1. All Rights Reserved Dr David P Echevarria 1 MUTUAL FUNDS OPERATION CHAPTER 23

2. All Rights ReservedDr David P Echevarria2 INVESTMENT COMPANIES A.Definition of an Investment Company; A pool of funds belonging to individuals used to acquire a collection of individual securities such as stocks and bonds The value of shares in the fund is determined daily by the Net Asset Value (NAV).

3. INVESTMENT COMPANIES B. Management of Investment Companies 1.Portfolio Managers Oversee activities of analysts Oversee activities of analysts 2.Investment Analysts Nearly all are CFA’s (Chartered Financial Analyst) Nearly all are CFA’s (Chartered Financial Analyst) Will Specialize in a single industry Will Specialize in a single industry Stepping stone to portfolio manager Stepping stone to portfolio manager 3.Transfer Agents Third party intermediaires – verify buy/sell transfers Third party intermediaires – verify buy/sell transfers All Rights ReservedDr David P Echevarria3

4. All Rights ReservedDr David P Echevarria4 INVESTMENT COMPANIES C.Types of Funds 1.Open-Ended Funds a.Investment pools which continue to take investor funds b.Redemptions by fund at Net Asset Values (NAV) 2.Closed-End Funds a.A one-time subscription. b.Stock traded in secondary market; stock price typically < NAV c.No redemptions by fund; if you want out, sell in market. (NYSE, AMEX)

5. INVESTMENT COMPANIES 3. Load vs. No-Load Open-End Funds a.Load = a sales charge based on $ amount of transaction Front-end load: charged on sale day Front-end load: charged on sale day Back-end: charged when shares are sold Back-end: charged when shares are sold May be imposed on a graduated scale based on time position is held May be imposed on a graduated scale based on time position is held b.No-Load: no sales charges (commissions) 4. Exchange Traded Funds (ETF) a.Structure similar to mutual funds b.Advantage: no minimum holding period c.Disadvantage: not managed All Rights ReservedDr David P Echevarria5

6. INVESTMENT COMPANIES 5. Hedge Funds: High leverage: using margin to leverage returns High leverage: using margin to leverage returns Long/Short: may hold long and short positions Long/Short: may hold long and short positions Derivatives: may use derivative securities (options and/or futures to hedge positions Derivatives: may use derivative securities (options and/or futures to hedge positions Participation limited to high Net Worth individuals` Participation limited to high Net Worth individuals` All Rights ReservedDr David P Echevarria6

7. All Rights ReservedDr David P Echevarria7 INVESTMENT COMPANIES D.Investment Company Portfolio Objectives 1.Common Stock Funds; Growth: sales and earningsGrowth: sales and earnings Income: focus on good dividend paying stocksIncome: focus on good dividend paying stocks G&I,G&I, International,International, Sector,Sector, SpecializedSpecialized 2.Balanced Funds; dividend paying stocks & bonds 3.Bond Funds, Money Market Fund, Real Estate Investment Trusts 4.Hedge Funds

8. INVESTMENT COMPANIES D.Performance of Investment Companies 1.Sharpe Study; Excess Return per Unit of Risk Few funds outperform the DJIAFew funds outperform the DJIA 2.Jensen Study; Examining intercept term (a) a.alpha = abnormal return: Is alpha different from zero? b.Results: funds earn 1.1% less per year given their level of risk 3.Carlson Study; three categories, none outperformed the S&P 500 All Rights ReservedDr David P Echevarria8

9. All Rights ReservedDr David P Echevarria9 INVESTMENT COMPANIES 4.Implications of Performance Studies a.For market efficiency: you cannot beat the market b.For active versus passive management c.Risk reduction through diversification 5.The exception a.Warren Buffet (Berkshire Hathaway) b.Long-run average performance measurement bias

10. All Rights ReservedDr David P Echevarria10 REGULATION A.SEC is principal oversight body B.Investment Company Act (1940) is primary legislation as amended 1.1993: Prospectus requires revealing names, etc., of managers. 2.90% of income must be distributed to investors C.Investment Advisor Act – must register if more than $25 million under management.

11. All Rights ReservedDr David P Echevarria11 HOMEWORK QUESTION A.What important services do Investment Companies provide investors? B.How do Open-end and Closed-end funds differ? C.What is the advantage of a no-load fund? Advantage of a front-end load fund? D.Why are there different types of funds? E.How does the Sharpe Measure differ from the Jensen measure? F.Overall, what is the verdict on Professional Fund Managers (in general)?