Understanding Mutual Funds

Introduction

• Mutual funds span across asset classes, offering exposure in equities, fixed income, balanced portfolios, or money markets.
• Determining appropriate mutual funds involves examining qualitative factors.

Why Invest in Mutual Funds?

• Mutual funds provide professional management and better diversification than individual portfolios
• Mutual funds offer diverse options for portfolio construction across asset classes, regions, and strategies.
• There is a difference between traditional asset class funds and funds investing in alternative assets

Different Mutual Fund Types

• The two main fund categories are open-end and closed-end.
• Open-end funds allow unit numbers to vary with investor subscriptions and redemptions.
• Closed-end funds have a fixed number of units, with prices based of supply and demand.
• Expense ratios are higher than open-end funds.
• Closed-end funds are common in illiquid markets or those with investment restrictions, such as emerging countries.
• Most mutual funds are open-ended.
• A fund's net asset value (NAV) is the total closing value of its portfolio divided by the number of units held by investors.
• Mutual fund categories include money market, debt securities, equities securities, real estate and asset diversification funds.
• Funds can be actively managed to outperform the market or passively managed to replicate a benchmark index.
• Exchange-Traded Funds (ETFs) replicate a benchmark index and are traded continuously like equities.
• ETFs generally have lower costs than actively managed funds.
• Tracking error measures the volatility of the performance difference between a fund and its benchmark index
• The extent to which an actively managed fund deviates from its index depends on investment selections.
• Main categories of funds can be managed actively or passively which enables different equity and fixed-income management styles

Equity Funds

• Value investing promotes a conservative portfolio approach by purchasing securities at a lower price than the company's asset value.
• Focus is to avoid paying premiums for growth company securities in order to find good deals among mature companies.
• Value investors need at least five years for a good chance at success.
• Value philosophy takes two forms: passive screening and contrarian investing.
• Ben Graham used passive screening in the 1930s and the manager partitions the universe using metrics such as the price/book value ratio, the price/earnings ratio and the price/sales ratio
• Equities that figure on the list must not exceed the threshold level of the value ratios
• Contrarian investing seeks out securities or sectors that are out of favor
• Contrarian investors aims to buy quality companies with safety margins as opposed to low price/book value or low price/earnings ratios

Growth Funds

• Focus is on a company's prospects rather than its stock price
• Earnings growth should increase intrinsic value above current price
• Growth investors seek companies in sectors entering earnings growth with limited competition and high-quality research
• Development programs, low labor costs, and high return on capital invested are also important
• Securities are bough on expected high future earnings growth that approach a historic peak
• Sector rotation is the belief that certain sectors will outperform in economic cycle stages
• Sector rotation involves timing securities buying and selling to overweight sectors that are expected to have high performance

Momentum Funds

• Focus is on rises in earnings or prices that translate into stronger rises
• Technical or quantitative models are used for picking stocks, using fundamental variables to reduce volatility
• Momentum is a high-risk/high-return strategy for high turnover portfolio rates where falling securities are sold immediately
• Focus is set on certain economic areas
• Growth at a Reasonable Price (GARP) focuses on value when buying securities in companies with future earnings growth
• GARP managers seek companies with projected earnings that show growth and rising return on equity compared to industry average.
• GARP managers avoid high price/earnings and price/book value ratios.
• GARP prospects need price/earnings ratios are between 15 and 25 and growing more slowly than earnings, and a price/book value ratio that is lower than industry average.
• PEG ratio is the price/earnings ratio (P/E) divided by earnings growth (g); managers also use this metric
• The most ideal PEG ratio is less than 1 and nearing 0.5, a ratio <1 means the stock price should increase, and >1 means the instrument is overvalued.

Fixed Income Funds

• Interest rate anticipation involves moving from long-term government bonds to short-term treasury bills based on interest rate forecasts
• Investment managers allocate money to debt securities with time to maturity based on forecast reliability and major consideration of short-term monetary policy and inflation expectations
• Price sensitivity to interest rate changes grows with an extended time to maturity and a falling coupon
• Securities selection uses fundamental, credit, and quantitative analysis to value debt securities
• The analysis assesses the financial instrument, its cash flow, the likelihood of payments according to contract terms, and the economic, industry, and macroeconomic factors
• Sector trading is the different weighting given to each debt securities category in a portfolio
• Portfolio managers value sector of the debt securities market and its benchmarks/technical factors to compare against historic benchmarks and manager portfolio weightings to assess performance
• High yield includes investors agreeing to raise portfolio return by taking on interest rate risk, often because they want to earn more income

How to Analyze/Select Mutual Funds

• The number of mutual funds requires a structured approach to selection based on client needs and risk profile
• It is important to decide type of fund to invest in and whether criteria help shrink the potential universe
• Draw up a list of characteristics the mutual fund must possess such as:
• Active or passive management.
• Asset class: equity, debt, money market, or real estate.
• Sub-category: sector, style, or size.
• Investment region or country.
• Mutual fund reference currency and distribution type for reinvestment or income.
• Risk level: conservative, balanced, or aggressive.
• Historic performance, the expense ratio, and Sharpe ratio.
• Once initial filtering occurs, an analysis quantitative and qualitative occurs in regard to people, process, philosophy, and return.
• Qualitative and quantitative elements are weighed when buying a fund for relationships with management business to management.
• Completing a risk assessment and asset allocation needs an investor to assess the criteria for suitable investments
• People refers to investment firm personnel managing a particular fund with a manager that has experience
• A dedicated team of analysts, client/back office service, and technology are important
• An ideal organization has stable strong ownership capitalized to grow and portfolio and an equity stake with managers
• Remuneration needs incentives of performance bonus incentives

