12 -- Part 1: Mutual Funds and Exchange-Traded Funds
Unlike other mutual funds, the goal of the Vanguard 500 Index fund is not to beat the market but to keep pace with it.
First, because the fund simply purchased whatever stocks were included in the S&P 500 stock index, there was no need for employees to conduct analysis to determine which stocks they should buy and sell.
You should be able to find mutual funds in the world with net assets of $213 billion after studying this chapter.
The trustees of his estate should put most of his wealth into what they have to offer as investments.
The popularity of open- and closed-end funds shows no signs of slowing.
Exchange-traded funds and other types of professionally investors poured $216 billion into Vanguard, a record inflow of managed investment companies, and discussed the various funds for any mutual fund company.
The emphasis on limited stock turnover has kept operating expenses low.
For every $1,000 an investor places in Vanguard, the company extracts just $1.80 per year for operating costs of investment objectives these funds seek to fulfill.
Over the past 39 years, the S&P 500 fund has earned an average annual return of approximately 11%, which is better than almost all of the other stock mutual funds that program.
State Street Global Advisors created the first exchange-traded fund in 1993 to describe the investor uses of mutual funds along with index funds.
The Standard & Poor's Depositary Receipt was the first exchange traded fund.
The spider tracks the movements of the S&P of return earned on a mutual fund investment.
The 500 index has an advantage.
If you want to buy or sell shares in mutual funds, you have to wait until the stock market closes each day, but investors can buy or sell shares at any time during the day.
Questions of which stock or bond to pick, how best to build a diversified portfolio, and how to manage the costs of building a portfolio have challenged investors for as long as there have been organized securities markets.
The growth that mutual funds have experienced is explained by the concerns at the very heart of the mutual fund concept.
Many investors don't have the time or commitment to manage their portfolios.
Many investors don't have enough funds to create a well-diversified portfolio, so they turn to professional money man agers and allow them to decide which securities to buy and sell.
When investors need professional help, they look to mutual funds.
Some of the security selection decisions are delegated to professional money managers when investors invest in mutual funds.
As a result, investors can focus on key asset allocation decisions, which play a vital role in determining long-term portfolio returns.
Many investors consider mutual funds to be the ultimate asset allocation vehicle.
The pro fessional money managers at the mutual funds will take care of the rest if investors decide to invest in one of the funds.
For the past 90 years, mutual funds have been part of the investment landscape in the United States.
The first one started in Boston in 1924.
There were more than 9,300 mutual funds by the year 2015.
There are more mutual funds in existence today than there are stocks listed on all the major U.S. stock exchanges combined.
As the number of fund offerings has increased, so have the assets managed by these funds, rising from about $135 billion in 1980 to $15.8 trillion by the end of the year.
In 1980, less than 3% of U.S. households owned mutual funds.
The mutual fund industry has grown so much that it is now the largest financial intermediary in the country.
In the United States and all over the world, mutual funds are big business.
There were more than 79,000 mutual funds in operation in the world last year.
Roughly half of the assets were held by U.S. mutual funds.
U.S. stock funds have the largest share of mutual fund assets.
42% of the assets held by mutual funds were invested in U.S. stocks, and another 14% were invested in foreign stocks.
The share of mutual fund assets invested in domestic and world stocks has risen in recent years, while the share of assets invested in fixed-income securities has fallen.
The historically low interest rates that have prevailed in the market in recent years have led to a decline in assets invested in fixed-income instruments.
The distribution of mutual fund assets is shown in the chart.
The majority of industry assets were managed by funds that invested in either domestic or foreign stocks.
With interest rates stuck at historically low levels, investors have been moving out of bonds and into stocks, while equity and fixed-income funds held an equal share of industry assets.
All income levels and walks of life can benefit from mutual funds.
Both inexperienced and experienced investors hold mutual funds.
All of these investors have decided to turn over at least part of their investment management activities to professionals.
The idea of com bining money from a group of people with similar investment goals and investing that money in a diversified portfolio is what the mutual fund concept is based on.
