CH 14 INVESTMENT MANAGEMENT MUTUAL FUNDS.ppt - PowerPoint by lovemacromastia


									     Chapter 15

Management: Mutual

15.1   Mutual Fund Basics
15.2   Advantages and Disadvantages
15.3   Mutual Fund Performance
15.4   Mutual Fund Risk
15.5   Assessing Stock Fund Risk
15.6   Bond Fund Investing
15.7   Specialized Funds
15.8   Taxes
           “What’s All This I Hear
           About Mutual Funds?”
 Open-end investment company
 Traditionally growth, income, or other focuses
 Mutual fund watchdog group Lipper Analytical Services,
  Inc. lists over 20 different categories based on
    actual portfolio holdings
    riskiness of investment style
 Pooled money is invested in wide range of stocks, bonds,
  money market instruments.
 Professional money managers handle fund portfolios
  according to stated investment policies.
             Mutual Fund Basics

 Net Asset Value: per-share value of a mutual fund’s
   stock, bond, and cash reserve holdings
 Open-End Investment Companies: another name for
   mutual funds; continuously offer to sell and buy shares
 Mutual funds have been around for 75 years.

 Currently more than $6 TRILLION in more than
   10,000 various funds; 20-25% of total stock and bond
   market value.
                Mutual Fund Types

 Money Market Mutual Funds: invest in cash reserves
   or short term IOUs (Repos, CDs, T-bills, commercial
   paper, and BAs)
 Bond Funds: invest in debt instruments—fixed-income
 Stock Funds: invest in equities—seek capital
 Index Funds: strategy designed to mimic performance
   of some broad market benchmark
Sources of Mutual Fund

        Print Media:
           Smart Money
           Forbes
           Barron’s

        Web Sources:
                 MUTUAL FUNDS
              Advantages & Disadvantages

   Broad diversification                   Not federally insured
   Ability to retain professional          Subject to market value
    money managers                           fluctuations
   Investor convenience                    Diversification limits chances
       automatic monthly investment         for huge returns
       easy to move money among            High management fees, sales
        funds                                commissions
       automatic dividend/income               load funds
        payments or reinvestment
                                                no-load funds
       easy to track fund performance
         Sources of Mutual Fund
           Investment Returns

 Total Return: dividend and interest income and
   realized/unrealized appreciation
 Unrealized Capital Gains: increase in fund value
   caused by a rise in the value of fund investments
 Capital Gains Distribution: payment of realized
   capital gains
 Capital losses are also possible.
            Mutual Fund Expenses
 Operating Expense Ratio: operating expenses expressed as a
   percentage of fund assets
     range from 0.2% to 2%
     most important source of difference in yield among similar
 Load Charges: sales commissions
     front end loads
     low-load funds
     back-end load
     12b-1 fees
     level load
           Mutual Fund Expenses

 Exchange Fee: charge assessed when investor
   exchanges shares from one fund to another within the
   same fund family
 Maintenance Fees: bookkeeping charges
 Transaction Fees: charges for redemptions of initial
 Prospectuses (offering circulars) outline all fees.
 Index funds typically have lowest management fees.
Money Market Funds

       Provide current income

       Maintain constant $1 per share NAV

       95% of assets in highest grade short-
         term debt instruments

       Not insured by government entities

       Inflation Risk: chance that rising
         prices will erode real (after inflation)
         investment returns
             MUTUAL FUND RISK
                Bond Funds

 Bond fund values, like bond prices
   themselves, can be volatile

 Interest Rate Risk: when interest rates
   rise, bond prices fall—existing bonds
   become less valuable.

 Income Risk: chance that income from
   mutual fund investments will fluctuate

 Especially important for retirees
             MUTUAL FUND RISK
                Stock Funds

 Market Risk: change in NAV because prices of stocks (and
  bonds) fluctuate

 Inferior Management Risk: chance that poor timing or
  substandard security selection will result in bad performance

 Sector Risk: chance of loss due to focus on some
  underperforming industry or industry group.

 Style Risk: chance of loss or inferior short-term performance
  when valid investment styles suffer through inevitable periods of
Investors cannot
eliminate all types of
mutual fund risks
            Portfolio Characteristics

 Look to company’s annual report to shareholders, 10-k
   report to SEC, and fund prospectus for free
   information about
      fund assets and holdings
      earnings
      Management          SEC Link to Prospectus Info
      Strategy                 Columbia Fund Info
 Performance is bottom line
    Relative performance
    Benchmarks
Assessing Fund

   Clarifies fund investment
     philosophy or strategy
   May indicate departures from
     fund goals
   Percentage of fund assets
     invested in top 10 securities—
     ready for correction
   Gives only snapshot—track over
     time to get clear picture
                     ALPHA, BETA & R2
 Under CAPM, Security Market Line (SML) shows relation between expected
   rate of return and systematic risk
 ßP is beta measure of portfolio systematic risk
 Risk premium for typical mutual fund should be ßP times as great as market risk
  signifies annual return on portfolio not tied to volatility in overall market
 Better than theoretical performance expectations:
       Selectivity (stock picking ability)
       Market timing (punctual purchase and sale of securities)
 R2 shows association between fund return volatility and overall market volatility.
              Adjusted Performance

 , , R2 not very useful in depicting risk/reward ratio
   for mutual funds over time

 Reward-to-variability measure (Sharpe ratio) gives risk
   premium earned relative to total risk.

