Investing in Mutual Funds

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Investing in Mutual Funds

• Topic 11

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A. Pooled Diversification

• 1. Professional Money Managers
• 2. Combines the Funds of many people with
  similar investment goals
• 3. Receive shares of stock in the mutual fund
  a pooled common investment.
• 4. An indirect investment

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B. Attractions and Drawbacks of Mutual Fund
Ownership

• 1. Diversification
• 2. Full-time Professional Management
• 3. Modest Capital Investment
• 4. Services offered
• a. Automatic reinvestment of dividends
• b. Withdrawal plans
• c. Exchange privileges
• d. Check writing privileges

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B. Attractions and Drawbacks of Mutual Fund
Ownership

• 5. Convenience
• a. Easy to acquire
• b. Paperwork and record keeping
• c. Prices are widely quoted
• 6. Lack of liquidity
• a. Normally must be sold back to the fund
• b. No brokerage commissions
• 7. Consistently average to below average
  performance

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C. Essential Characteristics

• 1. Open-end Funds
• a. Investors buy and sell shares back to the
  fund itself
• b. There is no limit on the number of shares the
  fund can issue
• c. NET ASSET VALUE (NAV)
• Defined as the total market value of all
  securities held by the fund less liabilities,
  divided by the number of fund shares outstanding.

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Net Asset Value Example

• Example NAV
• XYZ Mutual Fund owns assets totaling 10M and
  liabilities equal to 500,000 with 500,000 shares
  outstanding
• Therefore, NAV is 10,000,000 - 500,000
  / 500,000
• 19/share

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C. Essential Characteristics (continued)

• 2. Closed-end Funds
• a. A fixed number of shares outstanding
• b. 100 Closed-end funds
• c. 8 billion market value
• 3. Investment Trusts
• a. Interest is an unmanaged pool of
  investments
• b. Usually consist of corporate, government, or
  municipal bonds

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C. Essential Characteristics (continued)

• 4. Load or No Load
• a. Load Fund
• Charges a commission when shares are bought (7 -
  8 1/2 or more)
• b. No Load Fund
• No sales charges are levied
• 5. Other fees and Costs
• a. Professional Management Fee
• .25 to 1.75 percent of the average dollar amount
  of assets under management

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D. Types of Funds (Equity)

• 1. Growth
• Goal is capital appreciation
• 2. Maximum Growth
• Highly speculative, seeking large profits from
  capital gains
• a. Often buy stocks of small, unseasoned
  companies
• b. Highly speculative

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D. Types of Funds (continued)

• 3. Income
• CURRENT income is main objective
• a. Interest income
• b. Dividend income
• 4. Balanced Funds
• Objective is to earn both capital gains and
  current income
• a. High-grade common stocks (60 - 75)
• b. Fixed income securities (25 - 40)

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D. Types of Funds (continued)

• 5. Small Company
• Invest in small companies that usually have sales
  of 100 million or less.
• 6. International
• Can invest in one region or area of the world
• Can invest in specific country

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D. Types of Funds (continued)

• Bond Funds
• Objective is to invest in bonds
• a. Income is primary objective
• b. Two advantages
• Liquidity
• Diversification

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D. Types of Funds (continued)

• 6. Money Market Funds
• Offers the individual investor access to
  high-yielding money market instruments without
  having to pay 100,000 denominations
• a. Bank CDs
• b. Treasury Bills
• c. Commercial Paper

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D. Types of Funds (continued)

• 7. Dual Funds
• Closed-end Funds with two types of shares
• a. INCOME shares (Senior) which receive two
  times income as Junior
• b. CAPITAL shares (Junior) which receive two
  times the capital gains as Senior

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D. Types of Funds (continued)

• 8. Specialty Funds - Single Industry
• a. Option trading
• b. Commodity funds
• c. Oil drilling
• d. Cattle funds
• e. Electronics
• f. Gold
• g. Chemicals
• h. Health

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E. Special Services

• 1. Saving Plans
• Investor adds funds on a regular basis
• 2. Automatic Reinvestment Plans
• Dividends and capital gains are reinvested in
  additional shares
• 3. Regular Income
• Through withdrawal plans, the investor can
  receive periodic repayment or income
• Shares or Dollars

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E. Special Services (continued)

• 4. Conversion Privileges
• Allows the investor the right to switch from one
  fund to another
• a. Must confine switches within the same family
  of funds
• b. Usually no transfer charges

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E. Special Services (continued)

• 5. Check Writing Privileges
• a. Shareholders have the right to write checks
  drawn on the Mutual Fund account
• b. Normally checks must be written for at least
  500
• c. Almost all Money Funds have this privilege

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F. Risk

• Because Mutual Funds are so well diversified
  (typically), the inherent risk is similar to that
  in the Market
• However, Specialty Fund risk can vary
  significantly from overall Market risk

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Analyzing Mutual Funds

• Assessment of your risk tolerance
• Importance of diversification
• Should hold six mutual funds
• Should be able to earn 16 plus with a beta
  equivalent to 1.0 or slightly less

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Mutual Fund Analysis

• Style Analysis Style analysis identifies the
  process of investing by fund managers that leads
  them to pick certain kinds of securities.
• Three factors of style analysis
• Growth
• Value
• Company Size

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Mutual Fund Analysis

• Growth Managers buy stocks in companies whose
  earnings are growing rapidly.
• Value Managers are bargain hunters seeking stocks
  with low prices compared to intrinsic value.
• Company Size Managers specialize in small
  companies or large cos.

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Mutual Fund Style Analysis

• Style determines 85-90 of a fund portfolios
  return.
• The technique looks at the way funds perform on a
  monthly basis against one of 12 different
  indexes. The mix of indexes that are most highly
  correlated determines the style of the mutual
  fund manager.