Even if the amount of money that they can invest is relatively small, mutual funds make it easy for investors to hold well-diversified portfolios.
A single mutual fund can hold hundreds of different stocks or bonds.
The Dreyfus GNMA fund held 830 securities, while Fidelity Contrafund held 335.
That's more than most individual investors could ever hope to achieve by buying their own securities.
Each investor who owns shares in a fund is a part owner of that fund's diversified portfolio of securities.
The market value of the mutual fund shares changes with the price of the securities it holds.
The dividends and interest payments are passed on to the mutual fund shareholders on the basis of their prorated ownership.
If you own 1,000 shares in a mutual fund, you will receive 1% of the dividends paid by the fund.
Capital gain is passed on to fund shareholders on a prorated basis when the fund sells a security for a profit.
Depending on how they decide which securities to buy, mutual funds fall into one of two categories.
The portfolio manager might conduct fundamental analysis by combing through companies' financial reports and developing complex valuation models to estimate the intrinsic value of many different securities.
The securities that the manager would invest in had greater intrinsic values than their market prices.
Alternatively, the manager could use technical analysis to spot trends that predict the direction in which securities prices will move in the future.
The manager's goal is to invest in securities that will achieve superior performance.
The performance of the portfolio is compared to a benchmark to see if the man succeeds or fails.
The risk profile of a particular fund should be the same as that of the benchmark.
The fund manager's goal is to generate higher returns, after fees, than the S&P 500 stock index.
Consider the consequences of setting an inappropriate benchmark.
The S&P 500 would be set by a fund as its bench mark.
Investment companies that offer a S&P 500, not because the fund manager is skillful, but because the fund invests variety of mutual funds often in riskier assets.
To the extent that fund managers are judged on their ability to earn a return above a benchmark, there will be at least some incensing of their funds.
The fund's performance should be compared to a less risky benchmark.
In these funds, the manager's percentage of mutual funds in a goal is to track the performance of the index as closely as possible while particular family performs better than keeping expenses low.
Management fees are charged by benchmark.
Most mutual funds trail their benchmarks.
One of the most important reasons for owning mutual funds is the portfolio diversification that they can offer.
Diversification benefits can be achieved by spreading fund holdings over a wide variety of industries and companies, thus reducing risk.
Because they buy and sell large quantities of securities, mutual funds pay lower transaction costs than individual investors.
Full-time professional management is an appeal of mutual funds.
M13_SMAR3988_13_GE_C12.indd 501 is more efficient than individual investors.
Most mutual fund investments can be started with a small amount of investment capital.
An investor can purchase a claim on a portfolio with a few thousand dollars.
Many investors find the services that mutual funds offer appealing.
Automatic reinvested dividends and capital gains, record keeping for taxes, and exchange privi leges are included in these services.
Convenience is offered by mutual funds.
They are easy to buy and sell, and investors can find up-to-date information about a fund's recent performance.
There are some costs associated with mutual fund ownership.
There are a variety of fees that mutual funds charge.
The sales load is an up-front fee that investors pay to acquire shares in the fund.
Other fees are charged to cover the costs of running the fund.
Administrative and operating costs include compensation of the portfolio man ager and staff.
The expense ratio is the percentage of assets managed by a fund that fund investors pay each year.
The expenses are paid by investors regardless of whether the fund has a good or bad year.
Equity funds that were $125 per year in fees regardless of how the fund's investments perform.
$166 billion of new money is charged by the passively managed received expense ratios.
Passive funds had a mean expense ratio of 0.44%, while actively managed funds had a mean expense ratio of 0.11%.
Some mutual funds justify higher fees by claiming that they have better managers who will generate better returns.
There isn't much evidence that mutual funds earn more than average returns.
Most actively managed funds do little more than keep up with the 2000 to 20.2% growth in equity funds.
They don't do that a lot.
Over time, the spotty performance record and high fees of actively managed funds have drawn more and more people to passively managed funds.
