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Mutual Fund Investors: Divergent Profiles Alan Palmiter & Ahmed Taha Wake Law 01 Oct 07.

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Presentation on theme: "Mutual Fund Investors: Divergent Profiles Alan Palmiter & Ahmed Taha Wake Law 01 Oct 07."— Presentation transcript:

1 Mutual Fund Investors: Divergent Profiles Alan Palmiter & Ahmed Taha Wake Law 01 Oct 07

2 A pop quiz …

3 1.Mutual funds are primarily owned by: a.Individuals on their own b.Individuals with retirement accounts c.Institutional investors 2.Mutual funds mostly invest in: a.Stocks b.Bonds c.Notes (money market) 3.What have been annual returns (1926-2004): a.Small-cap stocks b.Large-cap stocks c.Corporate bonds d.Treasury bills 4.Warren Buffet predicts that annual US stock returns over the next 10 years will be: a.6.5% b.9.6% c.12.3% d.21.7% 5.Past performance of stock funds generally predicts future returns. a.Yes b.No c.Only low-performing funds 6.Mutual fund investors say they pay attention more to fees than to performance. a.True b.False

4 7.As a mutual fund investor, you are entitled to: a.Prospectus (before you invest) b.Annual report (showing fund performance) c.Statements (breakdown of expenses / fees / trading costs) 8.Mutual funds only impose a sales charge at the time you invest. a.True b.False 9.Annual rate that average stock fund sells and replaces stock (turnover) in its portfolio: a.6% b.56% c.90% d.153% 10. What is a no-load fund? a.An unleveraged fund b.A fund without sales charges c.A fund without trading costs d.A fund without withdrawal fees 11. Think about your own largest mutual fund. What is -- a.Your current balance b.Fund’s investment objectives c.Fund’s sales charges, expense ratio, trading costs d.Fund’s performance last year 12. Consider your car/vehicle: a.Its make, model, year b.Its cost, MSRP, total miles, safety rating, gas efficiency c.You get our point

5 US mutual fund market …

6 US Households (112 million) Own mutual funds (55 million / 49%) Retirement account 54% Broker 79% On own 46% Direct 29% IRAs 48% DC plans 52% Stocks 60% Money Mkt 23% Bonds 17% Mutual funds ($11.3 T) Demand-side Fund Types

7 Supply-side mutual fund market …

8 Top 10 groups (38%) Next 15 groups (35%) Rest (27%) Mutual fund market Financial retirement market Mutual Funds (27%)

9 Asset classes (risk/return primer)

10 Asset Classes (1926-2004) Average Return Standard Deviation Small Company Stocks12.7%33.1% Large Company Stocks10.4%20.3% Long-Term Corporate Bonds5.4%9.3% Treasury Bills3.7%3.1%

11 Effect of investing $10,000 for 20 years … 12.7% 3.7%

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13 Mutual fund investor profiles (demand-side)

14 Industry profile

15 ICI Investor Preferences (2006)

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17 “The 90 million fund shareholders’ demand for investment performance and services at a competitive level of fees and expenses continuously impacts mutual funds.” Paul Schott Stevens ICI President

18 SEC portrait William O. Douglas: ”The investors’ advocate”

19 The number/types of funds has proliferated, increasing need for information to help investors compare and contrast alternatives. SEC (Mar 29, 1995) Investors will benefit from a uniform fee table and management’s discussion of fund performance SEC (1983) Many investors find prospectuses “unintelligible, tedious, and legalistic” … Investors need to be provided with clear and comprehensible information. SEC (Feb 27, 1997) Funds may resort to advertising techniques that create unrealistic investor expectations. SEC (Mar 17, 2002)

20 Prospectus VFINX VFINX Disseminated –after investment / then once annually –Including electronically / filed SEC Disclosure –Investment strategies –Risks (narrative) –Performance (1/5/10 years) –Expenses (sales charge, 12b-1 fees, mgmt fees) –Turnover rate Effect –Omissions in fund literature not fraudulent, if info in prospectus Fund comparer (SEC website / NASD)SEC website NASD)

