Mutual_funds.ppt

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Mutual_funds.ppt

  1. 1. Chapter 13 Mutual Funds: Professionally Managed Portfolios
  2. 2. Mutual Funds <ul><li>Learning Goals </li></ul><ul><ul><li>Describe the basic features of mutual funds, and note what they have to offer as investment vehicles. </li></ul></ul><ul><ul><li>Distinguish between open- and closed-end funds, as well as other types of professionally managed investment companies, and discuss the various types of fund loads, fees, and charges. </li></ul></ul><ul><ul><li>Discuss the types of funds available and the variety of investment objectives these funds seek to fulfill. </li></ul></ul>
  3. 3. Mutual Funds <ul><li>Learning Goals (cont’d) </li></ul><ul><ul><li>Discuss the investor services offered by mutual funds and how these services can fit into an investment program. </li></ul></ul><ul><ul><li>Gain an appreciation of the investor uses of mutual funds, along with the variables to consider when assessing and selecting funds for investment purposes. </li></ul></ul><ul><ul><li>Identify the sources of return and compute the rate of return earned on a mutual fund investment. </li></ul></ul>
  4. 4. Mutual Funds <ul><li>Mutual Fund : an investment company that invests its shareholders’ money in a diversified portfolio of securities </li></ul><ul><ul><li>Investors own a share of the fund proportionate to the amount of the investment </li></ul></ul><ul><li>First started in 1924 </li></ul><ul><li>Nearly 8,300 mutual funds available today </li></ul><ul><li>More mutual funds in existence today than stocks listed on NYSE and AMEX combined </li></ul><ul><li>Nearly half of all U.S. households own mutual funds </li></ul>
  5. 5. Attractions of Mutual Funds <ul><li>Diversification </li></ul><ul><ul><li>Owning numerous securities reduces risk </li></ul></ul><ul><li>Professional management </li></ul><ul><li>Ability to invest small amounts </li></ul><ul><li>Service </li></ul><ul><ul><li>Automatic reinvestment of dividends </li></ul></ul><ul><ul><li>Withdrawal plans </li></ul></ul><ul><ul><li>Exchange privileges </li></ul></ul><ul><li>Convenience </li></ul><ul><ul><li>Easy to buy and sell; high liquidity </li></ul></ul><ul><ul><li>Funds handle recordkeeping </li></ul></ul><ul><ul><li>Easy to track prices </li></ul></ul>
  6. 6. Drawbacks of Mutual Funds <ul><li>Substantial transaction costs </li></ul><ul><ul><li>Management fee </li></ul></ul><ul><ul><li>Commission fees on load funds </li></ul></ul><ul><li>Lower-than-market performance </li></ul><ul><ul><li>Consistently beating the market is difficult </li></ul></ul><ul><ul><li>Many mutual funds just keep even with overall stock market index </li></ul></ul>
  7. 7. Figure 13.2 Mutual Fund Performance
  8. 8. How Mutual Funds are Organized <ul><li>Management company runs the funds’ daily operations </li></ul><ul><li>Investment advisor buys and sells stocks or bonds and oversees the investment portfolio </li></ul><ul><li>Distributor sells the fund shares </li></ul><ul><ul><li>Direct to the public </li></ul></ul><ul><ul><li>Through brokers </li></ul></ul><ul><li>Custodian physically safeguards the securities </li></ul><ul><li>Transfer agent keeps track of purchases and redemption requests from shareholders </li></ul>
  9. 9. Open-End Investment Companies <ul><li>Investors buy and sell shares directly with the mutual fund company without a secondary market </li></ul><ul><li>Have an unlimited number of shares </li></ul><ul><li>Purchase and selling price is determined by the Net Asset Value (NAV) of the fund </li></ul><ul><li>All purchases and sales are completed at the end of the day after the stock markets have closed </li></ul>
  10. 10. Closed-End Investment Companies <ul><li>Sell only the initial offering </li></ul><ul><ul><li>Subsequent trades are done in a secondary market, similar to the common stock market </li></ul></ul><ul><li>Have a limited number of shares </li></ul><ul><li>Investment advisor doesn’t have to worry about cash inflow or outflows </li></ul><ul><li>Purchase and selling price is determined by supply and demand </li></ul><ul><li>Generally sell at premium or discount (usually discount) to NAV </li></ul>
