1. MFIN 403 Financial Markets and Institutions
Mutual Funds
MFIN 403
Financial Markets and Institutions

2. Definition
Mutual funds are investment companies pool investors’ money to purchase securities.

3. Advantages Diversification Professional money management
Tax advantages
Lower relative transactions costs

4. Disadvantages High fees Too much or too little diversification
Trade without regard to tax consequences for individual investors
High turnover (high transactions costs)
Management may not always invest in the style that they advertise

5. Who can start mutual funds in TR?
Banks
Brokerage firms
Insurance companies
Unemployment and pension funds

6. What asset classes do mutual funds invest in?
Stocks
Bonds
Money market securities
Gold
Commodities

7. Funds according to investment style
1. Money Market Funds
These funds invest primarily in money market securities.
2. Fixed Income Funds
These funds specialize in fixed income securities including one or more of: corporate bonds, Treasury bonds, mortgage-backed securities, low grade corporate debt (junk bonds), or municipal debt (Munis.)
3. Equity Funds
These funds invest primarily (though not always completely!) in stock. Equity funds often specify the types of stocks in which they invest.
Growth/Value
Index
Sector
ETFs (Exchange Traded Funds)

8. Investment restrictions in TR
To sustain the fair price in the transactions of the fund, which is the lowest price when buying and the highest price when selling an asset.
Not to invest in non-listed securities, with a limited exception for the securities, the founder or the portfolio manager of the fund underwrites.
Not to invest in the securities of a single issuer more than 10% of its net asset value.
Not to purchase more than 9% of one issuer's shares.
Not to invest in the securities of the founder or the portfolio manager.
Not to be represented in the management of the companies whose shares it has purchased.

9. Type A vs. Type B Funds
Funds that permanently invest at least 25% of their portfolio in stocks are called Type A funds.
There is no such requirement for Type B funds.
Type A funds are riskier because they include highly volatile equity securities.
Both types are free from corporate taxes. Type B funds are subject to 11% income tax.

10. What is NAV (net asset value)?
Since mutual funds pool the investments of individual investors, they need a method to divide the assets (or claims to the assets) among the investors.
Investors buy shares in the fund (and ownership in the fund) in proportion to the number of shares owned.
The accounting value of each share is called the NAV, which is equal to the market value of the assets less any accumulated liabilities divided by the number of shares outstanding.
NAV = Market value of assets less liabilities
Number of shares outstanding

11. Open vs. Closed end funds
Open end funds stand ready to sell or redeem shares at their net asset value less any sales commissions that may be charged (The number of shares is not limited as in closed-end funds) An investor can purchase shares in such funds directly from the mutual fund company, or through a brokerage house. Most Turkish mutual funds are open end.
A closed end fund has a fixed number of shares that are often traded on organized exchanges. No new shares are issued after the fund is launched. These funds often trade at a substantial discount to the net asset value (NAV) of the underlying assets. Why?

12. Load vs. No-Load funds
A load fund is a fund with shares sold at a price including a large sales charge (paid to the broker not to the fund itself).
Front-end load: a sales commission paid when you purchase mutual fund shares. For example, if the fund has a 5% front-end sales load, $500 sales load is deducted from a $10,000 investment, the remaining $9,500 is used to purchase fund shares for the investor.
Back-end load: a redemption fee incurred when the investor redeems shares. Typically these fees decrease with the time the money has been invested. Typically, a fund calculates the amount of a back-end sales load based on the lesser of the value of the shareholder’s initial investment or the value of the shareholder’s investment at redemption.

13. Other mutual fund fees
Purchase and redemption fee (<2% of investment) – paid to the fund not the broker
Exchange fee
Account fee (charged for maintenance of small accounts)
Operating expenses (0.2% to 2%)
12b-1 charges (to cover marketing and distribution costs, < 1%)

14. Fund fees and performance
The structure and size of mutual fund fees can have large affect on performance. Consider the following three funds:
Fund A has a front-end load of 5% and an expense ratio (which includes both operating expenses and 12b-1 fees) of 2%.
Fund B has a redemption fee of 5% in the first year but declines by 1% for each year the investment is held. The expense ratio is 2.5%
Fund C is a no-load index fund with an expense ratio of 0.5%.
Compare the performance of an investment in each fund for horizons of 1, 5 and 10 years if the expected return of each fund is 10% per year before fees.

15. Fund A
Fund B
Fund C
Initial Investment
$10,000
Net Investment
$9,500
Value at 1 year
$10,260
$10,750
$10,950
Proceeds if liquidated
$10,213
Annualized return
2.60%
2.13%
9.50%
Value at 5 years
$13,959
$14,356
$15,742
$14,213
6.90%
7.28%
Value at 10 years
$20,510
$20,610
$24,782
7.45%
7.50%

16. Mutual fund industry performance
One comparison that might be made is to compare the performance of all diversified equity funds to a broad-based market benchmark.
The Wilshire 5000 is a value weighted market index of stocks that trade on the NYSE, AMEX, and NASDAQ. If mutual fund managers are able to outperform the market then the median fund should outperform this benchmark.
During the period , a span of 30 years, the Wilshire 5000 outperformed the median fund 21 times.

17. Skill or Luck?
Even if the industry performs, on average, worse than the market, might it be the case that there exist some skillful mutual fund managers who can systematically beat the market?
Goetzman and Ibbotson (1994) examine the performance of a large sample of equity mutual fund portfolios over the period. Looking at successive 2-year periods they ask, “Are managers who perform in the top 50% in one period likely to also perform in the top 50% the following period?”
Successive Period Performance
Initial Period Performance
Top Half
Bottom Half
62.0%
38.0%
36.6%
63.4%

18. Skill or Luck?
Malkiel (1995) performed a similar study but compares one-year rather than two-year performance. Using a larger sample and a longer time period, he finds that the G&I results are driven by data from the 1970s and the effect disappears in the 1980s.
Malkiel (1970s)
Successive Period Performance
Initial Period Performance
Top Half
Bottom Half
65.1%
34.9%
35.5%
64.5%
Malkiel (1980s)
51.7%
48.3%
47.5%
52.5%