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Mutual Fund Investors: Divergent Profiles. Alan Palmiter & Ahmed Taha Wake Law 01 Oct 07. A pop quiz …. 4. Warren Buffet predicts that annual US stock returns over the next 10 years will be: 6.5% 9.6% 12.3% 21.7% 5. Past performance of stock funds generally predicts future returns. Yes

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Mutual fund investors divergent profiles

Mutual Fund Investors:Divergent Profiles

Alan Palmiter & Ahmed Taha

Wake Law

01 Oct 07



  • 4. Warren Buffet predicts that annual US stock returns over the next 10 years will be:

    • 6.5%

    • 9.6%

    • 12.3%

    • 21.7%

  • 5. Past performance of stock funds generally predicts future returns.

    • Yes

    • No

    • Only low-performing funds

  • Mutual fund investors say they pay attention more to fees than to performance.

    • True

    • False

  • Mutual funds are primarily owned by:

    • Individuals on their own

    • Individuals with retirement accounts

    • Institutional investors

  • Mutual funds mostly invest in:

    • Stocks

    • Bonds

    • Notes (money market)

      3. What have been annual returns (1926-2004):

    • Small-cap stocks

    • Large-cap stocks

    • Corporate bonds

    • Treasury bills


  • 10. What is a no-load fund? the next 10 years will be:

    • An unleveraged fund

    • A fund without sales charges

    • A fund without trading costs

    • A fund without withdrawal fees

  • 11. Think about your own largest mutual fund. What is --

    • Your current balance

    • Fund’s investment objectives

    • Fund’s sales charges, expense ratio, trading costs

    • Fund’s performance last year

  • 12. Consider your car/vehicle:

    • Its make, model, year

    • Its cost, MSRP, total miles, safety rating, gas efficiency

    • You get our point

7. As a mutual fund investor, you are entitled to:

  • Prospectus (before you invest)

  • Annual report (showing fund performance)

  • Statements (breakdown of expenses / fees / trading costs)

    8. Mutual funds only impose a sales charge at the time you invest.

  • True

  • False

    9. Annual rate that average stock fund sells and replaces stock (turnover) in its portfolio:

  • 6%

  • 56%

  • 90%

  • 153%


Us mutual fund market
US mutual fund market … the next 10 years will be:


US Households the next 10 years will be:

(112 million)

Own mutual funds

(55 million / 49%)

Demand-side

On own

46%

Retirement account

54%

Broker79%

Direct29%

IRAs48%

DC plans52%

Stocks 60%

Mutual funds ($11.3 T)

Bonds 17%

Money Mkt 23%

Fund Types


Supply side mutual fund market
Supply-side the next 10 years will be:mutual fund market …


Mutual fund market the next 10 years will be:

Next 15

groups

(35%)

Top 10

groups

(38%)

Rest

(27%)

Financial retirement market

Mutual

Funds

(27%)


Asset classes risk return primer
Asset classes the next 10 years will be:(risk/return primer)


12.7% the next 10 years will be:

Effect of investing $10,000 for 20 years …

3.7%


Mutual fund investor profiles demand side

Mutual fund investor profiles the next 10 years will be:(demand-side)


Industry profile
Industry profile the next 10 years will be:


ICI Investor Preferences (2006) the next 10 years will be:


ICI Investor Preferences (2006) the next 10 years will be:


“The 90 million fund shareholders’ the next 10 years will be:demand for investment performance and services at a competitive level

of fees and expenses continuously

impacts mutual funds.”

Paul Schott StevensICI President


Sec portrait
SEC portrait the next 10 years will be:

William O. Douglas:

”The investors’ advocate”


Investors will benefit from a uniform fee table and management’s discussion of fund performance

SEC (1983)

The number/types of funds has proliferated, increasing need for information to help investors compare and contrast alternatives.

SEC (Mar 29, 1995)

Many investors find prospectuses “unintelligible, tedious, and legalistic” … Investors need to be provided with clear and comprehensible information.

SEC (Feb 27, 1997)

Funds may resort to advertising techniques that create unrealistic investor expectations.

