Week 11

The Philippine Stock Exchange

Topic/s: ❖Mutual Funds
INTRODUCTION
When people think of investing, they tend to think of stocks and bonds, investing in
companies that create productivity, employment, and profit. Investments in stocks and
bonds are ways of sharing in that profit and ultimately in economic growth.
While companies are the engines of economic growth, other assets such as real estate
and commodities—natural resources or raw materials—fuel those engines. Increased
market transparency and access, largely through the technologies of the Internet and
global communications, have made it possible for more investors to invest in the “fuels”
as well as the “engines” of commerce. Real estate and commodities investing have
become increasingly popular as diversifiers for a sound investment portfolio.
Mutual funds are not another kind of asset but another way of investing in any kind of
asset.
A mutual fund can also provide security selection, expertise, liquidity, and convenience.
Some funds are even designed to perform the asset allocation task for the investor.
Mutual funds are fast becoming the dominant investment vehicle for individual investors,
changing the role of the broker and financial advisor.
LEARNING CONTENT
Mutual Funds
A mutual fund is a portfolio of securities, consisting of one type of security or a
combination of several different types. A fund serves as a convenient way for an
investor to have a diversified portfolio of investments in just about any investable
asset. The oldest mutual fund is believed to have been founded by Adriaan van
Ketwich in 1774. Ketwich invited investors to contribute to a trust fund to spread the
risk of investing in foreign bonds. The idea moved from the Netherlands to Scotland
to the United States, where the Boston Personal Property Trust established the first
mutual fund in 1893.
Mutual funds play a significant role in individual investment decisions.
A mutual fund also provides stock and bond issuers with a mass market. Rather than
selling shares to investors individually (and incurring the costs of doing so), issuers can
more easily find a market for their shares in mutual funds.

Structures and Types of Mutual Funds

Like stocks and bonds, mutual funds may be actively or passively managed.
Actively managed funds provide investors with professional management and the
expected research, analysis, and watchfulness that goes with it. Passively
managed index funds, on the other hand, are designed to mirror the performance of
a specific index constructed to be representative of an asset class. Recall, for
example, that the PSE Index is designed to mirror the performance of the large cap
stocks in the Philippines.
Closed-end funds are funds for which a limited number of shares are issued. Once all
shares have been issued, the fund is “closed” so a new investor can only buy shares from
an existing investor. Since the shares are traded on an exchange, the limited supply of
shares and the demand for them in that market directly determines the value of the shares
for a closed-end fund.
Most mutual funds are open-end funds in which investors buy shares directly from the
fund and redeem or sell shares back to the fund. The price of a share is its net asset value
(NAV), or the market value of each share as determined by the fund’s assets and
liabilities and the number of shares that exist. Here is the basic formula for calculating
NAV:
NAV = (market value of fund securities − fund liabilities) ÷ number of
shares outstanding.
Demand for shares is reflected in the number of shares outstanding, because the fund
can create new shares for new investors. NAV calculations are usually done once per
day at the close of trading, when mutual fund transactions are recorded.
The NAV is the price that the fund will pay you when you redeem your shares, so it is a
gauge of the shares’ value. It will increase if the market value of the securities in the fund
increases faster than the number of new shares.
Exchange-traded funds (ETFs) are structured like closed-end funds but are traded
like stocks. Shares are traded and priced continuously throughout the day’s trading
session, rather than once per day at the end of trading. ETFs trade more like individual
securities; that is, if you are trying to time a market, they are a livelier asset to trade than
open-end or closed-end funds.

Originally designed as index funds, exchange-traded funds now target just about every
asset, sector, and economic region imaginable.
Shares of closed-end funds and exchange-traded funds are bought and sold on
exchanges, much like shares of stock. You would go through a broker to make those
transactions. Shares of open-end funds may be bought and sold directly from the fund
sponsor, a mutual fund company, or investment manager.

COMPANY FUND NAME

FAMI First Metro Phil. Equity Exchange Traded Fund, Inc.
Philequity Philequity PSE Index Fund Inc.
ALFM Philippine Stock Index Fund Corp.
Sun Life Sun Life Prosperity Philippine Stock Index Fund, Inc.
Philam PAMI Equity Index Fund, Inc.
FAMI First Metro Save and Learn Philippine Index Fund, Inc.
You can make those transactions at any of the company’s offices, by telephone, or online.
Other types of Mutual Funds are the following:

Mutual funds that own shares in other mutual funds rather than
in specific securities. If you decide to use mutual funds rather
Funds of than select securities, a fund of funds will provide expertise in
funds choosing funds. Funds of stocks and bonds that manage
portfolio risk based on age or the time horizon for liquidity
needs.
Lifestyle funds perform both security selection and asset allocation
for investors, determined by the target date. For example, if you were
now thirty years old, you might choose a lifestyle fund with a target
Lifestyle date of thirty-five years from now for your retirement savings. As the
funds fund approaches its target date, its allocation of investments in
stocks and bonds will shift to carry less risk as the target nears.
Lifestyle funds are used primarily in saving for retirement; many are
created as funds of funds.
Funds that invest both investors’ money and money that the fund
Leveraged borrows to augment the investable assets and thus potential returns.
funds Because they use borrowing, leveraged funds are riskier than funds
that do not use leverage.
Funds that aim to increase in value when the market declines, to be
countercyclical to index funds, which aim to increase in value when
the market rises. Inverse funds, also called bear funds, are set up to
Inverse funds perform contrary to the index. Since most economies become more
productive over time, however, you can expect indexes to rise over
time, so an inverse fund would make sense only as a very short-term
investment.