21 Statement of Additional Information Not disseminated –Available to investors (incorporated by ref into prospectus) / file SEC –No fraud liability if in SAI Disclosure –Fund organization –Investment policies / limitations –Management of fund –Proxy voting policies –Financial statements Can cover multiple funds Only disclosure of trading costs (brokerage commissions)

22 Annual and semi-annual statements Disseminated –Send semi-annually to all investors –Available on SEC website Disclosure –Annually, MDFP (what’s affecting performance, line graph comparison to relevant index) –Financials (including expenses, turnover rate) –List of portfolio holdings (now summary of significant holdings, chart of category breakdown) Focus on performance, not expenses

23 Advertising Regulated –SEC Rule 482 – must state where can get prospectus –NASD Rule 2210 – must file with Advertising Reg Dept Disclosure –Can include performance data (standardized format) –Info beyond prospectus Required disclaimer –“Consider investment objectives, risks, charges, expenses” –“Past performance does not guarantee future results” No longer does info need to be from prospectus

24 “The Commission should not be the arbiter of the appropriate level of fund fees. Whether fund fees are too high or too low is a question that we believe must be answered by competition in the marketplace, not by government intervention.” Arthur Levitt SEC Chair (1993-2001)

25 SEC attention to ICI, academic research …

26 Topic Comment letters ICI comments News stories Non-academic research ICI research Academic research Prospectus disclosure (1998) 783191*70 Fund profile disclosure (1998) 25612040 Advertising rules (2003) 2902010 Compliance programs (2003) 47261000 Portfolio manager (2004) 3430001** 2% fee for redemption (2005) 400105026*** SEC citations (footnotes / rulemaking releases) * AARP survey of MF investors ** Textbook, Regulation of Investment Companies *** Articles/studies on trading abuses (finance journals, SSRN)

27 “Academic” portrait How many colors do you see?

28 Investors’ Behavior Chase Returns Ignore Expenses (but not Loads) Ignorant of Objectives and Holdings Inattentive to Risk Behavior: Investors chase hottest funds Convex Flow-Return Relationship Reality: Little evidence of returns persistence: past returns generally don’t predict future returns

29 Investors’ Behavior Chase Returns Ignore Expenses (but not Loads) Ignorant of Objectives and Holdings Inattentive to Risk Behavior: Expense level generally doesn’t affect fund choices More sensitive to loads Reality: Annual expenses greatly affect investors’ wealth

30 Value of $15,500 YEAR $336,730 $232,104 $159.429 Annual Return

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32 Investors’ Behavior Chase Returns Ignore Expenses (but not Loads) Ignorant of Objectives and Holdings Inattentive to Risk Behavior: Most investors are unaware of their funds’ objectives or holdings Implication: Mismatch between investors’ objectives and funds’ objectives

33 Investors’ Behavior Chase Returns Ignore Expenses (but not Loads) Ignorant of Objectives and Holdings Inattentive to Risk Behavior: Expense level generally doesn’t affect fund choices Implication: Mismatch between funds’ risk and investors’ risk tolerance

34 Modest proposals … (1) Point of sale disclosure (2) Post-purchase statements

35 Fund XYZ performance Inv return Expenses/costsNet return 1-year 4.5% 2.1% 2.4% 5-years 7.6% 2.4% 5.2% 10-years11.5% 1.9% 9.6% 20-years 8.9% 1.6% 7.3%

36 Your statement (Fund XYZ) Beginning balance$10,000 Investments$ 2,000 Withdrawals$ -- Investment return$ 850 7.7% Expenses Sales charge$ 60 0.5% Adm/advisory fees$ 140 1.3% Trading costs$ 80 0.7% TOTAL$ 280 2.5% Net return$ 570 5.2% Ending balance$12,570 66% - lower expenses 34% - higher expenses Expenses (compare to other comparable funds) 2.5% XYZ 6.3%0.3% Your fund has about average expenses, but 40% of other similar funds have lower expenses. You could be saving up to 2.2% on fund expenses.

37 The end


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