For an actively managed fund, the goal is to earn a return that exceeds the fund's benchmark by more than enough to cover the fund's fees.
The percentage of mutual funds in various categories that were outperformed by their benchmark over a five-year period is shown in the figure.
The figure focuses on a five-year investment horizon in part to smooth out the volatility of year-to-year performance but also because investors want to know whether actively managed funds can deliver superior performance consistently.
A majority of portfolio managers trail their benchmark.
The majority of managers failed to earn a higher five-year return than their benchmark.
Most junk bond funds and most long-term bond funds are trailing their benchmarks.
It's difficult to beat the market with the services of professional money managers.
Only one fund category had a majority of funds that beat the market over the course of five years.
Consistently beating the market is not easy for a professional money manager.
Most mutual funds don't meet the levels of performance that a handful of funds have given investors.
This doesn't mean that the long-term returns from mutual funds are substandard or that they don't equal what you could achieve by putting your money in a savings account.
The long-term returns from mutual funds have been substantial and even better than what many indi vidual investors could have achieved on their own, but a good deal of those returns can be traced to strong market conditions and/or the reinvestment of dividends and capital gains.
It's tempting to think of a mutual fund as a single large entity.
Investments, record keeping, safekeeping, and others are split among two or more companies.
There is a separate trust for the fund.
The shareholders own it, not the firm that runs it.
The practice resembles a place to invest money.
It was a big shock to investors when they bet on a winning horse after the horse race.
Market timing in violation of funds that offer many different funds give investors the written policies and other abuses.
The investment company's other funds were dragged by the compa option of investing in a fund that only holds shares of nies.
Some of the abuses stem from market timing, but instead decides how to allocate investors' dollars a practice in which short-term traders seek to exploit across different mutual funds.
This company's funds are hit by a large practice.
A U.S. mutual fund holds a Japanese request for withdrawals.
The stocks could be forced by such an event.
The net discount prices to raise cash and lower the fund's asset value will be calculated as a result of the Japanese market closing at 14 hours before the U.S. market.
The U.S. market has a strong rally if she reallocates some dollars under her Monday.
It is very likely that stocks will withdraw and sell shares in other funds not open higher on Tuesday morning in Japan because of the pressure to distribute cash to shareholders.
Buying shares in the mutual fund can help the fund family as a whole, but not buy Japanese stocks at prices that are the shareholders in the fund of funds.
The prices do not reflect the good in the news that the U.S market rallied on Monday.
The family hit by redemption requests without being the fund's net asset value is reflected in the prices in Japan.
When the U.S. market goes "fund of funds" harmed if their fund manager down, traders can earn profits that are far above purchases of shares in another fund that has been hit by normal.
They created the funds in the first place.
The management firm is an investment advisor.
You deal with the distributor when you request a prospectus.
An independent party serves in this capacity to discourage foul play.
mutual fund shareholders are protected by the separation of duties.
If your fund's stock or bond holdings go down in value, you can lose money as a mutual fund investor, but that's usually the only risk you face with a mutual fund.
One of the provisions of the contract between the mutual fund and the company that manages it is that the fund's assets-- stocks, bonds, cash, or other securities in the portfolio--can never be in the hands of the management.
Each fund must have a board of directors, or trustees, who are elected by shareholders, who are charged with keeping an eye on the management company.
Some mutual funds have engaged in some improper trading which resulted in losses for their investors.
New shares are given to investors when they send money to an open-end fund.
There is no limit to the number of shares that the mutual fund can issue, and as long as new money flows in from investors, the portfolio of securities grows.
When investors withdraw their money from the fund, the fund manager redeems their shares in cash.
Fund shareholders may force the fund manager to sell securities in order to get the cash to distribute to investors.
A fire sale is when a fund needs to raise cash quickly.
In a fire sale, the fund may have to reduce the price of the bonds it wants to sell.
The discounted price that buyers receive on the securities that they purchase from the fund is a form of compensation that they earn for providing that liquidity.