 Reward-to-volatility measure (RVOL or Treynor ratio)
   gives risk premium earned relative to systematic risk.
               Adjusted Performance

 Sharpe Ratio = ( Rp – Rf ) / s(Rp)

 Treynor Ratio = ( Rp – Rf ) / p

  What is the Sharpe ratio of a portfolio with a
    historical average return of 15% and a standard
    deviation of 16% if the risk free rate is 2.2%?
        Sharpe Ratio = (.15 – 0.022) / 0.16 = 0.8
              Adjusted Performance

 Sharpe Ratio = ( Rp – Rf ) / s(Rp)

 Treynor Ratio = ( Rp – Rf ) / p

  What is the standard devaition of a portfolio
    with a historical average return of 15% and a
    Sharpe ratio of 1.1 if the risk free rate is 1.5%?
        Sharpe Ratio = 1.1 = (0.15 – 0.015) / s

        therefore s = 12.3%
              Adjusted Performance

 Sharpe Ratio = ( Rp – Rf ) / s(Rp)

 Treynor Ratio = ( Rp – Rf ) / p

 What is the Treynor ratio of a portfolio with a
   historical average return of 15% and a Beta of
   1.2 if the risk free rate is 2.2%?
       Treynor Ratio = ( 0.15 – 0.022) / 1.2 = 0.11
Bond Fund Investing

         Bonds are part of many
          people’s portfolios.
         Stable income
         Diversification

         Tax-exempt municipal
          bond income
               BOND INVESTING
             Advantages & Disadvantages
 Individual Bonds: laddering    Dividend income varies with
  to meet specific investor       overall interest rates.
  needs                          No fixed maturity date
 Funds:                         NAV varies with interest rate
      professional manager       changes.
      diversification           Call Risk: chance of bond
      regular monthly income     redemption when doing so
                                  would be economically
      appropriate for small
                                  advantageous to the issuer
      diversification           Prepayment Risk: chance of
                                  mortgage-backed security
      ready liquidity            redemption
             Specialized Funds

 Exchange-Traded Funds (ETFs): tradable shares that
  represent proportional ownership in baskets of stocks
 Standard and Poor’s Depository Receipts (SPDRs):
  ETFs that track the price performance and dividend
  yield of the S&P 500 Index (unit investment trusts or
  closed-end mutual funds)
 DIAMONDS: ETFs that track
  the price performance and
  dividend yield of the DJIA
               Specialized Funds

 QQQs: ETFs that track the price and dividend yield of the
   Nasdaq 100 Index
               MidCap SPDRs: ETFs that track the price
                and performance and dividend yield of the
                S&P MidCap 400 Index
               Select Sector SPDRs: ETFs that track the
                price performance and dividend yield of
                particular industry groups
               iShares: index shares (ETFs) created by
                Barclay’s Global Investors
           Closed-end & Hedge
              Mutual Funds

 Discount: when the market price per share
  for a closed-end fund is less than NAV
     Fund owns 3 stocks:
       IBM ($80), MSFT($40) and YHOO($40)
       Value of stocks in fund: $160 (Net Asset Value)
     Price of the fund: $155
     This fund is at a discount
     An arbitrage?
              Closed-end & Hedge
                 Mutual Funds
 Investment companies that issue a fixed number of shares
   at a given point in time
       Premium: when the market price per share for closed-end
        funds exceeds the NAV
       Discount: when the market price per share for a closed-end
        fund is less than NAV
       No implicit agreement to redeem shares
 Hedge Funds: investment partnerships that use speculative
   investment techniques, such as leverage and short selling,
   that are very risky and prohibited for most mutual funds
            Mutual Funds & Taxes

 Taxes on distributions
 Influences on distribution sizes
      Turnover Rate: common
       measure of mutual fund’s
       trading activity

 Taxes on sales and exchanges
   Wash Sale: investor redeems shares at a loss and
    purchases shares in same fund within 30 days
                    KEY TERMS
                    Mutual Funds

 mutual fund              bond funds
 net asset value          index fund
 open-end investment      total return
                           unrealized capital gains
 money market mutual
                           capital gains distribution
                           operating expense ratio
 stock funds
                   KEY TERMS
                   Mutual Funds

 load charges            load fund
 front-end-loads         no-load fund
 low-load funds          exchange fee

 back-end load           maintenance fees
 12b-1 fees              transaction fees

 level load              prospectus
                   KEY TERMS
          Mutual Fund Risk & Performance

 inflation risk         selectivity
 income risk            market timing
 market risk            reward-to-variability
                           measure (Sharpe ratio)
 sector risk
                         Reward-to-volatility ratio
 inferior management
                           (Treynor ratio)
                         laddering
 style risk
                 KEY TERMS
         Mutual Fund Risk & Performance

 call risk                MidCap SPDRs
 prepayment risk          Select Sector SPDRs
 exchange-traded funds
                           iShares
 Standard and Poor’s      closed-end funds
   Depositary Receipts
                           hedge funds
 DIAMONDS                 turnover rate
 QQQs                     wash sale

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