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Course Outline Part XI (Mutual Funds)
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Course Outline Part XI (Mutual Funds)

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  • 1. X. MUTUAL FUNDS
  • 2. A. The Mechanics of Mutual Funds 1. Mutual funds pool money from many investors 2. Mutual fund investors own a part of all of the securities in the mutual fund “pool” 3. The fund manager is responsible for tracking the securities in the pool 4. Profits are paid in two ways: a. Income Distributions – Dividends and interest paid by the underlying securities are subsequently paid to investors b. Capital Gains Distributions – Payment to investors of profits obtained from sales of securities
  • 3. A. The Mechanics of Mutual Funds 5. Passive Funds – Primarily index funds 6. Active Funds – Run by a professional manager – active funds have: a. Professional managers b. An investment objective, and c. An investment program designed to meet the investment objective
  • 4. A. The Mechanics of Mutual Funds 7. Open and Closed End Funds a. Open end – sold by brokerage firms and by fund distributors, issues or purchases shares depending upon demand, uses client funds to buy or sell securities b. Closed end – raise money only once, invest in a variety of securities, and offer a fixed number of shares – traded Over the Counter or on the market – price varies with the price of the underlying securities and with market demand (discount or premium from Net Asset Value)
  • 5. B. TYPES OF MUTUAL FUNDS 1. Stock Funds – invest in equity securities, can be growth, value, dividend, sector, market cap, etc. 2. Bond Funds – invest in Treasury bonds, municipal bonds, passive trading of securities, active trading of securities, high yield bonds, corporate bonds, etc. 3. Commodity Funds – invest in stocks of commodities or in commodity futures 4. Balanced Funds – contain a mix of stocks and bonds (generally 60% stocks, 40% bonds)
  • 6. B. TYPES OF MUTUAL FUNDS 5. Target Date Funds – change investment allocation as a target date approaches (ex. - §529 funds) 6. Money Market Funds – cash equivalent securities – like a savings account 7. International Funds – invest in Europe, China, Asia, Far East, Latin America, emerging markets, etc. 8. Miscellaneous – socially responsible funds, sin funds, green funds, etc.
  • 7. C. DEFINITIONS 1. Turnover Rate – the number of times per year that the equivalent of all of the underlying securities in the fund are purchased or sold 2. Volatility – the historic deviation of rates of return above and below the average rate of return 3. Prospectus – similar to a stock prospectus, explains fund objectives, investment strategy, fees, historic before and after tax returns, and fund risk profile
  • 8. C. DEFINITIONS 4. Rating – An independent analyst’s opinion of how the fund has performed compared to benchmarks 5. Ranking – The relative standing of a mutual fund compared to others with similar investment strategies 6. Sharpe Ratio – Calculated as a fund’s rate of return – the rate of return on 3 month Treasury bills divided by the standard deviation of fund returns Sharpe Ratio = (Fund Return – 3 mo. Treasury Yield) Standard Deviation of Fund Returns
  • 9. C. DEFINITIONS 7. Standard Deviation – The amount by which the annual returns of a fund vary above and below the fund’s average return 8. Rating Firms: a. Standard and Poors b. Morningstar c. Lipper
  • 10. C. DEFINITIONS 9. Fund Style a. Growth/Blend/Value – Invests in growth stocks, a blend of growth and value stocks, and value stocks b. Dividend (Yield) – Invests in securities with the highest dividend payments c. Contrarian – Against the accepted (current trend) in management d. Style Drift – When a fund manager changes styles to make up for below market returns 10.Portfolio Overlap – Where a holder of several mutual funds owns duplicate underlying shares of stock
  • 11. D. FEES AND CHARGES Fees have the greatest impact on fund returns other than the manager’s performance 1. Sales Charges (Loads) a. Front End Load – A sales charge on fund purchase, reduces the number of shares purchased b. Back End Load (Redemption Fee or Contingent Deferred Sales Charge) – Paid when shares are sold – usually declines to 0 after 5-7 years – designed to prevent investor “churn”
  • 12. D. FEES AND CHARGES 2. Fund Classes a. A = Front end load b. B = Back end load c. C = Level load – no sales charges, but higher fees than A or B – higher annual fees and charges instead of front end or back end loads 3. Exchange Fees – A charge for moving assets between different funds issued by the same group
  • 13. D. FEES AND CHARGES 4. Early Redemption Charge – Exit fee, can be 5 days to 1 year 5. Breakpoint – A point where more money is invested to reduce the front end load a. Right of Accumulation – Where and investor can combine past and new investments to reach a breakpoint b. Letter of Intent – A promise by the investor to increase the amount invested to reach a breakpoint
  • 14. D. FEES AND CHARGES 6. Other Types of Fees – Total annual fees are quoted as an “Expense Ratio” – must be listed in the fund prospectus, generally range from 0.1% to 2.75% a. 12-b 1 Fees – Marketing and distribution expenses – limited by NASD rule to 1% of assets per year or less, with marketing fees at 0.75% or less; and with shareholder services capped at 0.25% of assets b. Management Fees – Charge to pay the advisory firm that invests fund assets