Mutual Funds

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Mutual Funds

• Portfolio of assets

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Mutual Funds and Relatives

• Open end
• Closed end
• ETF
• Money market funds
• REIT
• UITs
• Hedge funds
• Managed money

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Advantages

• Instant diversification
• Record keeping
• Professional management
• Administrative Trading costs
• Convenience
• Fees deducted pretax

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Advantages of Bond funds

• Individual
• High initial cost
• Diversification
• Liquidity
• Mutual fund
• Monthly distributions

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History

• 1st US fund 1924
• Securities Act of 1933
• Full disclosure
• Investment Company Act of 1940
• Fund promotions, Pricing, Reporting, and
  Investing

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• Low growth until 1970s
• 1970s Regulation Q and Money Market Funds
• 1980s IRA, 401k, and distribution channels

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Structure

• Independent Directors
• Shareholders MF Securities
• Management company

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Returns
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• Arithmetic return
• (100 - 50 20) / 3 10
• Geometric return
• 100(1 R)3 80 R -7.168
• Cumulative return -20

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• Geometric return
• (1R1)(1R2)(1RN)1/N - 1
• RG (1.10)(1.20)(1.30)1/3 1
• RG 19.72
• As long as there is variance in returns,
  arithmetic is always larger than geometric

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Blumes Formula

• T years of data
• N years for projection

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• RG 9
• RA 12
• T 25 years of data
• N 10 years

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Net Asset Value (NAV)

• NAV

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• Liabilities 750
• NAV
• NAV 24.79
• Notice, shares of MF do not necessarily equal
  total shares of stock

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• NAV is calculated once a day (typically 4PM
  eastern time)
• All transactions at that days NAV

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Returns and Distributions

• Increase in share price (NAV)
• Income distributions (dividends and interest
  payments)
• Short-term capital gains distributions
• Capital gains distributions
• Usually in December

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General Concepts

• Diversification Rule 1940 Act
• 75 of assets can hold no more than 10 of voting
  securities in any one issue
• AND
• No more than 5 in any single issue
• Remaining 25 can be in a single issue
• IRS rules less diversification

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• Conduit Theory
• 90 of investment income
• 98 of dividends interest - expenses
• MF report aftertax returns
• Highest marginal tax rate

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• Securities Act of 1933
• Prospectus
• No material misrepresentation
• 1998 Plain English prospectus
• Mid 2002 Fund name
• 80 of assets invested in fund name

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• Electronic delivery of prospectus
• 2001 Majority of directors must be independent

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Code of Ethics

• Prevent fraudulent and manipulative practices
• Access persons must file reports of personal
  trading no front running
• Records of personal trading

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• Material changes approved by Board of Directors,
  including majority of independent directors
• SAI states Code of Ethics and if personal trading
  is allowed

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Open-End Funds

• Continuous public offering
• Redemption
• Priced at next NAV
• Usually paid next business day, but can be
  delayed for up to 7 days in unusual circumstances

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Sales Charges

• Front end load
• 8 ½ percent max
• Back end load
• Contingent deferred sales charge (CDSC)
• Typically declining

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Front end loads

• Percentage of NAV
• NAV 13.91
• Offer price 15.20
• Load 15.20 - 13.91 1.29
• Load 1.29 / 15.20 0.085

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• 3 Front-end load, NAV 8.71
• Offer price NAV / (1 FL)
• Offer price 8.71 / (1 - .03) 8.979

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Fees Expenses

• 12b-1 fee
• 0.75 max
• The SEC does not limit the size of 12b-1 fees
  that funds may pay. But under NASD rules, 12b-1
  fees that are used to pay marketing and
  distribution expenses (as opposed to shareholder
  service expenses) cannot exceed 0.75 percent of a
  funds average net assets per year.
• Distribution, marketing, advertising, direct mail
• Management fee
• Other
• Transfer agent, website, 800 number
• Annual expense ratio

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Other fees

• Redemption fee
• Exchange fee
• Annual account maintenance

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Share Classes

• A shares
• Front-end, low 12b-1
• B shares
• Back-end, high 12b-1 fee
• C shares
• No (or 1 CDSC) load, high 12b-1 fee
• No Load
• Less than 0.25 12b-1 fee and shareholder service
  fee

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• A shares
• 5, front end load, 0.75 management fee, 0.25
  12b-1 fee
• B shares
• 0.75 management fee, 1.00 12b-1 fee

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100 investment, 10 return

• A shares in one year
• 951 (.10 - .0075 - .00250) 103.55
• B shares in one year
• 1001 (.10 - .0075 - .01) 108.25

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• A shares in ten years
• 951 (.10 - .0075 - .00250)10 224.90
• B shares in ten years
• 1001 (.10 - .0075 - .01)10 220.94

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When is breakeven?

• 951 (.10 - .0075 - .00250)t
• 1001 (.10 - .0075 - .01)t
• 95(1.09)t 100(1.0825)t
• 95 / 100 1.0825t / 1.09t
• ln(95/100) t ln (1.0825/1.09)
• t 7.43 years