Alan Palmiter & Ahmed Taha
Wake Law
01 Oct 07

1. Mutual funds are primarily owned by: a. Individuals on their own b. Individuals with retirement accounts c. Institutional investors
2. Mutual funds mostly invest in: a. Stocks b. Bonds c. Notes (money market)
3. What have been annual returns (1926-2004): a. Small-cap stocks b. Large-cap stocks c. Corporate bonds d. Treasury bills
4. Warren Buffet predicts that annual US stock returns over the next 10 years will be: a. 6.5% b. 9.6% c. 12.3% d. 21.7%
5. Past performance of stock funds generally predicts future returns.
a. Yes b. No c. Only low-performing funds
6. Mutual fund investors say they pay attention more to fees than to performance.
a. True b. False

7. As a mutual fund investor, you are entitled to: a. Prospectus (before you invest) b. Annual report (showing fund performance) c. Statements (breakdown of expenses / fees / trading costs)
10. What is a no-load fund?
a. An unleveraged fund b. A fund without sales charges c. A fund without trading costs d. A fund without withdrawal fees
8. Mutual funds only impose a sales charge at the time you invest.
a. True b. False
11. Think about your own largest mutual fund. What is -a. Your current balance b.
Fund’s investment objectives c.
Fund’s sales charges, expense ratio, trading costs d.
Fund’s performance last year
9. Annual rate that average stock fund sells and replaces stock
(turnover) in its portfolio: a. 6% b. 56% c. 90% d. 153%
12. Consider your car/vehicle: a. Its make, model, year b. Its cost, MSRP, total miles, safety rating, gas efficiency c. You get our point

(112 million)
Own mutual funds
(55 million / 49%)
Demand-side
On own
46%
Broker
79%
Direct
29%
Retirement account
54%
IRAs
48%
DC plans
52%
Stocks
60%
($11.3 T)
Bonds
17%
Money Mkt
23%
Fund Types

Mutual fund market
Next 15 groups
(35%)
Top 10 groups
(38%)
Rest
(27%)
Financial retirement market
Mutual
Funds
(27%)

Asset Classes
(1926-2004)
Small Company Stocks
Large Company Stocks
Long-Term Corporate Bonds
Treasury Bills
Average
Return
12.7%
10.4%
5.4%
3.7%
Standard
Deviation
33.1%
20.3%
9.3%
3.1%

12.7%
Effect of investing
$10,000 for 20 years …
3.7%

120,000
100,000
80,000
60,000
40,000
20,000
0
$10,000
$10,000 (invested over 20 years)
Small Company Stocks,
$109,264
Large Company Stocks,
$72,340
Long-Term Corporate
Bonds, $28,629
Treasury Bills, $20,681

Information before purchasing
Fund investors (outside retirement plans)
Fees / expenses
Historical performance
Fund risks
Net asset value
Types of securities
Minimum investment
Performance vs. index
Sales charge (if any)
Tax consequences
61%
58%
57%
57%
55%
47%
52%
74%
69%
0% 10% 20% 30% 40% 50% 60% 70% 80%
ICI Investor Preferences (2006)

Fund investors (outside retirement plans)
Professional financial adviser
Fund company
Friends / family / associates
Fund prospectus
Media
Fund reports
Fund literature
Rating services
Fund telephone rep
0%
14%
20%
25%
30%
34%
33%
40%
46%
20% 40% 60%
73%
80%
ICI Investor Preferences (2006)

Paul Schott Stevens
ICI President
“The 90 million fund shareholders’ demand for investment performance and services at a competitive level of fees and expenses continuously impacts mutual funds.”

William O. Douglas:
”The investors’ advocate”

Investors will benefit from a uniform fee table and management’s discussion of fund performance
SEC (1983)
The number/types of funds has proliferated, increasing need for information to help investors compare and contrast alternatives.
SEC (Mar 29, 1995)
Many investors find prospectuses
“unintelligible, tedious, and legalistic” … Investors need to be provided with clear and comprehensible information.
SEC (Feb 27, 1997)
Funds may resort to advertising techniques that create unrealistic investor expectations.
SEC (Mar 17, 2002)

VFINX
• Disseminated
– after investment / then once annually
– Including electronically / filed SEC
•
Disclosure
– Investment strategies
– Risks (narrative)
– Performance (1/5/10 years)
– Expenses (sales charge, 12b-1 fees, mgmt fees)
– Turnover rate
•
Effect
– Omissions in fund literature not fraudulent, if info in prospectus
Fund comparer
( SEC website / NASD)

