1. Institutional Details
b. Open v. Closed
c. Costs and fees
2. Fund Types
a. Money Market
b. Stock Funds
c. Bond funds
d. Balanced funds
1. Institutional details:
A mutual fund is simply a fund that pools the funds of a large group of investors and
then invests in particular securities according to the fund’s objectives. An investment
company is a company that obtains money from individual investors and invests it.
There are two broad types of mutual funds: open-end funds and closed-end funds.
An open-end fund is a fund in which the number of shares varies depending on the
aggregate buying and selling activity of individual investors. When an investor
purchases open-end fund shares, the fund simply issues new shares and invests the
proceeds in new securities. When an investor sells, the fund sells some of its assets to
redeem the shares. With a closed-end fund the number of shares remains fixed.
Investors simply buy or sell shares from/to other investors.
Unit Investment trusts are pools of money that are invested in a fixed portfolio for the
life of the fund. The trusts provide investors a means of investing in a pool of a particular
type of asset, i.e. corporate bonds. These trusts, once established, require little
management since the underlying portfolio is fixed.
Like mutual funds, hedge funds collect pools of money from investors. However,
– Hedge funds are not required to register with the SEC.
– Hedge funds are not required to maintain any particular degree of
diversification or liquidity.
– Hedge fund investors must qualify as “financially sophisticated” investors.
Hedge fund managers have considerable freedom to follow various investment strategies,
or styles. Typically they will attempt to exploit apparent relative mispricing of assets, in
effect betting the pricing spread will decline.
Hedge fund fees:
– General management fee of 1-2% of fund assets
– Performance fee of 20-40% of profits
Net asset value (NAV) represents the value of the underlying assets held by the fund
divided by the number of shares outstanding. Open-end funds are bought and sold at
their net asset value. The share prices of closed-end funds may or may not equal the
NAV, and in fact often sell at a discount to NAV.
Although a mutual fund is a separate corporation with shareholders, most mutual funds
are created by investment advisory firms (such as Fidelity, Vanguard, Dreyfus, etc.) that
specialize in managing mutual funds. The mutual fund pays management fees to the
advisory firm. As long as the investment company meets certain rules of the IRS the
income is simply passed through to the fund shareholders.
Advantages to Investors:
Investment companies, by virtue of pooling a large amount of investors’ funds, are able
to achieve economies of scale and thus provide the following services at lower cost to
• Record keeping and administration of accounts
• Diversification and liquidity
• Professional management
• Lower transaction costs
Costs and Fees: Of particular importance to investors are the costs and fees associated
with mutual funds. These include:
• Sales charges (“loads”)
• 12b-1 Fees
• Management Fees
• Trading costs
Some mutual funds charge a fee when the fund is purchased. In this case the investor
pays more than the NAV for the mutual fund shares. The fee is called a “front-end
load” and is essentially a sales charge. Such funds are called load funds. Funds without
the sales charges are called no-load funds. Some funds have “back-end loads” which
are sales charges on fund redemptions and are often called deferred sales charges. Back-
end loads typically decline through time.
12b-1 fees, named for the SEC rule that governs them, are basically expenses incurred by
the fund for marketing and distribution costs, whether directly to the public or through
other brokers. Fund assets are used to pay for such costs.
Management fees are fees paid to the investment advisory firm to manage the fund’s
assets. These fees are typically based on the size and complexity of the fund and may
range from .25 percent to 1 percent of fund assets each year. Trading costs pertain to the
costs of actually buying and selling securities. These are a function of how much trading
the fund does, known as the fund turnover.
Mutual funds are required to report expenses in a certain format. (see example in text)
This will be included in the mutual fund prospectus, which is a required legal document
that discloses financial and other relevant information about the fund.
One controversial issue involving mutual funds is whether an investor should buy “load”
funds when there are so many “no-load” fund available. There are two reasons for
buying a “load” fund. One reason would be to obtain a fund with a particular fund
manager. Here you are paying for a particular manager. A second reason would be to
obtain a very specialized type of fund. Most specialty funds are “load” funds.
2. Fund Types:
These notes will present just a basic summary. Details can be found in the text. In
general terms there are:
• Money Market Funds
• Long-term funds
i. Stock Funds
1. Growth v. Income
2. Company size-base
ii. Bond Funds – are characterized by:
2. Credit Quality
4. Types of bonds
iii. Balanced Funds
iv. Asset Allocation Funds
v. Exchange Traded Funds (ETFs) – trading index portfolios just like shares
1. Trade continuously (MFs priced only once a day)
2. Can be sold short or purchased on margin
3. Performance – How does mutual fund performance stack up against a benchmark such as
the Wilshire 5000 (a passive, feasible, low-cost strategy)?
• Index fund outperforms by approx. .7% per year
• Persistence – unclear