Mutual Funds
•Definition: Financial intermediary through
which savers pool their monies for
collective investment, primarily in publicly
trades securities.
•A fund is “mutual” in the sense that all of
its returns minus its expenses, are shared by
its shareholders.
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Mutual Funds
•Returns consist of dividends, realized and
unrealized capital gains (losses)
•Expenses consist of advisory fee for
servicing the shareholders, annual fee for
distribution (12b-1)
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Mutual Funds Vs. Individual
Securities
• Objective
is to maximize return with
minimum risk
• Efficient Market hypothesis and undervalued
securities
• Mean reversion in the equity market
3
Mutual Funds Vs. Individual
Securities
•Individual securities have two main
sources of risk: alpha and beta.
•Alpha - company specific risk
usually accounts for 50%-70% of
security’s price volatility;
•Beta - market risk accounts for
30%-50% of price volatility.
4
Bond Funds Vs. Individual
Bonds
• Investors
are focused on income
stream
• To receive income, investors can buy
individual bonds - T-bonds, agency
bonds, corp. bonds, municipal bonds,
and hold to their maturity. Receive
periodic fixed interest payment and
principal at maturity.
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Bond Funds Vs. Individual
Bonds
•Alternatively, receive income stream by
buying a diversified bond mutual fund. No
fixed interest payment nor an obligation to
pay principal at maturity.
• Higher minimum requirements for
individual bonds (usually $25,000; T-bonds
$1,000). Lot size is usually $100,000. One
$25,000 bond lacks diversification.
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Bond Funds Vs. Individual
Bonds
•Cost : 2% - 4% of value.
•Bond mutual fund minimum: As low as $1,000.
Can redeem fund on any business day. Do not
have to hold till maturity.
•Fund offers more diversification. Offer
convenient services, such as monthly income
payments, compared to quarterly or semiannually for individual bonds
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Benefits of Investing in
Mutual Funds
• Diversification :Typically lowers ; global fund may
also lower 
• Professional Management: Professional qualifications
(CFA); access to company executives; in house research
team, wall street research.
• Lower Transaction Costs: Lower admn. cost, savings on
record keeping, better execution of securities.
• Convenience: Automatic deposits/ withdrawal, tax
reporting, retirement planning, educational materials.
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Disadvantages of Investing in
Mutual Funds
•Need to pay fees/expenses even when fund performs
poorly
•Increased diversification may prevent the chance of
“hitting the jackpot” from one security
•Online trading and security research on the internet
have reduced the advantage of cost and research access
•Less control over securities portfolio and therefore
timing of realized capital gains for tax purposes.
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What Investors Need to Know?
•Structure and working of a typical fund
•Roles of various entities involved in operating a
fund.
•Fund Manager, Custodian, distributor, etc.
•Minimum investment requirement
•Fees and Expenses
•Services provided to the shareholders
•Performance measurements
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Investment Objectives and
Risks of Stock and Bond Funds
•Investor must clearly evaluate his/her own goals.
•What is the purpose of the investment?
•What is the time horizon?
•What is your risk tolerance?
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Mutual Fund Investment
Objectives
• A fund’s objective is established when the fund is
created. Objective can be changed with a majority vote
of the shareholders.
• A fund’s objective denotes the type of assets a fund
manger will buy or sell; such as:
• primary method by which the manager seeks to
generate value for shareholders (capital
appreciation, dividend payment, interest income,
etc.)
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Mutual Fund Investment
Objectives
• the class or classes of assets (stocks, bonds, money
market securities) and types of securities (growth
stoc, income stock, municipal bonds, corporate
bonds, etc.)
• Reasons for proliferation of fund objectives:
• Competition - sponsors imitating successful funds
by competitors;
• Shareholder retention - sponsors profit from higher
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Mutual Fund Investment
Objectives
retention of shareholders. Greater variety of
objectives offer the likelihood of customers staying
within the same fund family;
• Refinement of investment objective - ‘splicing’
allows investor with a specific risk tolerance and
time horizon to invest in appropriate fund.
• Greater variety allows investors a broader arena for
optimizing returns, but makes selecting a fund that is
suitable to investment goal more complex.