• Not disseminated
– Available to investors (incorporated by ref into prospectus) / file SEC
– No fraud liability if in SAI
• Disclosure
– Fund organization
– Investment policies / limitations
– Management of fund
– Proxy voting policies
– Financial statements
• Can cover multiple funds
Only disclosure of trading costs
(brokerage commissions)

Focus on performance, not expenses
• Disseminated
– Send semi-annually to all investors
– Available on SEC website
• Disclosure
– Annually, MDFP (what’s affecting performance, line graph comparison to relevant index)
– Financials (including expenses, turnover rate)
– List of portfolio holdings (now summary of significant holdings, chart of category breakdown)

No longer does info need to be from prospectus
• Regulated
– SEC Rule 482 – must state where can get prospectus
– NASD Rule 2210 – must file with
Advertising Reg Dept
• Disclosure
– Can include performance data
(standardized format)
– Info beyond prospectus
• Required disclaimer
– “Consider investment objectives, risks, charges, expenses”
– “Past performance does not guarantee future results”

Arthur Levitt
SEC Chair (1993-2001)
“The Commission should not be the arbiter of the appropriate level of fund fees. Whether fund fees are too high or too low is a question that we believe must be answered by competition in the marketplace, not by government intervention.”

SEC citations (footnotes / rulemaking releases)
Topic
Prospectus disclosure (1998)
Fund profile disclosure (1998)
Advertising rules
(2003)
Compliance programs (2003)
Portfolio manager
(2004)
2% fee for redemption (2005)
Comment letters
78
256
29
47
34
400
ICI comments
3
1
0
26
3
10
News stories
19
2
2
1
0
5
* AARP survey of MF investors
** Textbook, Regulation of Investment Companies
*** Articles/studies on trading abuses (finance journals, SSRN)
Non-academic research
ICI research
1* 7
Academic research
0
0
0
0
0
0
4
1
0
0
2
0
0
0
1**
6***

How many colors do you see?

Behavior :
• Investors chase hottest funds
• Convex Flow-Return
Relationship
Reality:
Little evidence of returns persistence: past returns generally don’t predict future returns

• Chase Returns
• Ignore Expenses
(but not Loads)
Behavior:
• Expense level generally doesn’t affect fund choices
• More sensitive to loads
• Ignorant of Objectives and Holdings
• Inattentive to Risk
Reality:
Annual expenses greatly affect investors’ wealth

$350,000
$300,000
$250,000
$200,000
$150,000
$100,000
$50,000
$0
$336,730
$232,104
$159.429
10 20
YEAR
30 40
Annual
Return
6%
7%
8%

• Chase Returns
• Ignore Expenses
(but not Loads)
Behavior:
Most investors are unaware of their funds’ objectives or holdings
• Ignorant of Objectives and Holdings
• Inattentive to Risk
Implication:
Mismatch between investors’ objectives and funds’ objectives

• Chase Returns
• Ignore Expenses
(but not Loads)
Behavior:
Expense level generally doesn’t affect fund choices
• Ignorant of Objectives and Holdings
• Inattentive to Risk
Implication:
Mismatch between funds’ risk and investors’ risk tolerance

Fund XYZ performance
Inv return Expenses/costs Net return
1-year
5-years
10-years
20-years
4.5%
7.6%
11.5%
8.9%
2.1%
2.4%
2.4%
5.2%
1.9% 9.6%
1.6% 7.3%
Comparison
Fund XYZ vs.
Asset Class
Asset class
Fund
Asset class
Fund
Asset class
Fund
Asset class
Fund
0.00% 5.00% 10.00% 15.00%

Your statement (Fund XYZ)
Beginning balance
Investments
Withdrawals
Investment return
Expenses
Sales charge
Adm/advisory fees
Trading costs
TOTAL
Net return
Ending balance
$10,000
$ 2,000
$ --
$ 850
$ 60
$ 140
$ 80
$ 280
$ 570
$12,570
Expenses
(compare to other comparable funds)
66% - lower expenses
0.3% 2.5%
XYZ
7.7%
0.5%
1.3%
0.7%
2.5%
5.2%
Your fund has about average expenses, but 40% of other similar funds have lower expenses.
You could be saving up to 2.2% on fund expenses.
34% - higher expenses
6.3%