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Understanding Mutual Funds: Types, Performance, and Evaluation Criteria

Mutual funds provide an efficient way for investors to diversify their portfolios, managed by expert fund managers. This chapter explores the different types of mutual funds, distinguishing between open-end and closed-end funds, as well as load versus no-load funds. It explains how to compute a fund's net asset value (NAV) and how to evaluate fund performance using key information sources like Morningstar and Barron's. Additionally, it highlights the advantages and disadvantages of mutual funds, offering insights into their investment objectives and types.

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Understanding Mutual Funds: Types, Performance, and Evaluation Criteria

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  1. Chapter Nineteen Mutual Funds

  2. Learning Objectives 1. Understand the concept of a mutual fund. 2. Distinguish between closed-end and open-end funds 3. Explain the difference between load and no-load funds. 4. Compute the net asset value of a fund. 5. Identify the key information sources for mutual funds. 6. Explain how to evaluate the performance of a mutual fund.

  3. Percent of U.S. Households 60 50 40 30 20 10 0

  4. Advantages of Mutual Funds • Efficient way to diversify • The expertise of fund managers • Broad range of funds • Stock funds • Bonds: U.S. gov't. and corporate • Municipal securities

  5. Disadvantages of Mutual Funds • Mutual funds do not outperform the market in the long-run. • Some mutual funds can be expensive to purchase. • Buyer beware: Past performance does not guarantee future performance.

  6. Closed-end Funds • A closed end mutual fund has a fixed number of shares. • Purchasers and sellers of shares must trade with each other. • Shares are bought from the fund at inception only. • Fund does not stand ready to buy the shares back from investors.

  7. Closed-end Funds (Cont.) • Closed-end funds trade in securities markets at a discount or premium from Net Asset Value (NAV). • NAV = Total Value of Securities - Liabilities Shares Outstanding • Funds may trade at discount or premium, depending upon past performance.

  8. Index Traded Closed-End Funds • Essentially index-based mutual funds that imitate a market index such as S&P 500. • Fund numbers (Sept. 2001) • domestic funds = Sixty Six (66) • International funds = Twenty Six (26) • Advantage • Enables investor to "buy the market" • Disadvantage • Investor gets "market results"

  9. Open-End Funds • An open-end fund stands ready at all times to sell or buy back shares. • NAV= Total Value of Securities - Liabilities Shares Outstanding • NAV is computed at the end of each day for a fund. • Only factor that changes the NAV is the up and down movement of the securities in the funds portfolio

  10. Comparison of funds

  11. Load versus No-Load Funds • A load fund is a fund which charges a commission for the sale of its shares. • Commission may run as high as 7.25%. • NAV is usually less than offer price because the commission must be paid. • Low-load funds • Back-end load funds • No-load funds • Sold directly, thus no commission • Annual management fee of .75% - 1.25% of fund value ( similar to load fund management fees). • No-load funds performance equivalent to load-funds.

  12. Mutual Fund Information Sources • Wall Street Journal • NAV, Net change, Year-to-date % return • Barron's • Morningstar Mutual Fund Survey • Ranks funds on a One-star to Five-star rating system

  13. Differing Objectives and the Diversity of Mutual Funds • Money Market Funds • short-term securities (t-bills, CDs, etc.) • Growth Funds • emphasis capital appreciation • Growth with Income • steady dividends with growth potential • Balanced Funds • Combine common stock, bonds, and may include preferred stock.

  14. Differing Objectives and the Diversity of Mutual Funds • Index funds • replicate a market index • Bond Funds • corporate, U.S. govt., municipals • junk bond funds • Sector Funds • Foreign Funds • Specialty Funds • Hedge Funds

  15. Investment Objective and Fund Types • Goal: Safety of principal and steady income • Money market funds • intermediate term bond funds • Goal: licquidity • all funds • Goal: Capital appreciation • aggressive growth funds • Goal: Growth and income • growth-income and balanced funds

  16. The Prospectus • Information deemed essential by SEC in providing "full disclosure" • Investment Objectives and Policies • Portfolio (or “Investment Holdings”) • Management Fees and Expenses • Turnover Rate

  17. Distribution and Taxation • Distributions • Capital gains distributed annually • Income distributed quarterly or annually • Fund not subject to Federal Income taxes if 90% or more of gains are distributed • Sale of mutual fund shares subject to normal securities sales income tax liabilities.

  18. Shareholder Services • Automatic Reinvestment • Safekeeping • Exchange Privilege • Pre-authorized check plan • Systematic withdrawal plan • Checking privileges

  19. Table 19-7. Dollar-Cost Averaging

  20. Computing Total Return Assume the following: 14.05= Beginning NAV 15.10= Ending NAV 1.05= Change in NAV (+) 0.40= Dividends distributed 0.32= Capital Gains distributed $ 1.77= Total Return Total Return $ 1.77 Beginning NAV $14.05 = = 12.60%

  21. Evaluating Fund Performance • Sources of information • Forbes ratings • Morningstar ratings • American Association of Individual Investors • Lipper Mutual Fund Performance

  22. Potential Sources of Return • Change in NAV • Macro-economic effects of market movements • Dividends • Dividends collected by the fund on stocks in the fund and distributed to shareholders • Capital gains • Gains from trading operations of the funds

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