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Types of Mutual Funds
Types of Funds
Money market
Equity
Bond
Hybrid
(Stock & Bond)
Index
Taxable
Taxable
Equity
Tax Exempt
Tax Exampt
Bond
Fund of Fund
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Types of Mutual Funds
(Money Market)
• MONEY MARKET FUNDS: Invests in high quality,
low risk, short-term debt securities (T-bills, banker’s
acceptance, negotiable CD’s, etc.).
•Low risk of default and high liquidity. Managers are
limited to buying short-term securities rated investment
grade by Moody’s and S&P.
•Attempts to maintain NAV of the fund at $1 per share;
achieve this by purchasing debt securities that are
trading at a discount to their face value.
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Types of Mutual Funds
(Money Market)
• Interest accrues daily
• Money market funds are neither insured nor
guaranteed by the U.S. Government. Funds are not
insured by the FDIC.
• Like other securities, MMF are insured by Securities
Investor Protection Corporation (SIPC). SIPC is a
government sponsored private corporation that provides
limited protection (up to $100,000) for customer if their
broker/dealer goes bankrupt.
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Types of Mutual Funds
(Money Market)
• Five Basic Types Of Money Market Funds:
1.GOV’T SECURITIES MONEY MARKET FUNDS
• Invests in T-bills, T-notes, and agency securities;
• 90 days or less to maturity;
• Income earned is subject to federal income tax but
may be exempt from state and local taxes;
•Considered to be the safest type of MMF.
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Types of Mutual Funds
(Money Market)
2. U.S. TREASURY MONEY MARKET FUND
• Invests only in U.S. government securities issued
directly by the U.S. Treasury with short term
maturity;
•Agency securities are not included;
• Income earned is subject to federal taxes, but
exempt from state and local taxes.
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Types of Mutual Funds
(Money Market)
3. TAXABLE MONEY MARKET FUND
• Invests in bank obligations such as, negotiable
CDs, short-term debt obligations traded between
institutions. Agency securities are not included;
• Income earned is subject to federal , state and
local taxes.
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Types of Mutual Funds
(Tax Exempt Money Market)
4. NATIONAL TAX EXEMPT MONEY MARKET
FUND
• 75% of its assets is invested in high quality debt
securities issued by municipality.
• 90 days or less to maturity;
• Income earned is exempt from federal income
taxes, but is subject to state and local taxes;
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Types of Mutual Funds
(Tax Exempt Money Market)
5 SINGLE STAT, DOUBLE TAX EXEMPT MONEY
MARKET FUND
• Invests in municipal securities issued by a single
state;
•Income earned is exempt from federal and state
taxes, but may be subject to local taxes.
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Types of Mutual Funds
(Equity Funds)
• EQUITY FUNDS invest primarily in common stocks
• Returns are generated through capital gains and
dividend yields
•Portfolio manager selects stocks whose profile
matches the fund’s investment objective
• Stocks are categorized based on features, such as
dividend history, potential for capital gains, asset
size, cyclical nature of the stock, etc.
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Types of Mutual Funds
(Categories of Common Stocks)
• Basic Categories of Common Stocks:
•Blue Chip - large and most successful public
companies (IBM, GE, DuPont, …); ability to
maintain and grow profits, as well as increase
dividends over a long period time through different
market conditions.
• Establish Growth - large in asset size; stocks
traded over several years; steady increase in sales
and earnings and therefore stock price; most pay
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Types of Mutual Funds
(Categories of Common Stocks)
little or no dividends (Microsoft; Coca-Cola,
McDonald’s, …).
• Returns are generated from price increase; price
volatility is greater than Blue Chips.
• Income Stocks - pay a higher percentage of
earnings as dividends (utility companies); investors
adhere to “buy-hold” philosophy; less volatile than
the market.
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Types of Mutual Funds
(Categories of Common Stocks)
•Emerging Growth Stocks - little or no track
record of steady growth of sales and earnings;
growth and earnings potentials have recently been
recognized investors (e-commerce, internet,
biotech,…); pay no dividends; have commercially
viable product; if successful, considerable fortune to
be made.
• Defensive Stocks - share prices are less adversely
affected during declines in the economy, yet offers a
reasonable rate of return when the economy is
doing well.
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Types of Mutual Funds
(Categories of Common Stocks)
• Capitalization: Current value of a publicly traded
company ( #shares at current market price)
• Large Cap: current market value of $5 billion
or more;
• Mid-Cap: current market value of between $1
billion to $5 billion;
• Small-Cap: current market value of between
$300 million to $1 billion;
•Micro-Cap: current market value of $300
million or less.