Portfolio Manager/Investment Team

• Assessing the Portfolio Manager and Investment Team is key with a good PM leading a competent team when it comes to assessing aspects
• Key evident points are the managers who have years of experience specializing managing money in the markets, at least 5 years long enough to see changes
• Managers in the business need qualifications working with well-respective individuals with deep qualifications
• Managers must have experience working with their investment team and must not be impacted by group dynamic matters from employer with low staff turnover

Ownership

• Portfolio managers have ethical responsibilities with investment management/regulatory with marketing/sales needing enough resources so investment professionals focus on management
• Strong stable ownership keeps the business running with staff and setting the tone for the businesses culture
• Creates a sound investment analysis through favorable ownership structures
• The firm has a large majority employee ownership
• Ownership has authority to grant equity/retain talent and stakeholders buy shares
• A transition for successions must be in place

Firm Business and Compliance

• The firm has a viable finance business with consistent growth, with AUM/accounts providing overhead and technological infrastructure
• Client and product lists are diversified with a large amount of clients vs product and are not overspecialized
• Business plans for growth improve service and technology
• Business plans should balance capital/executive staff
• Compensation requires managers to have strong performance where performance incentives need personal money
• Incentive fees are rewarded at 1% with risk reward
• Organizations need internal checks and balances and integrity
• Front running and high closing conflicts can impact management compliance and client loss
• It's important to follow good practices for Compliance
• Trades are frequently managed with trading desk routing under officers
• Investment ownership should be disallowed outside of mutual funds

Process Of Selecting Funds

• Process is methodology accruing value to the firm based on qualities using team-based descisions with verifiable transparent elements
• Process elements must be grounded in theory and are used to coordinate and value assets
• Company visits and metrics, interviews, records, and ranges are used
• Fundamental value of philosophy helps the manager implement more screens
• low P/B, low P/E, low P/sales and high profit margins.
• Managers should be demanding with stock at 25% market down flow for free cash
• Alternatively managers value the segments to entries of business

Team-Based and Philosophy

• Bond managers start top down and develop 3–5 year forecasts
• Specialist combine views to identify key strategies
• Emphasis must be set of the firm, and one must favor firms that emphasize team-based approach to manage money
• Firms need dominant influence that are organized in 2 way structures - team, and individuals
• Screening initial investment group's criteria is important
• Disciplined investment process and PM changes still must retain due to team vs individual success
• Processes must be profitable over long runs
• Team should have a preference that are firm based
• Firm must explain philosophy that matches risk tolerance

Measuring Performance

• Performance is the philosophy applied by the people in investments considering factors of benchmark
• Frequency and consistency must outweigh investment
• Good management needs to consistently out perform per peers and benchmarks, all while assessing risk
• Performance is not indicative of one that is difficult to project long term
• In depth performance analysis is key to select winning and qualitative factors to select mutual funds
• Style drifts focus is assessing holdings and drifts to be a key point in analyzing performance

Style Analysis

• Skilled small caps are unable to invest in large caps during period of capped small underperfomance
• Relative and dominating performance dominates style to be considered from coincidentally sheer manager skills
• Assessing risk levels can be difficult with grasp of ideal ratio
• Two methodologies of style come in holdings and returns
• Noble Sharpe developed style analysis for monthly returns to different style indices such cash/bonds
• Quadratic procedure is used to minimize difference of fund's performance and potrfolio weights styles
• Composite benchmark is measured to be small cap, value, government, and cash
• The performance of stocks to style measures capitalization and dividend
• Snapshot large enough is a part and profile of benchmark of funds

Buying/Selling

• Accuracy and ease of trade offer trade-offs, with funds based on software
• Monthly turns, and holdings need info that has commercial trade
• Returns based can only be done in 2 years

Fund Costs

• In order to access fund costs, consider awareness and direct factors
• The Shareholder fees are usually found with fees prospectuses
• The expenses fall into deducted investments, to fund funds
• Sales loads are fees external brokers pay, they usually pay front-end or for distribution fees
• Front end funds are assets of purchase by 5% and up
• There are also non load charges with administration
• Back end charges are fees paid at purchase to inure to sell charges until early years

Penalty

• If an advisor sets a total fee from Sponsor, then the investors need to pay returns and advisors long to generate
• Penalty will be recovered from investors who are using option early
• Nature charges and some funds base fee charges of assets to shrink or grow

Nature of Sales Charges

• Charges require purchases fees after being bought in certain years at year ends
• Company funds allows up to 10% as disposal
• Fees to broker is redemption fee paid before sales for the broker to redeem through sales
• Purchase fees are fund vs load fees paid to the broker

Investment Fees

• Exchange fees are fund that invest through selling investors
• Management fees contributes salaries with margin profit from investment company
• US distribution includes advertising/marketing/mail
• They come annually which applies to all fees
• Operative costs/audit includes operating taxes as expenses to manage

Total Funds

• Comparison costs needs 3 factors from ter and nav
• Portfolios with money bills are easier with equity charges than international equities
• Higher funds require fees that bonds, fund equity to get higher amounts
• Teams of Sponsers are fees with managing and advising all client

Implicit Costs

• Not all expenses charged to fund can be TER measured through brokerage
• Traded costs needs capitalization, which can manage hurdles

Investment

• Turnover rate, aka: PTF with total year end needs statistics, from prospectus
• Over 1 year funds, requires 100% that both sold funds sold from portfolio
• High funds, funds need 3.25% or 90% to generate 3.52% in true return
• This turnover differs in management Value needs 50%, while growth needs 100 and regional sector

Performance Factors

• Size from Fees needs brokerage impacts, trading small fees to manage costs
• High traders need costs and taxes, this with great costs for a hard time
• Cost should come from a source, and be centralized that investors have the service costs
• Funds with rates need total returns to be clear vs costs