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Mutual FundsMutual Funds

Chapter 5

K. R. Stanton

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Overview

In this segment ... Mutual Funds: Activities of mutual funds Size, structure and composition Balance sheets and recent trends Regulation of mutual funds Global issues Hedge funds*

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Mutual Funds

Open-ended Closed-end End of 2003:

More than 7,100 stock and bond mutual companies.

Total assets of $5.36 trillion. 8,200 firms and $7.41 trillion if money market

mutual funds included Slower rate of growth in the industry in early

2000s than in 1990s

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Size, structure and composition

First mutual fund: Boston, 1924. Slow growth, initially. Advent of money market mutual funds, 1972.

Regulation Q. Total assets in stock and bond mutual funds:

1940: $0.4 billion. 1990: $1,065.2 billion 2003: $7,414.1 billion.

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Size, Structure and Composition

By asset size, mutual fund industry second most important FI group.

Recent inroads by commercial banks and insurance companies

Mellon purchase of Dreyfus State Farm (9,000 agents) As of 2004, insurance companies managed

approximately 14% of mutual fund assets

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Types of Mutual Funds

Long-term funds 74.3% of assets, 1999 2002, long-term funds dropped to 62.1% of

assets, losing ground to MMMFs Types of Long-term Funds:

Bond and income funds. Equity funds. Hybrid.

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Types of Mutual Funds

Short-term funds 25.7% of assets, 1999. 30.2% of assets, 2002. Taxable and tax-exempt MMMFs Generally higher returns than bank deposits but

uninsured. Impact of low interest rates during early

2000s

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Number of Mutual Funds

Year

Equity

Hybrid

Bond

Taxable

MM

Tax-exempt

MM 1980 288 N/A 170 96 10

1990 1,099 193 1,046 506 235

2003 4,601 509 2,043 661 312

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Overview of Mutual Funds

Objectives (and adherence to stated objectives), rates of return and risk characteristics vary.

Examples: Capital appreciation funds Growth funds High-yield bond World equity Corporate bond

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Returns to Mutual Funds

Income and dividends of underlying portfolio. Capital gains on trades by mutual fund

management. Capital appreciation in values of assets held in

the portfolio. Marked-to-market. Net-asset value (NAV).

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Web Resources

For information on the performance of mutual funds, visit:

Morningstar www.morningstar.com

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Types of Funds

Open-ended funds: contrast with most corporate securities traded on stock exchanges.

Closed-end investment companies: Fixed number of shares

Example: REITs. May trade at premium or discount.

Load versus no-load funds.

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Mutual Fund Costs

Two types of fees: Sales loads

Generally, negative effect on performance outweighs benefits

Fund operating expenses Management fee 12b-1 fees

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Mutual Fund Share Quotes

Quotes include: Fund NAV, Fund name, Objective, one-month

through ten-year return and rating (A through E), Maximum initial charges, and Annual expenses.

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Balance Sheet and Trends

Money Market Funds Key assets are short-term securities (consistent

with deposit-like nature) 2003: $1,395.9 billion (69.2% of total assets)

Many have share values fixed at $1 and adjust number of shares owned by the investor.

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Balance Sheet and Trends

Long-term Funds Stocks comprised over 65.6 % of asset

portfolios in 2000. Credit market instruments 32.3% of asset

portfolios Shift to U.S. Treasuries, municipal bonds etc.

when equity markets not performing as well.

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Regulation

One of the most closely regulated among non-depository FIs.

Primary regulator: SEC Emphasis on full disclosure and anti-fraud measures

to protect small investors. NASD supervises mutual fund share distributions.

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Regulatory Changes

Prosecutions in light of trading abuses in early 2000s. Market timing Late trading Directed brokerage Improper fee assessments

Changes include: SEC requirements for independent board members; reporting and disclosure requirements

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Legislation

Securities Act 1933, 1934 Investment Advisers Act, 1940. Insider Trading and Securities Fraud

Enforcement Act of 1988. Market Reform Act of 1990

Allows SEC to halt trading and introduce circuit breakers.

National Securities Markets Improvement Act of 1996.

Exempts mutual fund sellers from state securities regulatory oversight.

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Pertinent Websites

American Banker www.americanbanker.com American Funds www.americanfunds.comFederal Reserve www.federalreserve.gov Fidelity Investments www.fidelity.comInvestment Company Institute www.ici.orgMorningstar, Inc. www.morningstar.com SEC: www.sec.govNASD: www.nasd.comVanguard www.vanguard.comWall Street Journal www.wsj.com

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Global Issues

Worldwide growth in mutual fund investment not as great as in the U.S. $1.626 trillion in 1992 to $6.543 trillion in 2003

Over 300% growth compared to 350% in U.S. Larger returns in U.S.stock markets Greatest development in countries with most

developed markets Opportunities from declining Japanese markets Efforts to reduce barriers for U.S. mutual fund

sponsors China and other Asian countries

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Hedge Funds*

Not technically mutual funds Not subject to SEC regulation Organized as limited partnership

Small number of sophisticated investors Common feature is use of leverage

High returns in 1990s

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Hedge Funds*

Near collapse of Long-Term Capital Management $3.6 billion bailout 2003 SEC scrutiny of hedge funds Scandals such as Canary Capital Partners

involving trades with mutual funds