Some funds invest almost solely in common stocks; others invest in preferred stocks, bonds, and so forth. Within common stock funds, wide differences are found in emphasis, including funds that focus on growth companies, small-cap stocks, companies in specific industries (e.g., Chemical Common Stock
Funds Fund Management Fees
1080 CHAPTER 25 PROFESSIONALASSETMANAGEMENT
Fund, Oceanography Fund), certain classes of industry (e.g., Technology Fund), or even geo- graphic areas (such as the Northeast Fund or international funds). Different common stock funds can suit almost any taste or investment objective. Therefore, you must decide whether you want a fund that invests only in common stock; then you must consider the type of common stock you desire. Exhibit 25.9 provides a list of some of the more popular mutual fund objectives and defin- itions for those objectives.
Balanced fundsdiversify outside the stock market by combining common stock with fixed- income securities, including government bonds, corporate bonds, convertible bonds, or preferred stock. The ratio of stocks to fixed-income securities will vary by fund, as stated in each fund’s prospectus. Flexible portfolio (or asset allocation) fundsseek high total returns by investing in a mix of stocks, bonds, and money-market securities.
Bond funds concentrate on various types of bonds to generate high current income with minimal risk. They are similar to common stock funds; however, their investment policies differ. Some funds concentrate on U.S. government or high-grade corporate bonds, others hold a mixture of investment-grade bonds, and some concentrate on high-yield (junk) bonds. Management strate- gies also can differ, ranging from buy and hold to extensive trading of the portfolio bonds.
In addition to government, mortgage, and corporate bond funds, a change in the tax law in 1976 caused the creation of numerous municipal bond funds. These funds provide investors with monthly interest payments that are exempt from federal income taxes, although some of the interest may be subject to state and local taxes. To avoid the state tax, some municipal bond funds concentrate on bonds from specific states, such as the New York Municipal Bond Fund, which allows New York residents to avoid most state taxes on the interest income.
Money market fundswere initiated during 1973 when short-term interest rates were at record levels. These funds attempt to provide current income, safety of principal, and liquidity by investing in diversified portfolios of short-term securities, such as Treasury bills, banker certifi- cates of deposit, bank acceptances, and commercial paper. They typically are no-load funds and impose no penalty for early withdrawal. Also, they generally allow holders to write checks against their account.6Exhibit 25.10 documents the significant growth of these funds. Changes in their growth rate usually are associated with investor attitudes toward the stock market. When investors are bullish toward stocks, they withdraw funds from their money market accounts to invest; when they are uncertain, they shift from stocks to the money funds.
Exhibit 25.11 groups funds by their method of sale and by investment objectives. The two major means of distribution are (1) by a sales force and (2) by direct purchase from the fund or direct marketing. Sales forces would include brokers, such as Merrill Lynch; commission-based finan- cial planners; or dedicated sales forces, such as those of American Express Retirement Services.
Almost all mutual funds acquired from these individuals charge sales fees (loads) from which salespeople are compensated.
Investors typically purchase shares of directly marketed funds through the mail, telephone, bankwire, or an office of the fund. These direct sales funds usually impose a low sales charge or none at all. In the past, because they had no sales fee, they had to be sold directly because a Breakdown
by Fund Characteristics Money Market Funds Bond Funds Hybrid Funds
6For a list of names and addresses of money market funds, write to Investment Company Institute, 1775 K Street N.W., Washington, DC 20006.
Capital Appreciation Funds seek capital appreciation; dividends are not a primary consideration
• Aggressive growth funds invest primarily in common stocks of small, growth
companies.
• Growth funds invest primarily in common stocks of well-established companies.
• Sector funds invest primarily in companies in related fields.
Total Return Funds seek a combination of current income and capital appreciation.
• Growth and income funds invest primarily in common stocks of established companies with the potential for growth and a consistent record of dividend payments.
• Income equity funds invest primarily in equity securities of companies with a consistent record of dividend payments.
They seek income more than capital appreciation.
World Equity Funds invest primarily in stocks of foreign companies.
• Emerging market funds invest primarily in companies based in developing regions of the world.
• Global equity funds invest primarily in equity securities traded worldwide, including those of U.S. companies.
• International equity funds invest primarily in equity securities of companies located outside the United States.
• Regional equity funds invest in companies based in a specific part of the world.
Hybrid Funds
Hybrid Funds may invest in a mix of equities, fixed-income securities, and derivative instruments.
• Asset allocation funds invest in various asset classes including, but not limited to, equities, fixed-income securities, and money market instruments. They seek high total return by maintaining precise weightings in asset classes. Global asset allocation funds invest in a mix of equity and debt securities issued worldwide.
• Balanced funds invest in a mix of equity securities and bonds with the three-part objective of conserving principal, providing income, and achieving long-term growth of both principal and income. These funds maintain target percentages in asset classes.
• Flexible portfolio funds invest in common stocks, bonds, other debt securities, and money market securities to provide high total return. These funds may invest up to
may easily change weightings depending upon market conditions.
• Income-mixed funds invest in a variety of income-producing securities, including equities and fixed-income instruments. These funds seek a high level of current income without regard to capital appreciation.
Taxable Bond Funds
Corporate Bond Funds seek current income by investing in high-quality debt securities issued by U.S. corporations.
• Corporate bond funds—general invest two- thirds or more of their portfolios in U.S.
corporate bonds with no explicit restrictions on average maturity.
• Corporate bond funds—intermediate-term invest two-thirds or more of their portfolios in U.S. corporate bonds with an average maturity of five to 10 years. These funds seek a high level of income with less price volatility than longer-term bond funds.
• Corporate bond funds—short-term invest two-thirds or more of their portfolios in U.S. corporate bonds with an average maturity of one to five years. These funds seek a high level of income with less price volatility than intermediate-term bond funds.