  11. 11. Exchange-Traded Funds (ETF) <ul><li>A basket of securities designed to track a specific market index </li></ul><ul><li>Similar to index mutual funds </li></ul><ul><li>Trade like individual stocks on stock exchanges </li></ul><ul><li>Can buy and sell ETFs any time of the day </li></ul><ul><li>Low management expenses due to limited trading by investment advisor </li></ul><ul><li>Low turnover helps avoid taxes until ETF is sold </li></ul><ul><li>Types of ETFs </li></ul><ul><ul><li>“ Diamonds” (DIA) track DJIA </li></ul></ul><ul><ul><li>“ Spiders” (SPY) track S&P 500 </li></ul></ul><ul><ul><li>“ Qubes (QQQ) track NASDAQ 100 </li></ul></ul>
  12. 12. Load and No-Load Funds <ul><li>Load fund : a mutual fund that charges a commission when shares are bought. </li></ul><ul><ul><li>Typically sold through a broker </li></ul></ul><ul><li>No-load fund : a mutual fund that does not charge a commission when shares are bought. </li></ul><ul><ul><li>Typically sold directly to investor by mutual fund </li></ul></ul><ul><ul><li>Cost savings tend to give investors a head start in achieving superior rates of return </li></ul></ul><ul><li>Low-load fund : a mutual fund that charges a small commission (2% to 3%) when shares are bought. </li></ul>
  13. 13. Load and No-Load Funds <ul><li>Back-end load : a commission charged on the sale of shares in a mutual fund. </li></ul><ul><li>12(b)-1 fee : fee charged by some mutual funds to cover management and other operating costs; amounts to as much as 1% of the average net assets. </li></ul><ul><li>Multiple-class sales charge : different shares classes of the same mutual fund are offered with different fee structures. </li></ul>
  14. 14. Other Fees and Costs <ul><li>Management fee : compensation paid to professional managers who administer the fund’s investment portfolio </li></ul><ul><ul><li>This fee is paid by all types of funds (load vs. no-load; open-end vs. closed-end) </li></ul></ul><ul><ul><li>Fee is charged annually on average net assets </li></ul></ul><ul><li>Administrative costs : the normal costs of doing business, such as trading expenses </li></ul><ul><li>Taxes on mutual funds </li></ul><ul><ul><li>Mutual funds do not pay taxes if income and capital gains are passed on to shareholders </li></ul></ul><ul><ul><li>Shareholders are taxed on their share of income and capital gains annually </li></ul></ul>
  15. 15. Figure 13.4 Fund Fees ©2003 Morningstar, Inc. Used with permission.
  16. 16. Table 13.2 Fund Fees
  17. 17. Unit Investment Trusts (UIT) <ul><li>Fixed pool of securities, normally bonds </li></ul><ul><li>Not actively managed; securities in portfolio remain static </li></ul><ul><li>Have shares that represent a proportionate share of the trust </li></ul><ul><li>Tend to be very costly due to high sales commissions and high management fees </li></ul>
  18. 18. Hedge Funds <ul><li>Not really mutual funds; private limited partnerships </li></ul><ul><li>Not regulated by mutual fund regulations </li></ul><ul><li>General partner runs fund and takes 10-20% of profits; limited partners are investors </li></ul><ul><li>Only sold to “accredited investors”—net worth greater than $1,000,000 and/or annual income over $200,000 </li></ul><ul><li>Use arbitrage strategies, options, short sales and other other complex strategies </li></ul>
  19. 19. Types of Mutual Funds <ul><li>Growth Fund : primary goals are capital gains and long-term growth </li></ul><ul><ul><li>Invest in large, well-established companies with above-average growth potential </li></ul></ul><ul><ul><li>Little or no dividend income </li></ul></ul><ul><ul><li>Moderately risk investments for more aggressive investors </li></ul></ul>
