Mutual Fund Industry Notes

The first mutual fund similar to today's funds was introduced in Boston in 1824.
The stock market crash of 1929 negatively impacted the mutual fund industry due to investor distrust.
The Investment Company Act of 1940 revitalized the industry by mandating better fee disclosure.
By the beginning of 2020, 47% of retirement assets were held in mutual funds.
Approximately 28% of the U.S. stock market and almost 44% of U.S. households invest in stocks through mutual funds.
Assets held by mutual funds have grown about 17% annually over the past 25 years, exceeding $23 trillion$ .

Total worldwide assets in mutual funds: $26.8 trillion$
U.S. Investment company total net assets: $14.7 trillion$
- Mutual funds: $13.0 trillion$
- Exchange-traded funds: $1.3 trillion$
- Closed-end funds: $265 billion$
- Unit investment trusts: $72 billion$
U.S. Investment companies' share of:
- U.S. corporate equity: 28%
- U.S. municipal securities: 28%
- Commercial paper: 42%
- U.S. government securities: 12%
U.S. household ownership of mutual funds:
- Number of households owning mutual funds: 53.8 million
- Number of individuals owning mutual funds: 92.4 million
- Percentage of households owning mutual funds: 44.4%
- Median mutual fund assets of fund-owning households: $100,000$
- Median number of mutual funds owned: 4
U.S. retirement market:
- Total retirement market assets: $19.5 trillion$
- Percentage of households with tax-advantaged retirement savings: 68%
- IRA and DC plan assets invested in mutual funds: $5.3 trillion$

Liquidity intermediation: Investors can easily convert investments to cash while the fund invests long-term.
Denomination intermediation: Investors can participate in equity and debt offerings requiring more capital than they have individually.
Diversification: Investors benefit from diversification, even with small investments.
Cost advantages: Mutual funds can negotiate lower transaction fees compared to individual investors.
Managerial expertise: Investors can rely on professional money managers to select investments.

Ownership in mutual funds has changed dramatically over the last 20 years.
- In 1980, only 5.7% of households held mutual fund shares.
- By the beginning of 2013, this number was approximately 50%.
Mutual funds account for $5.3 trillion$ of the retirement market, which is estimated at $19.5 trillion$ .

Investment companies typically offer various types of mutual funds.
Investors can often move investments among these funds without incurring penalties.
Complexes often issue consolidated statements for ease of tracking.

Closed-End Fund:
- A fixed number of nonredeemable shares are sold through an initial offering.
- These shares are then traded in the OTC (over-the-counter) market.
- The price is determined by supply and demand.
Open-End Fund:
- Investors can buy or redeem shares at any time.
- The price is determined by the net asset value (NAV) of the fund.

Definition: The total value of the mutual fund’s assets (stocks, bonds, cash, etc.) minus liabilities (accrued fees), divided by the number of shares outstanding.
Example:
- Stocks: $35,000,000$
- Bonds: $15,000,000$
- Cash: $3,000,000$
- Total value of assets: $53,000,000$
- Liabilities: – $800,000$
- Net worth: $52,200,000$
- Outstanding shares: 15 million
- NAV = rac{52,200,000}{15,000,000} = $3.48

Shareholders: The investors who own the mutual fund.
Board of Directors: Oversees the fund’s activities and hires:
- Investment advisor
- Underwriter
- Other parties to manage day-to-day operations.

Four primary classes:
1. Stock (equity) funds
2. Bond funds
3. Hybrid funds
4. Money market funds

Investment in common equity.
Specific objectives can vary widely:
- Capital Appreciation Funds: Seek rapid increase in share price, with less concern for dividends.
- Total Return Funds: Aim for a balance of current income and capital appreciation.
- World Equity Funds: Invest primarily in foreign firms.
- Other types: Value, Growth, specific industry funds, etc.

Strategic Income Funds: Invest mainly in U.S. corporate bonds, seeking a high level of current income.
Government Bond Funds: Invest in U.S. Treasury, state, and local government bonds.
Other types: World Bond Funds, etc.

Contain stocks that mimic a specific index (e.g., an S&P 500 index fund).
Offer benefits of traditional mutual funds but without the fees associated with a professional money manager.

Regulated by four primary laws:
- Securities Act of 1933: Specifies disclosure requirements.
- Securities Exchange Act of 1934: Details antifraud rules.
- Investment Company Act of 1940: Requires registration and minimal operating standards.
- Investment Advisors Act of 1940: Regulates fund advisors.

Mutual funds are required by law to have independent directors (2001 SEC rules):
- Independent directors must constitute a majority of the board.
- Independent directors select and nominate other independent directors.
- Legal counsel to the independent directors must also be independent.

Received attention following the collapse of Long-Term Capital Management (LTCM).
Differ from typical mutual funds:
- High minimum investment (averaging around $1 million$ ).
- Long-term commitment of funds required.
- High fees: Typically 2% of assets plus 20% of profits.
- Highly leveraged.
- Little current regulation.

Hedge funds often try to capitalize on unusual spreads between security prices.
Example: LTCM
- LTCM noticed that 29.5-year U.S. Treasury bonds seemed cheap relative to 30-year Treasury securities.
- They anticipated the values would converge over time.
- LTCM bought $2 billion$ of the 29.5-year bonds and sold short $2 billion$ of the 30-year bonds.
- Six months later, they reversed the transactions and realized a $25 million$ profit.

In 2006, the SEC passed regulations requiring hedge fund advisors to register with the SEC.
This was due to concerns about fraud and the increasing availability of hedge funds to average investors via “retailization.”