High-Yield Funds invest two-thirds or more of their portfolios in lower-rated U.S.
corporate bonds (Baa or lower by Moody’s and BBB or lower by Standard and Poor’s rating service.)
World Bond Funds invest in debt securities offered by foreign companies and
governments. They seek the highest level of current income available worldwide.
• Global bond funds—general invest in worldwide debt securities with no stated average maturity or an average maturity of five years or more. These funds may invest up to 25 percent of assets in companies located in the United States.
• Global bond funds—short-term invest in debt securities worldwide with an average maturity of one to five years. These funds may invest up to 25 percent of assets in companies located in the United States.
• Other world bond funds, such as international bond and emerging market debt funds, invest in foreign government and corporate debt instruments. Two-thirds of an international bond funds portfolio must be invested outside the United States.
Emerging market debt funds invest primarily in debt from underdeveloped regions of the world.
government bonds of varying maturities. They seek high current income.
• Government bond funds—general invest two-thirds or more of their portfolios in U.S. government securities of no stated average maturity. Securities utilized by investment managers may change with market conditions.
• Government bond funds—intermediate- term invest two-thirds or more of their portfolios in U.S. government securities with an average maturity of five to 10 years. Securities utilized by investment managers may change with market conditions.
• Government bond funds—short-term invest two-thirds or more of their portfolios in U.S. government securities with an average maturity of one to five years. Securities utilized by investment managers may change with market conditions.
• Mortgage-backed funds invest two-thirds or more of their portfolios in pooled mortgage-backed securities.
Strategic Income Funds invest in a combination of U.S. fixed-income securities to provide a high level of current income.
Tax-Free Bond Funds
State Municipal Bond Funds invest primarily in municipal bonds issued by a particular state. These funds seek high after- tax income for residents of individual states.
• State municipal bond funds—general invest primarily in single-state municipal bonds with an average maturity of greater than five years or no specific stated maturity.
The income from these funds is largely exempt from federal as well as state income tax for residents or the state.
• State municipal bond funds—short-term invest primarily in single-state municipal bonds with an average maturity of one to five years. The income of these funds is largely exempt from federal as well as state income tax for residents of the state.
National Municipal Bond Funds invest primarily in the bonds of various municipal issuers in the United States. These funds seek high current income free from federal tax.
• National municipal bond funds—general invest primarily in municipal bonds with an average maturity of more than five years or no specific stated maturity.
• National municipal bond funds—short-term invest primarily in municipal bonds with an average maturity of one to five years.
Source: 2002 Mutual Fund Fact Book, Copyright © 2002 Investment Company Institute. Reprinted by permission of the Investment Company Institute (www.ici.org).
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TAXABLE MONEY MARKET FUNDS (MILLIONS OF DOLLARS)
TOTAL AVERAGE TOTAL AVERAGE
NUMBER ACCOUNTS MATURITY TOTALNET NUMBER ACCOUNTS MATURITY TOTALNET
YEAR OFFUNDS OUTSTANDING (DAYS) ASSETS YEAR OFFUNDS OUTSTANDING (DAYS) ASSETS
1976 48 180,676 110 $ 3,685.8
1977 50 177,522 76 3,887.7
1978 61 467,803 42 10,858.0
1979 76 2,307,852 34 45,214.2
1980 96 4,745,572 24 74,447.7
1981 159 10,282,095 34 181,910.4
1982 281 13,101,347 37 206,607.5
1983 307 12,276,639 37 162,549.5
1984 329 13,556,180 43 209,731.9
1985 348 14,435,386 42 207,535.3
1986 360 15,653,595 45 228,345.8
1987 389 16,832,666 34 254,676.4
1988 434 17,630,528 31 272,293.3
Source: 1996 and 2002 Mutual Fund Fact Books, Copyright © 1996 and 2002 Investment Company Institute. Reprinted by permission of the Investment Company Institute (www.ici.org).
EXHIBIT 25.10
1989 470 20,173,265 40 $ 358,719.2
1990 506 21,577,559 47 414,733.3
1991 553 21,863,352 56 452,559.2
1992 585 21,770,693 58 451,353.4
1993 628 21,586,862 59 461,903.9
1994 646 23,339,838 38 500,635.5
1995 674 27,859,258 57 629,985.8
1996 666 29,907,471 54 761,989.0
1997 682 32,960,628 55 898,083.1
1998 685 36,442,150 56 1,163,166.7
1999 702 41,177,138 49 1,408,731.0
2000 703 45,479,697 51 1,607,248.2
2001 689 44,414,701 58 2,012,949.4
broker had no incentive to sell a no-load fund. This has changed recently because some broker- age firms, most notably Charles Schwab & Co., have developed agreements with specific no- load funds whereby they will sell these funds to their clients and collect a fee from the fund. As of March 2002, Schwab had a list of more than 1,100 no-load funds that they would sell through their OneSource service. As seen in the most recent figures available in Exhibit 25.11, the divi- sion between these two major distribution channels is currently about 60 to 40 percent in favor of the sales force method, although there has been a steady shift toward direct institutional mar- keting. Given the investor preference for no-load funds and the increasing availability through firms like Charles Schwab, this trend toward direct marketed funds should continue.
The breakdown by investment objective indicates the investment companies’ response to a shift in investor emphasis. The growth of an alternative investment objective category reflects not only the overall growth of the industry but also the creation of new funds in response to the evolving demands of investors. For example, aggressive growth, growth, and growth and income funds have continued to grow and generally increased their percentages. Finally, the growing desire for international diversification is reflected in the ongoing popularity of world equity funds. This trend is discussed more thoroughly in the next section.