Mutual Fund Investors:Divergent Profiles
Alan Palmiter & Ahmed TahaWake Law01 Oct 07
A pop quiz …
1. Mutual funds are primarily owned by:a. Individuals on their ownb. Individuals with retirement
accountsc. Institutional investors
2. Mutual funds mostly invest in:a. Stocksb. Bondsc. Notes (money market)
3. What have been annual returns (1926-2004):a. Small-cap stocksb. Large-cap stocks c. Corporate bondsd. 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. Yesb. Noc. Only low-performing funds
6. Mutual fund investors say they pay attention more to fees than to performance.a. Trueb. 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)
8. Mutual funds only impose a sales charge at the time you invest. a. Trueb. False
9. Annual rate that average stock fund sells and replaces stock (turnover) in its portfolio:a. 6%b. 56%c. 90%d. 153%
10. What is a no-load fund? a. An unleveraged fundb. A fund without sales chargesc. A fund without trading costsd. A fund without withdrawal fees
11. Think about your own largest mutual fund. What is -- a. Your current balanceb. Fund’s investment objectivesc. Fund’s sales charges, expense
ratio, trading costs d. Fund’s performance last year
12. Consider your car/vehicle: a. Its make, model, yearb. Its cost, MSRP, total miles,
safety rating, gas efficiencyc. You get our point
US mutual fund market …
US Households(112 million)
Own mutual funds(55 million / 49%)
Retirement account54%
Broker79%
On own46%
Direct29%
IRAs48%
DC plans52%
Stocks 60%
Money Mkt 23%
Bonds 17%
Mutual funds ($11.3 T)
Demand-side
Fund Types
Supply-side mutual fund market …
Top 10 groups(38%)
Next 15 groups(35%)
Rest(27%)
Mutual fund market
Financial retirement market
MutualFunds(27%)
Asset classes(risk/return primer)
Asset Classes(1926-2004)
Average Return
Standard Deviation
Small Company Stocks 12.7% 33.1%
Large Company Stocks 10.4% 20.3%
Long-Term Corporate Bonds 5.4% 9.3%
Treasury Bills 3.7% 3.1%
Effect of investing $10,000 for 20 years …
12.7%
3.7%
$10,000 (invested over 20 years)
Small Company Stocks, $109,264
Large Company Stocks, $72,340
Long-Term Corporate Bonds, $28,629
$10,000Treasury Bills, $20,681
0
20,000
40,000
60,000
80,000
100,000
120,000
Mutual fund investor profiles(demand-side)
Industry profile
Information before purchasing Fund investors (outside retirement plans)
47%
52%
55%
57%
57%
58%
61%
69%
74%
0% 10% 20% 30% 40% 50% 60% 70% 80%
Tax consequences
Sales charge (if any)
Performance vs. index
Minimum investment
Types of securities
Net asset value
Fund risks
Historical performance
Fees / expenses
ICI Investor Preferences (2006)
Where investors turn Fund investors (outside retirement plans)
14%
20%
25%
30%
33%
34%
40%
46%
73%
0% 20% 40% 60% 80%
Fund telephone rep
Rating services
Fund literature
Fund reports
Media
Fund prospectus
Friends / family / associates
Fund company
Professional financial adviser
ICI Investor Preferences (2006)
“The 90 million fund shareholders’ demand for investment performance and services at a competitive level of fees and expenses continuously impacts mutual funds.”
Paul Schott StevensICI President
The number/types of funds has proliferated, increasing need for information to help investors compare and contrast alternatives.
SEC (Mar 29, 1995)
Investors will benefit from a uniform fee table and management’s discussion of fund performance
SEC (1983)
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)
Prospectus 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)
Statement ofAdditional Information
• 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 disclosureof trading costs(brokerage commissions)
Annual and semi-annual statements
• 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)
Focus on performance,not expenses
Advertising
• 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”
No longer does info needto be from prospectus
“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.”
Arthur LevittSEC Chair (1993-2001)
SEC attention to ICI, academic research …
Topic
Comment letters
ICI comments
News stories
Non-academic research
ICI research
Academic research
Prospectus disclosure (1998) 78 3 19 1* 7 0
Fund profile disclosure (1998) 256 1 2 0 4 0
Advertising rules (2003) 29 0 2 0 1 0
Compliance programs (2003) 47 26 1 0 0 0
Portfolio manager (2004) 34 3 0 0 0 1**
2% fee for redemption (2005) 400 10 5 0 2 6***
SEC citations (footnotes / rulemaking releases)
* AARP survey of MF investors
** Textbook, Regulation of Investment Companies
*** Articles/studies on trading abuses (finance journals, SSRN)
“Academic” portrait
How many colors do you see?
Investors’ Behavior
• Chase Returns
• Ignore Expenses (but not Loads)
• Ignorant of Objectives and Holdings
• Inattentive to Risk
Behavior: • Investors chase hottest
funds
• Convex Flow-Return Relationship
Reality: Little evidence of returns
persistence: past returns generally don’t predict future returns
Investors’ Behavior
• Chase Returns
• Ignore Expenses (but not Loads)
• Ignorant of Objectives and Holdings
• Inattentive to Risk
Behavior: • Expense level generally
doesn’t affect fund choices
• More sensitive to loads
Reality:Annual expenses greatly
affect investors’ wealth
Value of $15,500
$0
$50,000
$100,000
$150,000
$200,000
$250,000
$300,000
$350,000
10 20 30 40
6%
7%
8%
YEAR
$336,730
$232,104
$159.429
AnnualReturn
Investors’ Behavior
• Chase Returns
• Ignore Expenses (but not Loads)
• Ignorant of Objectives and Holdings
• Inattentive to Risk
Behavior: Most investors are unaware
of their funds’ objectives or holdings
Implication: Mismatch between
investors’ objectives and funds’ objectives
Investors’ Behavior
• Chase Returns
• Ignore Expenses (but not Loads)
• Ignorant of Objectives and Holdings
• Inattentive to Risk
Behavior: Expense level generally
doesn’t affect fund choices
Implication: Mismatch between funds’
risk and investors’ risk tolerance
Modest proposals …
(1) Point of sale disclosure
(2) Post-purchase statements
Fund XYZ performance
Inv return Expenses/costs Net return
1-year 4.5% 2.1% 2.4%
5-years 7.6% 2.4% 5.2%
10-years 11.5% 1.9% 9.6%
20-years 8.9% 1.6% 7.3%
Comparison
Fund XYZ vs.
Asset Class
0.00% 5.00% 10.00% 15.00%
Fund
Asset class
Fund
Asset class
Fund
Asset class
Fund
Asset class1
-ye
ar5
-ye
ar
10
-
ye
ar
20
-
ye
ar
Your statement (Fund XYZ)
Beginning balance $10,000
Investments $ 2,000
Withdrawals $ --
Investment return $ 850 7.7%
Expenses
Sales charge $ 60 0.5%
Adm/advisory fees $ 140 1.3%
Trading costs $ 80 0.7%
TOTAL $ 280 2.5%
Net return $ 570 5.2%
Ending balance $12,570
66% - lower expenses 34% - higher expenses
Expenses (compare to other comparable funds)
2.5%XYZ
6.3%0.3%
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.
The end
Top Related