SEC (Mar 17, 2002)


Prospectus management’s discussion of fund performanceVFINX

  • Disseminated

    • after investment / then once annually

    • Including electronically / filed SEC

  • Disclosure

    • Investment strategies

    • Risks (narrative)

    • Performance (1/5/10 years)

    • Expenses (sales charge, 12b-1 fees, mgmt fees)

    • Turnover rate

  • Effect

    • Omissions in fund literature not fraudulent, if info in prospectus

Fund comparer

(SEC website / NASD)


Statement of management’s discussion of fund performance

Additional Information

  • Not disseminated

    • Available to investors (incorporated by ref into prospectus) / file SEC

    • No fraud liability if in SAI

  • Disclosure

    • Fund organization

    • Investment policies / limitations

    • Management of fund

    • Proxy voting policies

    • Financial statements

  • Can cover multiple funds

Only disclosure

of trading costs

(brokerage

commissions)


Annual and management’s discussion of fund performance

semi-annual statements

  • Disseminated

    • Send semi-annually to all investors

    • Available on SEC website

  • Disclosure

    • Annually, MDFP (what’s affecting performance, line graph comparison to relevant index)

    • Financials (including expenses, turnover rate)

    • List of portfolio holdings (now summary of significant holdings, chart of category breakdown)

Focus on performance,

not expenses


Advertising management’s discussion of fund performance

  • Regulated

    • SEC Rule 482 – must state where can get prospectus

    • NASD Rule 2210 – must file with Advertising Reg Dept

  • Disclosure

    • Can include performance data (standardized format)

    • Info beyond prospectus

  • Required disclaimer

    • “Consider investment objectives, risks, charges, expenses”

    • “Past performance does not guarantee future results”

No longer does info need

to be from prospectus


“The Commission should not be the arbiter management’s discussion of fund performanceof the appropriate level of fund fees. Whether fund fees are too high or too low is a question that we believe must be answered by competition in the marketplace, not by government intervention.”

Arthur LevittSEC Chair (1993-2001)


Sec attention to ici academic research
SEC attention to management’s discussion of fund performanceICI, academic research …


SEC citations (footnotes / rulemaking releases) management’s discussion of fund performance

* AARP survey of MF investors

** Textbook, Regulation of Investment Companies

*** Articles/studies on trading abuses (finance journals, SSRN)


Academic portrait
“Academic” portrait management’s discussion of fund performance

How many colors

do you see?


Investors behavior

Chase Returns management’s discussion of fund performance

Ignore Expenses

(but not Loads)

Ignorant of Objectives and Holdings

Inattentive to Risk

Behavior:

Investors chase hottest funds

Convex Flow-Return Relationship

Reality:

Little evidence of returns persistence: past returns generally don’t predict future returns

Investors’ Behavior


Investors behavior1

Chase Returns management’s discussion of fund performance

Ignore Expenses

(but not Loads)

Ignorant of Objectives and Holdings

Inattentive to Risk

Behavior:

Expense level generally doesn’t affect fund choices

More sensitive to loads

Reality:

Annual expenses greatly affect investors’ wealth

Investors’ Behavior


Value of 15 500
Value of $15,500 management’s discussion of fund performance

$336,730

Annual

Return

$232,104

$159.429

YEAR


Investors behavior2

Chase Returns management’s discussion of fund performance

Ignore Expenses

(but not Loads)

Ignorant of Objectives and Holdings

Inattentive to Risk

Behavior:

Most investors are unaware of their funds’ objectives or holdings

Implication:

Mismatch between investors’ objectives and funds’ objectives

Investors’ Behavior


Investors behavior3

Chase Returns management’s discussion of fund performance

Ignore Expenses

(but not Loads)

Ignorant of Objectives and Holdings

Inattentive to Risk

Behavior:

Expense level generally doesn’t affect fund choices

Implication:

Mismatch between funds’ risk and investors’ risk tolerance

Investors’ Behavior


Modest proposals

Modest proposals … management’s discussion of fund performance

(1) Point of sale disclosure

(2) Post-purchase statements


Fund XYZ performance management’s discussion of fund performance

Inv return Expenses/costs Net return

1-year 4.5% 2.1% 2.4%

5-years 7.6% 2.4% 5.2%

10-years 11.5% 1.9% 9.6%

20-years 8.9% 1.6% 7.3%


Your fund has about average expenses, but 40% of other similar funds have lower expenses.

You could be saving up to 2.2% on fund expenses.

Your statement(Fund XYZ)

Beginning balance $10,000

Investments $ 2,000

Withdrawals $ --

Investment return $ 850 7.7%

Expenses

Sales charge $ 60 0.5%

Adm/advisory fees $ 140 1.3%

Trading costs $ 80 0.7%

TOTAL $ 280 2.5%

Net return $ 570 5.2%

Ending balance $12,570

Expenses (compare to other comparable funds)

66% - lower expenses 34% - higher expenses

0.3%

2.5%

XYZ

6.3%


The end

The end similar funds have lower expenses.


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