1. 1 Chapter 3 Appendix Mutual Fund Evaluation Term Project Portfolio Construction, Management, & Protection, 4e, Robert A. Strong Copyright ©2006 by South-Western, a division of Thomson Business & Economics. All rights reserved.

2. 2 A small man—anyone with a portfolio of, say, under $100,000—is unlikely to do as well investing his own money as he can do in a no-load fund Paul Samuelson

3. 3 Outline u Introduction u Classification of Mutual Funds

4. 4 Introduction u A mutual fund is an existing portfolio of assets into which someone may invest directly Facilitates diversification

5. 5 Introduction (cont’d) u Mutual funds are extremely popular investment vehicles for both the small and the large investor Many institutions place a substantial part of their money with mutual funds By the end of 2003, there were about 8,300 mutual funds in the United States with assets totaling $7.4 trillion

6. 6 Classification of Mutual Funds u Open End versus Closed End u Net Asset Value versus Market Value u Load versus No Load u Management Fees u Buying Mutual Fund Shares u Mutual Fund Objectives

7. 7 Open End versus Closed End u There are two types of investment companies: Open-end funds: –May grow in size as new investors open accounts –May grow in size as existing investors add to their accounts –Have no set number of shares outstanding –Buy back their shares from investors (redemption)

8. 8 Open End versus Closed End (cont’d) u There are two types of investment companies (cont’d): Closed-end funds: –Have a fixed number of shares that trade like shares of common stock –Are unmanaged portfolios of stock with each share representing partial ownership of the portfolio –May trade on an exchange –Can be sold to other investors

9. 9 Net Asset Value versus Market Value u You buy and sell an open-end fund based on its net asset value Open-end fund: equals the fund’s assets minus its liabilities divided by the number of shares currently existing in the fund Closed-end fund: trades at market-determined portfolio prices that may be more or less than the net asset value

10. 10 Load versus No Load u Load funds: Have a sales charge associated with the purchase of new shares –A commission split between: A mutual fund salesperson An investment firm A national distributor –Typically ranges between 1.0 percent and 8.5 percent

11. 11 Load versus No Load (cont’d) u No-load funds: Have no sales charge Shares are bought and sold at net asset value

12. 12 Examples of Exchange-Traded Funds SPDR = Standard & Poor’s Depository Receipt (traded on the American Stock Exchange). HOLDR = Holding Company Depository Receipt (created by Merrill Lynch, traded on the American Stock Exchange). iShares = Index shares (created by Barclays Global Investors, traded on the American Stock Exchange, the Chicago Board Options Exchange, and the New York Stock Exchange). Source: Morningstar.com

13. 13 Management Fees u Management fees include: Postage costs Clerical time Commissions on the underlying assets Redemption fee –A fee to pay redemption expenses, ranging between 1 percent and 2 percent

14. 14 Management Fees (cont’d) u Management fees include (cont’d): Management fee –Paid to fund manager –Taken directly from the fund’s assets –Averages about 0.75 percent of fund’s total assets

15. 15 Buying Mutual Fund Shares u Fund prospectus outlines: The fund’s purpose The management team The mailing address and phone number The fund’s intended investment activity u Funds also provide descriptive brochures and other correspondence to anyone who inquires

16. 16 Buying Mutual Fund Shares (cont’d) u New account application asks for: Name, address, tax ID Investor’s choice of shareholder options: –Dividend reinvestment –Automatic monthly investment –Systematic withdrawal –IRA designation –Telephonic fund switching option

17. 17 Mutual Fund Objectives u The fund objective is the type of investment anticipated: Capital appreciation and growth funds seek appreciation in the value of shares Income funds seek current income from fixed- income securities and from dividends Growth and income funds seek a combination of income and capital appreciation

18. 18 Mutual Fund Objectives (cont’d) u The fund objective is the type of investment anticipated (cont’d): Balanced funds invest in growth and income securities Bond funds invest in debt only Money market funds seek stability of principal through investment in short-term debt instruments

19. 19 Mutual Fund Objectives (cont’d) u The fund objective is the type of investment anticipated (cont’d): Tax-free funds invest in municipal securities that are free from federal, and sometimes state, taxes Special-purpose funds may focus on a particular industry or region