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Investments: Analysis and Behavior

Dive into mutual funds with this analysis of their structure, pricing, advantages, and disadvantages. Discover how to assess fund performance, manager incentives, and tax implications on returns in this informative chapter.

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Investments: Analysis and Behavior

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  1. Investments: Analysis and Behavior Chapter 16- Mutual Funds

  2. Learning Objectives • Understand the structure and pricing of mutual funds • Know the advantages and disadvantages of buying mutual funds • Be able to assess mutual fund performance • Assess mutual fund manager incentives • Recognize the impact of taxable distributions on fund returns

  3. Mutual Funds • An investment company that issues portfolio shares to investors. • Money from shareholders invested in a wide range of stocks, bonds, or money market securities. • Managed by professional managers • Each investor shares proportionately in portfolio income and investment gains and losses, as well as the brokerage expenses and management fees. • Open end fund: # of shares issued solely depends on investor demand. • Bought and sold directly through the investment company (not an exchange)

  4. Net asset Value • NAV: per share value of a mutual fund’s investment holding. Example A mutual fund has $100 mil in assets and $3 mil in short term liabilities. 10.765 mil shares outstanding. What is the NAV? Solution ($100 mil - $3 mil)/10.765 mil = $9.0107 per share

  5. Table 16.1 Types of Mutual Funds

  6. Sources of Information • Morningstar.com: provide unbiased data and analysis and candid editorial commentary (www.morningstar.com) • Lipper Inc.: a provider of data and analysis on the investment company business (www.lipperweb.com) • Vanguard Group: providing competitive investment performance and the lowest operating expenses (www.vanguard.com)

  7. Mutual Fund Advantages • Broad diversification • Diversified stock funds hold large and small company stocks broadly spread across industries and economic sectors • Diversified bond funds hold bonds with different maturities, coupon, and credit quality • Ability to retain professional investment management at a reasonable cost. • Investor convenience • Many offer a “fund family” with lots of investment options.

  8. Mutual Fund Disadvantages • Volatility can be significant • Diversification doesn’t protect investors from the risk of loss from an overall decline in financial markets. • Mutual fund regulation doesn’t eliminate the risk of an investment falling in value. • High management fees and sales commissions • Some funds charge very high management fees. • Some funds charge very sales commissions.

  9. Sources of Investment Returns • Total Return: dividend and interest income ,and realized and unrealized appreciation • Income distribution: interest and dividend income after expenses. • Capital gains unrealized until the fund sells the shares (Unrealized capital gains) • The realized capital gains are paid out to shareholders at the end of the year (capital gains distributions)

  10. Mutual fund expenses • Operating expense ratio: total of investment advisory fees and costs of legal and accounting services, etc., expressed as a percentage of the fund’s average net assets (range from 0.2% to 2%) • Lowest for money market mutual funds and highest for international stock funds • Tend to be lowest for large, liquid funds • Load charges: one time sales commissions • Front-end loads (charged at the time of purchase) • Back-end loads (charged at the time of sales of shares) • Low-end funds: sales fee ranging from 1% to 3% • 12b-1 fees: marketing and distribution costs • No-load funds: fund without front-end or back-end load charges

  11. Table 16.4 A. Typical fee tables found in three different mutual fund prospectuses

  12. The impact of equity mutual fund costs on long-term investor returns. Fund A : typical cost efficient index fund Fund B : conventional no-load stock mutual fund Fund C : low-load stock mutual fund with less than typical annual operating expenses

  13. Figure 16.3 Yahoo! Finance Gives Detailed Information about Mutual Fund Style and Fees

  14. Figure 16.4 Dreyfus Appreciation Fund Performance from Yahoo! Finance

  15. Figure 16.4 Dreyfus Appreciation Fund Performance from Yahoo! Finance (cont.)

  16. Figure 16.4 Dreyfus Appreciation Fund Performance from Yahoo! Finance (cont.)

  17. Hedge Funds • Like mutual funds, hedge funds allow investors to pool financial resources. • Typically organized as partnership and available only to the wealthiest investors. • Flexibility to use speculative investment strategies, subject to limited oversight. • High fees (2% of assets plus 20% of returns is common.) • Hedgefund.net tracks nearly 3,000 hedgefunds

  18. Table 16.7 Hedge Funds Differ From Mutual Funds in a Number of Ways

  19. Taxes on distributions • Shareholders pay taxes on dividends and capital gains distributions. • Income and capital gains distributions are generally subject to income taxes. • Municipal bond or US T-securities interest income exempt from federal taxes, but capital gains are taxable.

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