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Equity Fund Objectives
Equit Fund Objectives
Aggressive Capital Equity Growth Growth International/ Sector/ Small World/
Growth Appreciation Income
and Income Foreign Specialty Comapany Global
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Types of Mutual Funds
(Equity Fund Objectives)
• AGGRESSIVE GROWTH: invest in stocks whose
market prices are expected to rise rapidly; also invests
in a single sector or industry; employs speculative
investment strategies, such as margin and selling
short; primary portfolio holdings in:
• Emerging growth stocks;
• mid cap stocks;
• small cap stocks.
• IPO
•Tend to provide high gains during rally and steep
drops during market declines; high volatility.
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Types of Mutual Funds
(Equity Fund Objectives)
• CAPITAL APPRECIATION: speculative in nature;
invest in stocks whose prices are expected to rise;
price increase may be due to increase in earnings
expectation or purely demand/supply led.
• Investment horizon may be short-term or long-term;
relatively high turnover and therefore higher
transaction costs.
• Employ speculative investment strategies, such as
margin and options; may also maintain large cash
holding.
• High price volatility.
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Types of Mutual Funds
(Equity Fund Objectives)
• EQUIY INCOME: primary objective is to provide
current income.
• Portfolio consists of large cap, blue chip and
defensive stocks that pay large dividends.
• Volatility moves in tandem with or lower than
overall market.
• Low shareholder turnover during a downturn; high
dividend makes the yield higher as the share price
declines.
• If stocks starts to pay low dividends, less incentive
to hold on to the fund.
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Types of Mutual Funds
(Equity Fund Objectives)
• GROWTH: primary objective is capital appreciation;
dividend payments are decidedly a secondary objective.
• Portfolio consists primarily of large cap and mid
cap growth stocks; may also contain a small
percentage of emerging growth and small cap growth
if the manager recognizes significant potential for
growth.
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Types of Mutual Funds
(Equity Fund Objectives)
•Volatility among growth funds varies widely:
• Type of stock that the fund manager
considers as a growth stock- Coca-Cola vs.
Amazon.com. Both considered growth stock,
but varied risk.
• Investment Style: more speculative (
profiting from short-term gains) style leads to
more volatility;
• Important to read the fund prospectus carefully to
determine the nature of risk involved.
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Types of Mutual Funds
(Equity Fund Objectives)
• GROWTH AND INCOME: capital appreciation and
current income are equally important.
• Portfolio consists of large cap, income and
established-growth stocks; stocks must have potential
for growth and ability to pay steady and increasing
dividends.
• The blend of growth and income stock creates a
portfolio volatility that is less than the overall market.
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Types of Mutual Funds
(Equity Fund Objectives)
• INTERNATIONAL OR FOREIGN: primary objective
is capital appreciation from commons stock companies
located outside the US; dividend payments are not
usually a consideration.
•Foreign funds are ‘spliced’ in different ways:
•Country/Region
•Diversified Emerging market
•Europe Fund
•Pacific Fund
•Latin America Fund
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Types of Mutual Funds
(Equity Fund Objectives)
•WHY INVEST IN FOREIGN STOCKS:
•Foreign stocks constitute a greater percentage of
the value of the world’s stock market than do US
stocks;
•Many foreign economies are in the early stages of
development - opportunity for significant capital
gains;
•Portfolio Diversification - not all foreign markets
move in tandem with the US market.
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Types of Mutual Funds
(Equity Fund Objectives)
• Risk of foreign funds varies depending on the type of
fund and the period of investment. Expose to currency
risk.
•Asset allocation models recommend 5 to 20 percent
holding of foreign funds.
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Types of Mutual Funds
(Equity Fund Objectives)
• GLOBAL FUND: invests in equity securities issued
throughout the world; maintains 25% - 50% of assets
in US companies.
• Safe way to invest in international markets:
• US multinationals pay dividends in dollars investors are shielded form currency risk;
• US multinationals’ shares are traded on the US
stock markets; performance closely follows the
US market performance and not the foreign
markets.
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Types of Mutual Funds
(Equity Fund Objectives)
• Fund Volatility: volatility depends on the mixture of
foreign and US equities. As high as 75% of assets can
be held in foreign equities. Depending on the mixture,
the fund volatility may track or move opposite to the
US markets.
