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  1. 1. Mutual Funds (Investment Companies) Definition An investment company invests a pool of funds belonging to many individuals in a portfolio of individual investments such as stocks and bonds. Structure and Management • The investment company (mutual fund) is a corporation with a board of directors. • The Board hires a separate management company to actually manage the fund’s portfolio and to perform clerical functions. • The portfolio management company usually starts the investment company. The distinction between the two is more legal than real. Open-End vs Closed End Funds After the initial stock offering an open-end mutual fund is ready to sell more shares to investors or buy back (redeem) shares of current stockholders at the net asset value (NAV). After the initial stock offering the shares of a closed-end fund are bought and sold in the secondary market between individual investors, just like the shares of any other publicly traded company. The price is determined by supply and demand, not by net asset value. The shares of a closed-end fund usually trade at a discount to the net asset value. The net asset value of a mutual fund is the market value of all of the fund’s assets divided by the number of shares in the fund (not the number of shares the fund owns). Transactions in mutual funds occur at the end of the day at net asset value.
  2. 2. -2- Loads “Loads” are any commissions charged for buying shares in the fund. • Front-end load: The commission is charged when the shares are purchased. Commissions can be as much as 8.5%. • Back-end load: The commission is charged when the shares are sold. This is done to encourage investors to be long-term investors. The commission may decrease with time and eventually disappear. • Low-load: The commission is front-end but much lower than 8%, like 2-3%. • No-load: The fund does not charge commissions for buying shares in the fund. Fees • 12(b)-1 fees. An annual fee to cover distribution and marketing costs of the fund. The fee can be as high as 1% of the assets under management. • Management fees. Compensation for professional management of the fund and for administrative fees. The fees range from . 5% to 3 or 4% of assets under management. • The fees are paid regardless of the performance of the fund. • The fees are calculated as a percentage of assets under management, so funds have a strong incentive to grow, either by performance or most likely by attracting more investors. Number of Funds The first mutual fund was started in 1924. There are now over 8,000 and more than that, depending on how you want to count. A booming stock market usually brings another flood of new funds.
  3. 3. -3- Types of Funds “A fund for everyone.” • growth common stock: capital appreciation • aggressive growth: aggressive capital appreciation • value funds: emphasize value investing • small-cap common stock: invests in small companies • equity income: dividends emphasized • growth and income: tries to balance growth with income • sector funds: diversified in one industry, etc. • country funds: Japan Fund, Brazil Fund, etc. • bond funds: emphasizes current income • foreign bond funds: foreign bonds may pay more • balanced: stocks and bonds • money market: invests in money market securities • index funds: mimic a selected market index • socially responsible funds: invest only in companies deemed to be socially responsible • asset allocation funds: emphasize asset allocation as the primary source of returns • international funds: invest internationally in many countries • etc. Families of funds allow the investors to move funds from one fund to another.
  4. 4. -4- Advantages • Instant diversification • Professional portfolio management • Small transactions possible, including initially • Regular investing facilitated • Ability to buy an entire industry or the entire market or… • Convenient means of investing • Average individual can't "beat the market" easily or consistently anyway. • Low transaction cost possible Disadvantages • Transaction costs can be heavy • Annual fees impair performance • Nowhere near as much fun as picking investments yourself Performance • The average mutual fund cannot match the market because of management fees and operating costs. • Good performance is linked to low management costs. • It is very difficult for a mutual fund performance to be consistent over time. The best performing fund one period could be the worst performing fund the next period. • There is no difference in performance between load funds and no-load funds. Note: The markets are dominated by large institutions. Therefore the average institution cannot beat the market average, because the average institution IS the market average.