  20. 20. Types of Mutual Funds (cont’d) <ul><li>Aggressive Growth Fund : highly speculative mutual fund that seeks large profits from capital gains </li></ul><ul><ul><li>Invest in small, unseasoned companies with high price/earnings ratios </li></ul></ul><ul><ul><li>Often look for turnaround situations </li></ul></ul><ul><ul><li>Prices are often highly volatile </li></ul></ul><ul><ul><li>High risk investments for very aggressive investors </li></ul></ul>
  21. 21. Types of Mutual Funds (cont’d) <ul><li>Value Fund : seeks stocks that are undervalued in the market </li></ul><ul><ul><li>Focus is on intrinsic value of stocks and requires extensive fundamental analysis </li></ul></ul><ul><ul><li>Invest in stocks with low P/E ratios, high dividend yields and promising futures </li></ul></ul><ul><ul><li>Looks for undiscovered companies with potential for future growth </li></ul></ul><ul><ul><li>Less risky investments for relatively conservative investors looking for moderate growth </li></ul></ul>
  22. 22. Types of Mutual Funds (cont’d) <ul><li>Equity-income Fund : emphasizes current income and capital preservation </li></ul><ul><ul><li>Focus is on high current income with some long-term capital appreciation </li></ul></ul><ul><ul><li>Invest in high-yielding common stocks, convertible securities or preferred stocks </li></ul></ul><ul><ul><li>Invests in “blue chip” stocks and other high-grade securities </li></ul></ul><ul><ul><li>Typically less price volatility than overall stock market </li></ul></ul><ul><ul><li>Less risky investments for relatively conservative investors looking for moderate growth </li></ul></ul>
  23. 23. Types of Mutual Funds (cont’d) <ul><li>Balanced Fund : generates a balanced return of both current income and long-term capital gains </li></ul><ul><ul><li>Invest in blend of fixed-income securities and common stocks, with 25% to 30% in fixed income </li></ul></ul><ul><ul><li>Allocation between stocks and bonds typically remains constant or varies very little </li></ul></ul><ul><ul><li>Emphasis between fixed-income and common stocks can be shifted as market conditions change </li></ul></ul><ul><ul><li>Less risky investments for relatively conservative investors looking for moderate growth </li></ul></ul>
  24. 24. Types of Mutual Funds (cont’d) <ul><li>Growth-and-Income Fund : seeks both long-term growth and current income, with primary emphasis on capital gains </li></ul><ul><ul><li>Focus is on long-term capital appreciation with some high income to provide limited stability </li></ul></ul><ul><ul><li>Invest in blend of commons stocks and fixed-income securities, with up to 90% in common stocks </li></ul></ul><ul><ul><li>Moderate risk investments for investors who can tolerate moderate price volatility </li></ul></ul>
  25. 25. Types of Mutual Funds (cont’d) <ul><li>Bond Funds : invests in various kinds and grades of bonds, with income as primary objective </li></ul><ul><ul><li>Advantages of bond funds over individual bonds: </li></ul></ul><ul><ul><ul><li>More liquid </li></ul></ul></ul><ul><ul><ul><li>Offer high diversification </li></ul></ul></ul><ul><ul><ul><li>Bond funds automatically reinvest interest </li></ul></ul></ul><ul><ul><li>Lower risk investments for investors who are looking for steady income </li></ul></ul><ul><ul><li>Some price volatility occurs with changing interest rates </li></ul></ul>
  26. 26. Types of Bond Funds <ul><li>Government bond funds : invest in U.S. Treasury and agency securities. </li></ul><ul><li>Mortgage-backed bond funds : invest in mortgage-backed securities of U.S. government, such as GNMA’s. </li></ul><ul><li>High-grade corporate bond funds : invest in corporate bonds rated triple-B or better. </li></ul><ul><li>High-yield corporate bond funds : invest in lower rated corporate bonds (junk bonds). </li></ul><ul><li>Convertible bond funds : invest in securities that can be converted into common stocks. </li></ul>
