All Rights Reserved Dr David P Echevarria 1 MUTUAL FUNDS OPERATION CHAPTER 23.

Dr David P Echevarria 1All Rights Reserved

MUTUAL FUNDS OPERATION

CHAPTER 23


INVESTMENT COMPANIES

A. Definition of an Investment Company;A pool of funds belonging to individuals used to acquire a collection of individual securities such as stocks and bonds

The value of shares in the fund is determined daily by the Net Asset Value (NAV).

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B. Management of Investment Companies1. Portfolio Managers

• Oversee activities of analysts

2. Investment Analysts• Nearly all are CFA’s (Chartered Financial Analyst)• Will Specialize in a single industry• Stepping stone to portfolio manager

3. Transfer Agents• Third party intermediaires – verify buy/sell transfers

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C. Types of Funds1. Open-Ended Funds

a. Investment pools which continue to take investor fundsb. Redemptions by fund at Net Asset Values (NAV)

2. Closed-End Funds a. A one-time subscription. b. Stock traded in secondary market; stock price typically < NAVc. No redemptions by fund; if you want out, sell in market. (NYSE,

AMEX)



3. Load vs. No-Load Open-End Fundsa. Load = a sales charge based on $ amount of transaction

• Front-end load: charged on sale day• Back-end: charged when shares are sold• May be imposed on a graduated scale based on time position

is held

b. No-Load: no sales charges (commissions)4. Exchange Traded Funds (ETF)

c. Structure similar to mutual funds d. Advantage: no minimum holding periode. Disadvantage: not managed

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5. Hedge Funds: • High leverage: using margin to leverage returns • Long/Short: may hold long and short positions• Derivatives: may use derivative securities (options

and/or futures to hedge positions• Participation limited to high Net Worth individuals`

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D. Investment Company Portfolio Objectives1. Common Stock Funds;

• Growth: sales and earnings • Income: focus on good dividend paying stocks • G&I, • International, • Sector, • Specialized

2. Balanced Funds; dividend paying stocks & bonds3. Bond Funds, Money Market Fund, Real Estate

Investment Trusts4. Hedge Funds



D. Performance of Investment Companies1. Sharpe Study; Excess Return per Unit of Risk

• Few funds outperform the DJIA

2. Jensen Study; Examining intercept term (a) a. alpha = abnormal return: Is alpha different from zero?b. Results: funds earn 1.1% less per year given their level of risk

3. Carlson Study; three categories, none outperformed the S&P 500

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4. Implications of Performance Studies a. For market efficiency: you cannot beat the market

b. For active versus passive management

c. Risk reduction through diversification

5. The exceptiona. Warren Buffet (Berkshire Hathaway)

b. Long-run average performance measurement bias


REGULATION

A. SEC is principal oversight body

B. Investment Company Act (1940) is primary legislation as amended

1. 1993: Prospectus requires revealing names, etc., of managers.

2. 90% of income must be distributed to investors

C. Investment Advisor Act – must register if more than $25 million under management.


HOMEWORK QUESTION

A. What important services do Investment Companies provide investors?

B. How do Open-end and Closed-end funds differ?C. What is the advantage of a no-load fund?

Advantage of a front-end load fund?D. Why are there different types of funds?E. How does the Sharpe Measure differ from the

Jensen measure?F. Overall, what is the verdict on Professional Fund

Managers (in general)?

All Rights Reserved Dr David P Echevarria 1 MUTUAL FUNDS OPERATION CHAPTER 23.

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