To avoid having to sell securities at fire-sale prices and to reward investors who leave their money in the fund for a long time, some funds charge redemption fees.
Unlike other fees that mutual funds charge, the redemption fees are reinvested into the fund.
When investors decide to sell their shares, all open-end mutual funds buy them back.
There is no trading of shares between individuals.
Open-end funds are the majority of mutual funds in the United States.
When investors buy and sell shares of an open-end fund, they do so based on the current market value of all the securities held in the fund's port folio and the number of shares the fund has issued.
The NAV is the total market value of securities held in the fund.
Open-end funds usually calculate their NAVs at the end of the day, and it is at that price that withdrawals from or contributions to the fund take place.
As the prices of the securities that the fund holds change, a fund's NAV changes throughout the day.
Transactions between open-end funds and their customers occur at the end of the day.
If you put new money into the fund, you will get one new share for every $20 you invest.
If investors liquidate their investment in the fund, they will receive $20 for each share of the fund they own.
The closed-end fund is an alternative mutual fund structure.
The fund raises money by issuing shares to investors and then invests that money in securities.
There are no new investments allowed in the fund.
The shares of closed-end investment companies are traded in the secondary market.
Unlike open-end funds, all trading in closed-end funds is done between investors in the open market.
When an investor in a closed end fund wants to redeem shares, he or she does not return them to the fund for cash, as would be the case with an open-end fund.
The investor sells the shares on the open market to someone else who wants to invest in the fund.
Buying and selling shares in closed-end funds is just like buying and selling shares in a company.
If you want to acquire shares in a particular fund, you have to buy them from other investors who already own them.
An important difference between closed-end and open-end funds is that investors in closed-end funds buy and sell their shares in the secondary market.
The NAV is the market value of assets held by the fund divided by the outstanding shares.
Closed-end fund investors trade their shares during the trading day at the fund's current market price, instead of buying or selling at the NAV at the end of the day.
In closed-end funds, the price of shares in the secondary market may or may not equal the fund's NAV.
When a closed-end fund's share price is below its NAV, the fund is said to be trading at a discount, and when the share price exceeds the fund's NAV, the fund is trading at a premium.
There is more to be said about how closed-end fund discounts and premiums affect investors' returns.
The capital at the disposal of closed-end funds is fixed because they don't have to deal with daily outflows of cash from investors.
Managers of these funds don't need to keep cash on hand to satisfy redemption requests, and they don't need to constantly search for new investment opportunities because more investors want to be part of the fund.
Most closed-end investment companies are traded on the New York Stock Exchange.
In the United States, closed-end funds had a total of $289 billion in assets, of which 60 percent were held in bond funds.
An exchange-traded fund is an investment company that combines some of the operating characteristics of an open-end fund with some of the trading characteristics of a closed-end fund.
Exchange-traded portfolios are sometimes referred to as exchange-traded funds.
When the SEC cleared the way for actively managed mutual funds in 2008, most of the exchange traded funds were structured as index funds.
A company called Smart Investors wants to create an exchange traded fund.
APs have the ability to acquire a large quantity of shares relatively quickly.
The AP acquires a portfolio of shares in which all of the companies in the S&P 500 Index are represented, and in proportions that match those of the index, and delivers those shares to Smart Investors, who then place the shares in a trust.
Smart Investors gives the AP a block of equally valued shares.
50,000 shares per creation unit is a common structure for the number of shares in one creation unit.
Each share rep resents a claim against the shares held in trust.
The shares that the AP sells to investors are used to start trading on the secondary market.
The total market value of all the stocks in the portfolio is $100 million.
The AP transfers these shares to Smart Investors, who in turn issues 100 creation units containing 50,000 shares each to the AP.
The value of the shares held in trust is equal to the total value of the shares sold to investors.
The value of the securities held in the trust will affect the share price of the exchange traded fund.
As closed-end funds do, ETFs give investors access to liquid assets.
During trading hours, investors can buy or sell their shares.
A closed end fund may have a fixed number of shares.