  27. 27. Types of Bond Funds (cont’d) <ul><li>Municipal bond funds : invest in tax-exempt securities issued by states and political subdivisions </li></ul><ul><ul><li>Single-state fund: invests in municipal issues of only one state to provide double tax-free income </li></ul></ul><ul><li>Intermediate-term bond funds : invest in bonds with maturities of 7 to 10 years or less </li></ul><ul><li>Short-term bond funds : invest in bonds with maturities of 2 to 5 years </li></ul><ul><ul><li>Often used as alternative to money market funds when interest rates are low </li></ul></ul>
  28. 28. Money Market Funds <ul><li>Invest in short-term securities with maturities of less than 90 days </li></ul><ul><li>Interest rates move up and down with market rates </li></ul><ul><li>Trade at a constant net asset value of $1 per share </li></ul><ul><li>Considered a safe, convenient investment to accumulate capital and temporarily store idle funds </li></ul><ul><li>Types of money market funds: </li></ul><ul><ul><li>General purpose: invests in all types of money market investments </li></ul></ul><ul><ul><li>Government securities: invest only in U.S. Treasury bills and other short-term government securities </li></ul></ul><ul><ul><li>Tax-exempt: invest in very short-term tax-exempt municipal securities </li></ul></ul>
  29. 29. Types of Mutual Funds <ul><li>Index Funds : buys and holds a portfolio of stocks (or bonds) equivalent to those in a specific market index </li></ul><ul><ul><li>Objective is to match, not beat, the specific index </li></ul></ul><ul><ul><li>Strategy is buy-and-hold, which provides tax advantages with very little taxable capital gains </li></ul></ul><ul><ul><li>Operating costs are very low due to low turnover in investment portfolio </li></ul></ul>
  30. 30. Types of Mutual Funds (cont’d) <ul><li>Sector Funds: investments are restricted to a particular segment of the market </li></ul><ul><ul><li>Investments are concentrated in one specific industry sector </li></ul></ul><ul><ul><li>Objective is to produce capital gains </li></ul></ul><ul><ul><li>Considered speculative because limited diversification can increase investment risks </li></ul></ul>
  31. 31. Types of Mutual Funds (cont’d) <ul><li>Socially Responsible Funds: funds that actively and directly incorporate ethics and morality into the investment decision </li></ul><ul><ul><li>Specific stocks are evaluated on financial criteria and moral, ethic or environmental tests </li></ul></ul><ul><ul><li>Stocks that do not meet these tests are not considered for the investment portfolio </li></ul></ul><ul><ul><li>Examples of excluded companies: </li></ul></ul><ul><ul><ul><li>Tobacco or alcohol </li></ul></ul></ul><ul><ul><ul><li>Gambling </li></ul></ul></ul><ul><ul><ul><li>Nuclear energy </li></ul></ul></ul><ul><ul><li>Returns may be reduced due to limited investment opportunities </li></ul></ul>
  32. 32. Types of Mutual Funds (cont’d) <ul><li>Asset Allocation Funds : funds that spread investors’ money across stocks, bonds, and money market securities </li></ul><ul><ul><li>Provides built-in asset allocation by professional investment manager </li></ul></ul><ul><ul><li>As market conditions change over time, the asset allocation mix changes as well </li></ul></ul><ul><ul><li>Provides convenience of “one-stop shopping” without having to own several mutual funds </li></ul></ul>
  33. 33. Types of Mutual Funds (cont’d) <ul><li>International Funds : funds that do all or most of their investing in foreign securities </li></ul><ul><ul><li>Objective is to benefit from changes in: </li></ul></ul><ul><ul><ul><li>International market conditions </li></ul></ul></ul><ul><ul><ul><li>Valuation of U.S. dollar </li></ul></ul></ul><ul><ul><li>Funds can specialize in international stocks, bonds or money market securities </li></ul></ul><ul><ul><li>Funds can specialize in growth, value, aggressive growth and other types of stocks </li></ul></ul><ul><ul><li>Funds can specialize in specific countries or regions of the world </li></ul></ul><ul><ul><li>Considered fairly high-risk due to currency exchange risks </li></ul></ul>
