A mutual fund invests in a diversified portfolio of securities and issues shares in the portfolio to individual investors. Mutual funds represent ownership in a managed portfolio of securities. The mutual fund concept revolves around diversification. Diversification reduces the overall risk borne by the investor without reducing the average return. This, together with the fact that mutual funds provide professional management which free individual investors from managing their own portfolios, makes mutual funds attractive to individuals.The major advantage of a mutual fund is the provision of diversification and full-time professional management. Investors with modest amounts of capital can invest in mutual funds and receive these advantages. In addition, mutual funds also handle all paperwork and record keeping, deal in fractional shares, and automatically reinvest dividends, if the investor so desires.There are several disadvantages, however. Funds can be quite expensive to acquire if they are load funds or have other types of charges and fees such as 12(b)-1 fees. While it’s expected that index-based, passively-managed mutual funds will have a slightly lower return than that of the market covered, actively-managed mutual funds, haven’t performed that well, either. Only a few have been able to outperform the market with any degree of regularity and their performance, generally, has corresponded only to the performance of the market as a whole. This is because of the high expenses which reduce investor returns.Mutual funds are open-ended investment companies. Investors in mutual funds are essentially buying a small piece of a large, well-diversified portfolio of securities. Mutual funds receive money from shareholders and invest it in a securities portfolio. Investors in a given mutual fund are all part-owners of that portfolio.An open-end investment company is a mutual fund in which investors buy their shares from and sell them back to the mutual fund, itself (direct investing.) There is no limit on the number of shares an open-end fund can issue. They are, by far, the most common type of mutual fund.An exchange-traded fund (ETF) is a type of open-end investment company (its assets are primarily a portfolio of securities) that trades as a listed security on one of the stock exchanges. It’s a hybrid product that combines some of the best features of mutual funds with closed-end funds.Like mutual funds, hedge funds sell shares (or participation units) in a professionally managed portfolio of securities. However, hedge funds are private partnerships that limit their clientele to ‘accredited investors.’ The manager is a general partner, while the investors are limited partners. There also tends to limit the number of limited partners to fewer than 100. Hedge funds have very limited reporting requirements to the SEC and are generally unregulated.A load fund is a mutual fund that charges a commission to purchase fund shares. A no-load fund does not charge investors a commission. No-load funds offer an advantage because, by avoiding commissions (can be as high as 8.5%), they can buy more fund shares with a given amount of capital. Other things being equal, this results in a higher rate of return.A mutual fund can legally refer to itself as a no-load fund if it charges no more that ¼ of a percent (.25%) in annual 12(b)-1 fees. A true no-load fund doesn’t charge any 12(b)-1 fees. Load funds can charge a maximum of 1% annual 12(b)-1 fees. 12(b)-1 funds are annual charges and can significantly reduce returns over time.Chapter 13Review Questions and Answers1. What is a mutual fund? Discuss the mutual fund concept, including the importance of diversification and professional management. A mutual fund invests in a diversified portfolio of securities and issues shares in the portfolio to individual investors. Mutual funds represent ownership in a managed portfolio of securities. Themutual fund concept revolves around diversification. Diversification reduces the overall risk borne by the investor without reducing the average return. This, together with the fact that mutual funds provide professional management which free individual investors from managing their own portfolios, makes mutual funds attractive to individuals.2. What are the advantages and disadvantages of mutual fund ownership?The major advantage of a mutual fund is the provision of diversification and full-time professional management. Investors with modest amounts of capital can invest in mutual funds and receive these advantages. In addition, mutual funds also handle all paperwork and record keeping, deal in fractional shares, and automatically reinvest dividends, if the investor so desires.There are several disadvantages, however. Funds can be quite expensive to acquire if they are load funds or have other types of charges and fees such as 12(b)-1 fees. While it’s expected thatindex-based, passively-managed mutual funds will have a slightly lower return than that of the market covered, actively-managed mutual funds, haven’t performed that well, either. Only a fewhave been able to outperform the market with any degree of regularity and their performance, generally, has corresponded only to the performance of the market as a whole. This is because ofthe high expenses which reduce investor returns.3. Briefly describe how mutual funds operate. Mutual funds are open-ended investment companies. Investors in mutual funds are essentially buying a small piece of a large, well-diversified portfolio of securities. Mutual funds receive money from shareholders and invest it in a securities portfolio. Investors in a given mutual fund are all part-owners of that portfolio.4. Define each of the following:a. Open-end investment companyAn open-end investment company is a mutual fund in which investors buy their shares from and sell them back to the mutual fund, itself (direct investing.) There is no limit on the number of shares an open-end fund can issue. They are, by far, the most common type of mutual fund.b. Closed-end investment companyA closed-end investment company is a fund that issues a fixed number of outstanding shares and does not regularly issue new stock shares. These funds, which are relatively few when compared to the number of open-end funds, operate with a fixed capital structure (relationship of debt to equity that a company has) and trade in the stock
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