a presentation on mutual funds

8/2/2019 A Presentation on Mutual Funds

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A Presentation on Mutual Funds


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Questions to start with

What is a mutual fund?

How does one compute the net asset value

(NAV)? What expenses and charges might a mutual

fund investor face?

What does research on mutual fundperformance tell about fund expenses,portfolio turnover, and returns?


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Questions to start with

What is a good procedure for determining

which mutual funds to purchase?

When might it be appropriate to sell sharesin a mutual fund?

What are the similarities between mutual

funds and some other managedinvestments?


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Mutual Fund Growth

Mutual funds havebecome very popularinvestment vehicles.

Nearly $7 trillion intotal assets in 2000 vs$13 trillion in NYSEin 2002.

Total assets havegrown 600% since1990.


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What is a mutual fund?

Mutual funds are open-end investment

companies.

The fund sells shares to the public andinvests the proceeds in a pool of funds,

which are jointly owned by the funds

investors.


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Computing Net Asset Value For investors, the performance of their investment

depends on what happens to the funds per sharevalue, or net asset value (NAV).

NAV= Market Value of AssetsLiabilities

Number of Shares OutstandingNAV

1=NAV

0+All Incomes-All Distributed

Example: NAV0=Rs.100, Distributed 1) Net

Realized Gains=Rs.2 and 2) Net InvestmentIncome=Re.1.

NAV1= Rs.100-Rs.2-Re.1=Rs.97


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Mutual Fund Management

Most funds are started by investment managementcompanies who hire the fund manager to makeinvestment decisions. Fidelity, Vanguard, etc.

Usually offer many different funds and allowinvestors to switch between funds.

Funds (open-end) sell additional shares to thosewho want to invest, redeem shares at the NAV(less any fees) to those who want to sell theirshares.


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Why invest with mutual funds?

Liquidity

Funds buy and sell their own shares quickly, even if

fund investments are illiquid Diversification

Small minimum investment buys a typically well-

diversified investment

Professional management and record-keeping Expertise and services


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Why invest with mutual funds?

Choice and flexibility

Families of funds offer a variety of investments

to match investor needs

Indexing

Some funds track a broad market index which

insures that investors will earn the marketreturn

Increasingly popular mutual fund alternative


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Mutual Fund Drawbacks

Active trading contributes to high costs

which lower fund returns

Tax consequences can be a disadvantage

Tax impacts of asset trading are passed through

to investors

Tax bill can be large even when the NAV falls


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Mutual Fund Returns

Three sources of return:

Income distributions (ID)

Bond interest, stock dividends

Capital gain distributions (CGD)

Realized gains/losses from selling assets

Changes in NAV (DNAV)

From unrealized gains/losses from assets


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Mutual Fund Returns

Return = (ID + CGDPayments +DNAV)/Beg.NAV

Ex. NAV0=Rs.35,NAV1=Rs.35.2, Net RealizedGain Rs.2, Net Investment Income =Rs..5.Return= (2+.5+35.2-35)/35=7.714%

Most mutual funds allow investors to eitherreceive distributions in cash or to reinvest inadditional shares.


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Types of Mutual Funds

Funds can be classified according to the

type of security in which they invest

Stock Funds

Taxable Bond Funds

Municipal Bond Funds

Stock and Bond FundsMoney Market Funds


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Common Stock Funds

Most popular type of fund

Wide variety with different objectives and

levels of riskGrowth

Industry or sector funds

Geographic areasInternational or Global

Equity Index funds


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Taxable Bond Funds

Generally seek to generate current income withlimited risk

Can vary by maturity Short-term, Intermediate-term, Long-term

Can vary by type of bond Government

Corporate Mortgage-backed

International/Global

Bond Index funds


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Municipal Bond Funds

Provide investors with

income exempt from

Federal taxation Often concentrate on

single states to avoid

state income taxation

as well


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Stock and Bond Funds Seek to provide a combination of income and

value appreciation.

Different namesBalanced funds (60% equity+40% of debt securities)

Goal: to conserve principal, by maintaining abalanced portfolio of both stocks and bonds

Blended funds: Mutipurpose funds(e.g., balancedtarget maturity, convertible securities that invest in

both stocks and bondsFlexible funds: Flexible income, flexible portfolio,

global flexible and income funds, that invest in bothstocks and bonds


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Money Market Funds

Provide safe, current income with highliquidity

Invest in money market securitiesT-bills, Bank CDs, Commercial paper, etc.

