of the economy </li></ul><ul><ul><li>Energy </li></ul></ul><ul><ul><li>Computers </li></ul></ul><ul><ul><li>Foreign investments </li></ul></ul><ul><li>Funds with an international orientation have enjoyed strong popularity in the last decade </li></ul>
  39. 39. Summary <ul><li>Examining a fund’s prospectus one can determine </li></ul><ul><li>Investment objectives </li></ul><ul><li>Policies </li></ul><ul><li>Portfolio holdings </li></ul><ul><li>Turnover rate </li></ul><ul><li>Management fees (SEC 12b-1) </li></ul><ul><li>Special services </li></ul><ul><ul><li>Automatic reinvestment of distributions </li></ul></ul><ul><ul><li>Exchange privileges among different funds </li></ul></ul><ul><ul><li>Systematic withdrawal plans </li></ul></ul><ul><ul><li>Check writing privileges </li></ul></ul>
  40. 40. Summary <ul><li>Return to fund holders may come from </li></ul><ul><li>Capital appreciation </li></ul><ul><li>Yield </li></ul><ul><li>Over the long term, mutual funds have not outperformed the popular market averages </li></ul><ul><li>offer an opportunity for </li></ul><ul><ul><li>Low-cost </li></ul></ul><ul><ul><li>Efficient diversification </li></ul></ul><ul><ul><li>Normally have experienced management </li></ul></ul><ul><li>Few funds have above-average returns </li></ul>