Investment Chapter 4: Mutual Funds Overview

Chapter 4: Mutual Funds and Other Investment Companies

• Mutual funds are a common type of investment company, comprising 80% of investment company assets in 2021.
• U.S. assets under management in mutual funds reached $23.9 trillion in 2021, while non-U.S. assets were $40 trillion.
• Investment companies pool funds from individual investors to invest in securities or other assets.
• Investment companies offer several benefits, including record keeping, administration, diversification, professional management, and lower transaction costs.
• Net Asset Value (NAV) is calculated by subtracting liabilities from the market value of assets held and dividing that by the outstanding shares.
• Unit investment trusts are pools of money invested in a fixed portfolio for the fund's life. These funds have declined in size from $105 billion in 1990 to $85 billion in 2017.
• Open-end funds stand ready to issue or redeem shares at the Net Asset Value (NAV), while closed-end funds maintain a constant number of shares outstanding. Investors in closed-end funds cash out by selling shares to other investors.
• Commingled funds are partnerships where investors pool funds.
• REITs (Real Estate Investment Trusts) are similar to closed-end funds.
• Hedge funds allow private investors to pool assets for investment by a fund manager.

Mutual Funds: Investment Policies

• Money Market: Invest in money market instruments like commercial paper, repurchase agreements, or certificates of deposit (CDs).
• Equity: Primarily invests in stocks.
• Sector: Concentrates on a particular industry or country.
• Bond: Specialises in the fixed income sector.
• International: Focuses on global, international, regional, and emerging markets.
• Balanced Funds: Designed for an entire investment portfolio, holding equities and fixed-income securities proportionally. Often are "funds of funds".
• Asset Allocation and Flexible Funds: Hold stocks and bonds. Often involved in market timing but are not necessarily low risk. Attempt to match a broad market index.

Costs of Investing in Mutual Funds

• Fee Structure: Includes operating expenses like front-end or back-end loads and 12b-1 charges.
• Information on fees must be included in the prospectus, or official document outlining fund details. Different share classes often come with different fees.

Mutual Funds: How Funds Are Sold

• Directly: Underwriters sell directly, often through mail, phone, or the internet.
• Indirectly: Brokers act on behalf of underwriters, charging commissions. This can create conflicts of interest. Financial supermarkets also sell shares of funds managed by different firms/companies. Brokers split management fees with the mutual fund company.

Mutual Funds: Taxation of Mutual Fund Income

• Taxes are levied on investors rather than the fund (pass-through status).
• High portfolio turnover rates can be tax inefficient. Turnover rate decreased to 32% in 2020.
• Investors have reduced tax control of securities timing from portfolios.

Exchange-Traded Funds (ETFs)

• ETFs are a type of mutual fund that allows for stock-like trading of index portfolios.
• Examples include "spiders," "diamonds," and "cubes."
• Key advantages include continuous trading, shortability/margin purchasing, lower costs compared to mutual funds, and tax efficiency.
• Prices for ETFs can diverge from NAV.
• ETFs are purchased through brokers.

Mutual Fund Performance

• Actively managed funds benchmark against indices like Wilshire 5000.
• Actively managed averages show returns slightly better than the average mutual fund from 1971–2020.

Investment Company Assets and Market Breakdown

• Figure 4.3 shows mutual fund assets as a large portion of investment company assets.
• Figures show the distribution of assets within this type of investment firm.

Information on Mutual Funds

• Prospectuses provide investment objectives, policies, manager information, and fees.
• Statements of Additional Information (SAIs) and fund annual reports offer more details.
• Online sources (e.g., Morningstar, Yahoo Finance, ICI) are available to obtain information. These are considered "encyclopedias" of mutual fund data.