NAV stays at Re.1; income either paid out

or reinvested daily Provide an alternative to bank deposits, butnot FDIC insured


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Mutual Fund Innovations

Life-stage funds

Offer different mixes of securities based on the

age of the investor

Supermarket funds

Offer a wide variety of funds with one-stop

fund shoppingTransfer services between funds

Expenses/fees can be high


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Mutual Fund Prospectus

Must be available to investors and should be

review by investors.

Contains: Funds investment objective

Investment strategy

Principal risks faced by investors

Recent investment performance

Expenses and fees

Lots of other detailed information


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Mutual Fund Expenses and

Considerations

Loads Commission to the broker to financial advisor who sold

the fund to the investor

For load funds, the offer price is the funds NAV plus

the load (while no-load funds are sold at their NAV) Ex. 4% load with NAV Rs.96, buy at Rs.100

Load range from around 3% (low-load) to 8.5%

12b-1 Fees: pay to the distributor (.25%-.75% )+

.25% servicing charge in some cases) Fees deducted from the asset value of the fund to cover

marketing expenses

An alternative to loads


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Offering Price= NAV/(1-load %).Investing Rs.1,000 in a load MF with 7% and

expected return of 10%,

Rs.value=1000(1-.07)(1.10)=1023 (2.3%growth)

Investing Rs.1,000 no load MF with 8% returnand 2% redemption fee,

Rs.value=1000(1-0)(1.08)(1-.02)= 1058.4(5.84% growth)

Rs.35.4 Difference


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Considerations Deferred Sales Loads

Redemption charges when fund shares are sold (ratherthan when purchased)

Often high (5-7%) if shares are sold within the firstyear, but then fall over time, perhaps even disappearingeventually

Share Classes

Many funds offer several different classes of shares (A-B-C) with different fee structures

Best choice usually depends of investment horizon


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Considerations Management Fees

Fees deducted from the funds asset value to

compensate the fund managers Some adjust fees according to the funds

performance

Expense ratioAdding all fees and calculating expenses as a

percentage of the funds asset


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*Mutual Fund Expenses and

Considerations Portfolio Turnover

Not an explicit cost, but very important determinant ofshareholder returns

Trading costs rise with turnover

In order for high turnover to pay off, fund managersmust be successful in their active trading strategies

Sources of Information Wall Street Journal, Business Week

Morningstar Fund history, tax efficiency, risk analysis


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Holding Period for a Portfolio

Portfolio Turnover

Holding Period = 12 months/(Portfolio

Turnover%)

Ex Turnover 125%=>12/1.25=9.6 month


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Mutual Fund Return and Risk

PerformanceReturn Performance

On a risk-adjusted basis, the average stock fundunder-performs market averages

While portfolio managers seem to out-perform themarket before expenses, net returns are below themarket index

Some above-average performers over short timehorizons, but such performance is not generallysustained (just luck?)

These results help to explain the growing

popularity of index funds


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PerformanceRisk Performance

While returns are not consistent, risk is

Objectives lead to strategies that lead to

varying degrees of investment risks

Return is positively related to the level of

risk

Risk is therefore an important consideration


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PerformanceFees and expenses: Do higher fees pay off?

Investment performance is no better (and perhapsworse) for load funds vs. no-load

Expenses lower returns in predictable wayslower expense funds give better returns

Turnover affects returns in several ways, including

taxeshigh turnover means more short-termrealized gains

Tax efficiency is an important considerationafter-tax returns may be 30-40% less than pre-tax


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Mutual Fund Investment

Strategies Choose in funds consistent with your objectives,

constraints, and tax situation.

Consider index funds for a large portion of yourfund portfolio.

When possible, invest in no-load funds withbelow-average expense and turnover ratios.

Invest at least 10-20% in international or globalfunds.

Own funds in different asset classes andconsider life-cycle investing.


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Mutual Fund Investment

Strategies If you actively manage your portfolio, consider

the past years hot funds.

Do not attempt to time the market; timingstrategies add little except costs and risk.

Use dollar cost averaging by investing a setdollar amount each month.

Avoid investing money shortly before the capitalgain distribution dates (prospectus).

Do not own too many funds. You will getaverage returns with high expenses.


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When should you sell a mutual

fund? Personal considerations

Portfolio rebalancing points due to life cycleconsiderations

Be aware of the quick trigger, selling on the first dip in NAV;think long-term

Be aware of capital gains with selling fund shares

Fund considerations

Change in portfolio manager Change in investment style

Fund is growing too large or too fast

Persistent bad performance.

a presentation on mutual funds

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