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Types of Mutual Funds
(Equity Fund Objectives)
• SECTOR FUND: primary objective is capital
appreciation.
• Portfolio consists of stocks of companies of a
single industry/sector/geographical region.
• RISK is high - specialized concentration can produce
spectacular returns and losses. Example: investment in
Telecom or Internet sectors in 1999-2000 vs. 2001-03.
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Types of Mutual Funds
(Equity Fund Objectives)
• Popular Sector Funds:
• Communications
• Financial Services
• Health Care
• Natural Resources
• Precious Metals
• Real Estate
• Technology
• Utilities
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Types of Mutual Funds
(Bond Fund Objectives)
• BOND FUNDS: considered to be safer than stock
funds. Attracts conservative investors with low risk
tolerance.
• Historically, returns are less than stock funds.
Principal source of return is interest payments with
limited potential for capital gains.
• Market price of bonds do not increase as company’s
sales and earnings grow; bond prices are inversely
related to interest rates.
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Types of Bond Funds
Taxable Bond Funds
Corportate
Bond Fund
Government
Bond Fund
General
Adjustable
Rate Mortage
High Quality
General
High Yield
(Junk Bonds)
MortgageBacked
Securities
International
Bond Fund
Multi-Sector
Bond Fund
World
Bond Fund
U.S.
Treasury
43
Types of Bond Funds
Tax Exempt
Bond Funds
National Tax Exempt
Bond Fund
Single State TaxExempt Bond Fund
44
Types of Mutual Funds
(Bond Fund Objectives)
• BOND FUND objectives are defined using criteria
such as:
• Types of bonds - corporate, government, yankee
(dollar denominated, issued in the US by foreign
corp. or gov’t), euro (dollar denominated, issued
outside the US), etc.
• Bond rating
• Average length of maturity
• Taxation of interest income from bonds - taxable
or tax exempt fund.
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Types of Mutual Funds
(Bond Fund Objectives)
• BOND FUNDS: considered to be safer than stock
funds. Attracts conservative investors with low risk
tolerance.
• Historically, returns are less than stock funds.
Principal source of return is interest payments with
limited potential for capital gains.
• Market price of bonds do not increase as company’s
sales and earnings grow; bond prices are inversely
related to interest rates.
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Types of Mutual Funds
(Taxable Bond Fund Objectives)
• CORPORATE BOND FUNDS: invest primarily in
US issued corporate bonds, but may invest in debt
securities issued by foreign corporations. Fixed income
securities include:
• Debentures : unsecured bonds;
• Mortgage bonds : secured by real estate and property
•Equipment Truest Certificates (ETC): secured by the
equipment of the issuers. Airlines use ETCs
extensively.
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Types of Mutual Funds
(Taxable Bond Fund Objectives)
• CORPORATE BOND FUNDS are further
categorized as:
•General Corp Bond Fund: buys only investment
grade bonds of US based corp. (Aaa -Baa/AAABBB);
• High Quality Corporate Bond Fund: majority of
assets are invested in bonds rated A or better;
manager tries to maintain a rating of Aa or AA
among all bonds;
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Types of Mutual Funds
(Taxable Bond Fund Objectives)
• High Yield Corporate Bond Fund: majority of
assets are invested in bonds rated BB of Ba, or
lower.
• Interest income from these securities are taxable at the
federal, state and local levels.
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Types of Mutual Funds
(Gov’t Bond Fund Objectives)
• GOVERNMENT BOND FUNDS: invest in longterm debt securities issued by the US gov’t or by its
agencies (GNMA, SLMA). Agency securities are not
backed by the gov’t but the agency itself. Agency
securities are as safe as the US gov’t issues.
• Interest income from US gov’t bonds are subject to
federal taxes, but are exempt from state and local taxes.
• Taxation of agency issues vary - Mortgage backed
securities are fully taxed; all other issues are taxed as
gov’t issues.
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Types of Mutual Funds
(Gov’t Bond Fund Objectives)
• TYPES OF GOVERNMENT BOND FUNDS include:
• Adjustable Rate Mortgage fund: majority of assets
are invested in mortgage backed securities (GNMA,
FNMA, FHLMC) secured by pool of adjustable rate
mortgages.