  34. 34. Mutual Fund Investor Services <ul><li>Automatic investment plans </li></ul><ul><ul><li>Regular investment from checking or savings account or paycheck </li></ul></ul><ul><ul><li>Monthly amounts as small as $25 </li></ul></ul><ul><ul><li>Excellent way to build up investment over time </li></ul></ul><ul><li>Automatic reinvestment of interest, dividends, and capital gains </li></ul><ul><li>Systematic withdrawal plans </li></ul>
  35. 35. Mutual Fund Investor Services (cont’d) <ul><li>Conversion (exchange) privileges </li></ul><ul><ul><li>Load funds usually allow exchanges between mutual funds in the same fund family without paying additional sales loads </li></ul></ul><ul><li>Phone switching </li></ul><ul><li>Easy establishment of retirement plans </li></ul>
  36. 36. Investor Uses of Mutual Funds <ul><li>Accumulation of Wealth </li></ul><ul><li>Storehouse of Value </li></ul><ul><li>Speculation and Short-Term Trading </li></ul>
  37. 37. Selecting Mutual Funds <ul><li>Determine if you want to use mutual funds in portfolio </li></ul><ul><ul><li>Mutual funds increase diversification </li></ul></ul><ul><ul><li>Mutual funds offer expertise in areas where investor may not be informed </li></ul></ul><ul><ul><li>Can use stocks and mutual funds </li></ul></ul><ul><li>Compare mutual fund’s investment objective to investor’s objective </li></ul><ul><li>Compare range of services offered </li></ul>
  38. 38. Sources of Information <ul><li>Fund prospectus </li></ul><ul><li>The Wall Street Journal </li></ul><ul><li>Barron’s , Money , Fortune or Forbes </li></ul><ul><li>Morningstar Mutual Funds </li></ul><ul><li>Wiesenberger Investment Companies Service </li></ul><ul><li>Value Line Mutual Fund Survey </li></ul>
  39. 39. Factors in Comparing Mutual Funds <ul><li>Fund’s investment performance </li></ul><ul><li>Tax efficiency </li></ul><ul><li>Fee structure </li></ul><ul><li>How particular fund fits into your portfolio </li></ul><ul><li>Investment skills of fund managers </li></ul><ul><li>Load or No-Load funds </li></ul><ul><li>Closed-End or Open-End funds </li></ul>
  40. 40. Comparing Closed-End and Open-End Funds <ul><li>Brokerage commissions apply to closed-end funds </li></ul><ul><li>Open-end funds have greater liquidity </li></ul><ul><li>Closed-end funds trade at premium (or discount) to NAV </li></ul><ul><ul><li>Avoid closed-end funds trading at premium </li></ul></ul><ul><ul><li>Look for closed-end funds trading at discount </li></ul></ul>
  41. 41. Sources of Return from Mutual Funds <ul><li>Dividend income </li></ul><ul><li>Capital gains distributions </li></ul><ul><li>Change in price/NAV </li></ul><ul><ul><li>Unrealized capital gains (paper profits): capital gain that has not been realized since fund’s holdings have not been sold </li></ul></ul>
  42. 42. Calculating Return: Holding Period Return <ul><li>Returns include distributions of dividends, distributions of capital gains, or NAV appreciation </li></ul><ul><li>Return for specific holding period </li></ul><ul><li>Best for one year returns since does not use present value </li></ul>
  43. 43. Chapter 13 Review <ul><li>Learning Goals </li></ul><ul><ul><li>Describe the basic features of mutual funds, and note what they have to offer as investment vehicles. </li></ul></ul><ul><ul><li>Distinguish between open- and closed-end funds, as well as other types of professionally managed investment companies, and discuss the various types of fund loads, fees, and charges. </li></ul></ul><ul><ul><li>Discuss the types of funds available and the variety of investment objectives these funds seek to fulfill. </li></ul></ul>
  44. 44. Chapter 13 Review (cont’d) <ul><li>Learning Goals (cont’d) </li></ul><ul><ul><li>Discuss the investor services offered by mutual funds and how these services can fit into an investment program. </li></ul></ul><ul><ul><li>Gain an appreciation of the investor uses of mutual funds, along with the variables to consider when assessing and selecting funds for investment purposes. </li></ul></ul><ul><ul><li>Identify the sources of return and compute the rate of return earned on a mutual fund investment. </li></ul></ul>

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