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Mutual Fund Style Analysis

• The mutual fund universe can be divided into six
  basic styles
• Small cap growth funds
• Large cap growth funds
• Small cap value
• Large cap value
• Foreign funds
• Fixed income funds

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Mutual Fund Style Analysis

• Source of Information
• Advisor Software
• Style Data
• 1-800-738-6369
• http//www.advisorsw.com

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Mutual Fund Annual Reports

• Two Reports a Year Mutual funds typically issue
  two financial reports a year - the semiannual
  report, which is often dated June 30 or April 30,
  and the year-end or annual report, which is often
  dated December 31 or October 31.
• Shareholder Letter A shareholder letter is
  usually written by the funds president or
  investment manager and reviews the funds
  investment objectives and performance for the
  current period.
• Top 10 By looking at a mutual funds top 10
  holdings, you will get a sense of the type of
  investments in the portfolio and the degree to
  which the fund meets your investment objectives.
  Similarly, study the industry composition of the
  portfolio - the percent of the funds asset that
  is invested in a particular industry.

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Mutual Fund Annual Reports

• Investment Portfolio An investment portfolio
  comprises the assets (securities) held within a
  mutual fund.
• Portfolio Turnover Portfolio turnover is the
  percentage of the portfolios investment that are
  bought and sold in one year. A fund with a
  portfolio turnover rate of 100 percent means they
  effectively bought and sold every security in the
  portfolio. High portfolio turnover increases
  transaction expenses and often reduces your rate
  of return.
• Charts and Graphs Many mutual fund reports
  include charts and graphs. A line graph may
  compare the growth of a 10,000 investment in the
  fund to the growth of similar investments over
  five years, ten years, or over the life of the
  fund. Pie charts are used to show the of each
  type of investment in the fund C.S., bonds, and
  cash.

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Mutual Fund Annual Reports

• Portfolio Some mutual fund financial reports
  include a more in-depth discussion of the funds
  performance for the period than the shareholders
  letter.
• Statement of Assets and Liabilities A mutual
  funds statement of assets and liabilities
  reflects the funds financial position at the
  stock or bond markets close on the date of the
  report. Assets typically include investments
  that are valued at market on the financial
  statement date. Other assets include collateral
  held for securities loaned and receivables. Two
  examples are dividends and interest income
  receivable, which represent income earned by the
  fund but not yet collected in cash. Liabilities
  primarily represent amounts the fund owes for the
  purchase of new securities.

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Mutual Fund Annual Reports

• Footnotes to the Financial Statements Mutual
  fund financial reports include footnotes similar
  to those found in other annual reports.
  Footnotes include significant accounting
  policies, and related party and affiliate
  transactions.
• Significant Accounting Policies Related party
  and affiliate transactions typically include
  three types of transactions. The first occurs
  when payment of fees is made to portfolio
  managers and financial advisors. The second
  occurs when a mutual fund accumulates an
  ownership stake of a least 5 of the company.
  The third occurs when one mutual fund sells some
  of its investments to another mutual fund
  sponsored by the same mutual fund family.

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Deadly Mutual Fund Myths - The Conventional
Wisdom Myth

• 1. The Conventional Wisdom Myth
• This is the number one mistake most investors
  make. Investors look at historic trends reported
  by Forbes, Kiplingers Business Week and others
  tend to recommend funds that have already made
  big gains rather than identify funds that are
  positioned to make profits in the future.

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The Diversification Myth

• 2. If you own at least 10 different mutual funds
  youll have a diversified portfolio.
• Owning 10 mutual funds wont assure you of
  anything but a lot of work trying to stay on top
  of them all. In fact, you can have a well
  diversified portfolio with just 4 to 6 funds or
  you can have a portfolio of 15 funds with very
  little diversification.

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The Momentum Myth

• 3. The easiest way to beat the market is to buy
  last years top-performing funds.
• The fact is that last years best funds are just
  as likely to be this years dogs. Blindly
  following this strategy is very dangerous for
  most investors. The very top-performing funds
  are usually those that took a lot of risk and
  happened to bet on the right market sector at the
  right time.

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The Five-Star Myth

• 4. The best funds to buy are those rated 4 or 5
  Stars by Morningstar.
• The star system tells you which funds were good,
  not which ones will be good. Even Morningstar
  will tell you that their ratings are a measure of
  past (risk-adjusted) performance, not the
  potential for future profits. Relying on
  statistical ratings is no substitute for a
  thorough examination and analysis of what a fund
  is doing today.

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The Market Timing Myth

• 5. The safest strategy is to move everything
  into money market funds when the market is
  declining and switch everything back into stock
  funds when the market is rising.
• This is a losers game. It has been proven over
  and over that investors are incapable of timing
  the market or identifying major bull or bear
  markets.

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The Long-Term Performance Myth

• 6. The best measure of a funds quality is its
  long-term performance.
• There is a fair amount of truth to this
  statement, but too many investors follow some
  brokers advice to buy this fund, it has a great
  10-year record, without asking some key
  questions. Who earned that record? Is the
  manager responsible for its returns still at the
  helm? If not, the record could be meaningless.

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The New fund Myth

• 7. You should wait until a fund has at least a
  3-year track record before investing.
• The fact is that brand new funds often enjoy
  superior gains. New funds from top fund families
  often show explosive gains in their rookie year.
  Montgomery Small Cap was up 98.8 in 1991,
  Oakmark was up 48.9 in 1992, DFA Pacific Rim
  Small Company was up 92.6 in 1993, and Janus
  Olympus was up 30 the first 9 months of 1996.