Mutual Funds

• Pool resources of small investors by selling shares and using proceeds to buy securities
• First mutual fund introduced in Boston in 1924
• 1929 Crash set back the industry
• Investment Co. Act of 1940 reinvigorated the interns try by requiring better disclosure of feeds, etc.
• CFs into mutual funds are highly correlated with stock market returns
• Growth also resulted from rise of retirement fu nds invested in these areas
• Second most important group of FIs as measured by asset size, second only to commercial banks

5 Benefits of investing in mutual funds

• Liquditiy intermediation (they are highly liquid)
• Denomination intermediation (reducing min. Amount required for investors to invest
• Diversification
• Cost advantages - they can negotiation lower transaction feeds than would be available to individual
investors
• Managerial expertise (reliance on professional money managers)

Types of MFs
• ST funds (MMMMFS) (Tax exempts)
• LT Funds (equity , bond, hybrid)
• Index Funds
• ETFs

MF managers must specify obj in a prospectus

• Contains historical information
• Must show historical fees in addition to returns
• Few information on risk is provided

MF Structure
• Sharedholers are the investors
• BoD can hire/fire the investment advisor
• Open-ended
• Closed-end
• Unit Investsment Trust (such as a REIT), that specializes in investing in an investment class/type
◦Typically static composition and fixed termination date

NET ASSEET VALUE

• total value of mutual funds stocks, and holdings MINUS any LIAVILITIES divided by # of shares

Fee structure
• load funds (class A) charge and upfront fee for buying shares. No load funds do not.
• deferred load (class B shares) charge a fee when shares are redeemed
• If it has no front/back end fees we call it a clcal class C share
• Other fees:
◦Contingent deferred sales charge
◦Redemption fee
◦Exchange fee
 ◦Account maintenance fee
◦12b-1 fee
• Fees can substantially impact returns
◦Initial INvestment = Investment - (Investment * load fee)
‣ Amt after gross return = A * 1 + r
‣ Avg asset = end point plus initial point
‣ Fees = C * fee %
‣ Ending amt = B - D
‣ Net rate = E / Initial investment -1
• Objective Class
◦Stock / Equity Funds
‣ Typically the largest class, as they have highest returns over longer run
• Could have a particular stated objective (LT cap appreciation, consistent dividends, low
PE, etc.)
◦MM
‣ Only MM securities, offer check writing privileges
‣ Not federally insured
‣
◦Bond
‣ Strategic Income, Corporates, Treasuries, Munis, etc.
◦Hybrid
‣ Combine stocks/bonds into a single fund
‣
• SEC is primary regulator of MFs
◦Mandated by law to have independent directors
• Conflicts of Interest in MF Industry
◦Investor confidence is critical to the industry
◦Principal agent problems and asymmetric information are prevalent
◦Types of abuses:
‣ Market timing
‣ Late trading
‣ Directed brokerage
‣ Improperly assessed fees
◦Recent Lawsuits and Settlements
‣ Fines not typically large | magnitude of these MFs
◦Govt Responses:
‣ Requirement of more independent directors
‣ Hardening the 4PM valuation rule
‣ Increased and enforcing of redemption fees
‣ Increased transparency
• Hedge Funds
◦Specialized mutual fund that caters to ‘sophisticated’ investors
◦High minimum investment
◦Long-term commitment
◦High fees
◦Highly levered
◦Little regulation
• HFS avoid regulation by limiting the # of investors to less than 100, and recquiring them to be
accredited (NW > 1MM, or annual income of 200k if single 9or 300 ifmarried))
◦HFS use aggressive strategies, such as short lelling, leverage, program, arbitrage, and derivative
usage
 ◦They look for pricing anomalies
◦As investing has become more modern, some traditional HF approaches have been incorporated
across other platforms etc.
• Management fees are computed as % of AUM
• Performance fees
◦~20%
◦Hurdle Rate (must be realized before performance fee can be assessed)
◦High water mark (when manager does not receive performance fee unless fund exceeds highest
NAV it previously achieved
◦Offshore HFS are attractive as they provide anonymity and shelter from US taxes
• HFS are prohibited from illegal trading practices
◦Dodd Frank required those withi >100MN to register with SeCC u Nader Investment Advisors
Act
◦Large funds must now report information to FSCO to help limit systemic risk
◦FRS can now exercise oversight over those deemed systemically important
• HF: LTCM
◦‘Too smart to fail’
◦Early returns of > 30% were high, but subsequent bets went the wrong way,,, and had 1 trillion in
derivative positions and 80bn of equity positions
‣ Bailout to avoid widespread impact to the economy
• HFS
◦Financial crisis reduced amount of HF assets due to losses
◦Recent performance has generally lagged markets
◦Greater public acceptance of efficient market hypothesis
• Summary
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