Investment Companies

Some nomenclature

Types (management companies)–Open-end (mutual fund): continuously sells and redeems (all transactions with issuer)–Closed-end: fixed number of shares issued (all post-issue transactions on market)

Mutual fund structure–Fund adviser, distributor, directors–Family of funds (nature of ownership - mutual or for-profit)

Competition–Insurance “special accounts” - variable annuities–Bank “agency accounts”

How does mutual fund operate?

Services• Investment (diversification)• Voting • Marketing/advertising• Management

Fees and expenses• Marketing/advertising fees• Advisory and investment expenses • Management expenses

QUESTIONS:• How are mutual funds regulated? Why must mutual funds register? • Why are mutual funds diversified? What does this mean? (75% of portfolio - not more

than 5% in any one issuer, not more than 10% of stock of any one issuer)• Reason for extensive federal regulation? Focus - disclosure, structure, ex ante

prohibitions, ex post enforcement?

Types of portfolios

Equity (more US mutual funds than US publicly-traded operating companies)• Growth• Large-cap• Small-cap• Index• Sector• International/global

Debt• Long-term• Short-term• Money market (priced daily so # shares = # dollars)• Government• Tax-free municipal• Junk bonds

QUESTIONS• What drives investor choice of funds?• How do MF investors allocate their investments?• How do MF investors re-allocate their investments?• Do mutual funds outperform the market (consider fees, expenses, taxes)?

The mutual fund “gorilla”Size (equity and debt)• 2003 - $7,000 billion• 1999 - $5,500 billion• 1989 - $900 billion

Percentage (US public equity market)• 2003 - 25.0%*• 2000 - 21.4% • 1995 - 14.6% • 1990 - 6.9%• 1985 - 5.3%

• Under management – 33%

How is mutual fund managed?

Mutual fund adviser does it all• sets up fund (organized as corporation or business trust) • chooses investment style • puts in initial board of directors

Directors (or trustees) are ostensible watchdogs• approves advisory contract• approves fees• supervises conflicts of interest

Computation of value • Rule 22c-1: NAV at least once daily• industry practice: 4:00pm EST

QUESTIONS:• Compare mutual fund to an operating corporation?• Do (should) MF directors function like corporate directors?