• General Government Bond Fund: invests in T-notes,
T-bonds, STRIPS, TIPS, mortgage backed securities
and other US government and agency securities.
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Types of Mutual Funds
(Gov’t Bond Fund Objectives)
• US Treasury Government Bond Fund: all assets
are invested in bonds and notes issued by the US
government. One of the safest mutual funds
available.
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Types of Mutual Funds
(Taxable Bond Fund Objectives)
• INTERNATIONAL BOND FUNDS: invest largely
in debt securities issued by foreign corporations or
governments; denominated in foreign currencies;
attempts to earn income from interest payments and
capital gains.
• Foreign securities are substantially more volatile than
domestic debt; exposed to currency risk.
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Types of Mutual Funds
(Taxable Bond Fund Objectives)
• MULTI-SECTOR BOND FUNDS: invest in longterm debt securities including government bonds,
corporate bonds, foreign bonds, and eurobonds. It may
also invest in high-yield (junk) bond issued by US based
corporations.
• WORLD BOND FUNDS: invest in long-tern debt
securities around the globe; large percentage of assets are
invested in sovereign debt. Interest payments, and to a
lesser extent, capital gains are the main sources of
income.
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Types of Mutual Funds
(Tax Exempt Bond Fund Objectives)
• NATIONAL TAX EXEMPT BOND FUND ( known
as National Municipal Bond Fund): invests in long-term
municipal debt securities of town, cities, states and
municipalities in the US.
• Income consist primarily of interest payments; interest
is exempt from federal taxes; subject to state and local
taxes.
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Types of Mutual Funds
(Tax Exempt Bond Fund Objectives)
• SINGLE STATE TAX EXEMPT BOND FUND:
consists of debt securities issued by and within one
state. New York and California, because of the size of
their bond issues are used most frequently.
• Interests are double tax exempt - exempt from federal
and state taxes for resident of the single state. May also
be triple tax exempt depending on the tax code of the
local municipality.
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Redeeming Fund Shares
• For front end load funds, especially with no
contingent deferred charges, fund simply buys back
shares at the NAV and distributes the proceeds.
• For back end load funds, all charges are deducted from
the proceed. The amount of deduction is based on the
number of shares sold. The percentage deduction is
calculated by the lesser of :
• a) the original purchase price of the shares, or
• b) the NAV at the time of redemption.
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Redeeming Fund Shares
Example of Redeeming a back end load fund:
•1000 shares purchased 3 years ago at NAV of $13.0;
back end load begins at 5% and declines by 1% each
year to 0%; current NAV $20.20; want to sell 50
shares; what is the back end load?
• Total proceed ($20.20x50) = $1,010
• Load based on original purchase price =
3%x$13x50= $19.50
• Net Proceed = ($1,010 - 19.5) = $990.50.
58
Redeeming Fund Shares
Load based on NAV at the time of redemption =
3%x$20.20x50= $30.30
• Net Proceed = ($1,010 - 30.30) = $979.70.
• Therefore, use original purchase price basis.
• If current NAV = $12.0
• Load = 3%x$12.0x50 = $18.0
•Use current NAV method.
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Deciding Which Shares to
Redeem
• Redeeming fund’s share has tax implications;
• If redemption results in capital gains, pay tax
during the year when the transaction occurred;
• capital loss can be used to offset gains on another
security.
• Tax planning is an important part of redemption;
• Decide which share of your holding will be sold,
because it will determine:
• Cost basis of current sale; and
• Tax on current sale.
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Redeeming Fund Shares
• Three methods of selecting the shares for redemption:
• First In. First Out. Shares purchased first will be
redeemed first.
• Average Cost: The fund computes the average
purchase price of the shares being sold; becomes the
cost basis.
• Specific Shares: Specify broker specific shares you
want to sell according to their cost basis
• Once a method is decided, it must be followed.
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Redeeming Fund Shares
Example of Redeeming a back end load fund:
•1000 shares purchased 3 years ago at NAV of $13.0;
back end load begins at 5% and declines by 1% each
year to 0%; current NAV $20.20; want to sell 50
shares; what is the back end load?
• Total proceed ($20.20x50) = $1,010
• Load based on original purchase price =
3%x$13x50= $19.50
• Net Proceed = ($1,010 - 19.5) = $990.50.
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