Mutual Fund Fees and Returns

All funds must disclose their fees to potential investors: sales fees, management fees,
and expenses. A load fund charges a sales commission on each share purchase. That
sales charge (also called a front- end load) is a percentage of the purchase price. A no-
load fund, in contrast, does not charge a sales commission, because shares may be
purchased directly from the fund or through a discount broker. The front-end load can be
as much as 8.5 percent, so if you plan to invest often or in large amounts, that can be a
substantial charge. For example, a Php250,000 investments may cost you 21,250,
reducing the amount you have to invest and earn a return.
A fund may charge a management fee on an annual basis. The management fee is stated
as a fixed percentage of the fund’s asset value per share. Management fees can range
from 0.1 percent to 2.0 percent annually. Typically, a more actively managed fund can
be expected to charge a higher management fee, while a passively managed fund such
as an index fund should charge a minimal management fee.
A fund may charge an annual distribution fee, also calculated as not more than 1.0
percent per year of the fund’s asset value. Some mutual funds charge other extra fees
as well, passing on fund expenses to shareholders. You should consider fee structure
and rate when choosing mutual funds, and this can be done through calculations of the
expense ratio.
Taken together, the annual management, distribution, and expense fees are measured
by the expense ratio—the total annual fees expressed as a percentage of your total
investment. The expense ratio averages around 0.99 percent for all mutual funds, but it
may be more than 2 percent of your investment’s value.
That may not sound like much, but it means that if the fund earns a 5 percent return,
your net return may be less than 3 percent (and after taxes, it’s even less). When
choosing a fund, you should be aware of all charges—especially annual or ongoing
charges—that can affect your investment return.
Say you invest in a load fund with a 5 percent front-end load and an expense ratio of
2.25 percent and suppose the fund earns a 5 percent return.
Expenses can be a significant determinant of your net return, and since expenses vary
by fund, fund strategy (active or passive), and fund sponsor, you should shop around and
understand what your costs of investing will be.
Owning shares of a mutual fund means owning shares in a pool of assets. The returns of
the fund are the returns of those assets: interest, dividends, or gains (losses). Income
may come from interest distribution if the fund invests in bonds or interest-producing
assets or as dividend distribution if the fund invests in stocks.
The table shows how your 5,000 investment would look after one year.

Mutual funds buy and sell or “turn over” the fund assets. Even passively managed funds
need to rebalance to keep pace with their benchmarks as market values change.
The turnover ratio is the percentage of fund assets that have been turned over or
replaced in the past year, a measure of the fund’s trading activity.
Turnover can create capital gains or losses. Periodically, usually once per year, the
fund’s net capital gains (or losses) are distributed on a per share basis as a capital gains
distribution. You would expect turnover to produce more gains than losses. The more
turnover, or the higher the turnover ratio, the greater the capital gains distributions you
may expect. A higher turnover ratio may mean a higher tax expense for capital gains
distributions. Most open-end mutual funds allow you the option of having your income
and gains distributions automatically reinvested rather than paid out, which means that
you may be paying taxes on earnings without ever “seeing” the money.
Mutual Fund Information and Strategies
All mutual fund companies must offer a prospectus, a published statement detailing the
fund’s assets, liabilities, management personnel, and performance record. You should
always take the time to read it and to take a closer look at the fund’s investments to make
sure that the fund will be compatible and appropriate to your investment goals.
For example, suppose you have an investment in an Index fund and now are looking for
a global stock fund to complement and diversify your holdings in domestic equities. You
go to the Web site of a large mutual fund company offering hundreds of funds. You find
a stock fund called “Global Stock Fund”—sounds like it’s just what you are looking for.
Looking closer, however, you can see that this fund is invested in the stocks of companies
in Germany, Japan, and the United Kingdom. While they are not domestic stocks, those
economies are similar to our economy, perhaps too similar to provide the diversity you
are looking for.
Or suppose you are looking for a bond fund to create income and security. You find a
fund called the “Investment Grade Fixed Income Fund.” On closer inspection, however,
you find that the fund does not invest only in investment-grade bonds but that
the average rating of its bonds is investment grade. This means that the fund invests in
many investment-grade bonds but also in some speculative-grade bonds to achieve
higher income. While this fund may suit your need for income, it may not be appropriate
for your risk tolerance.
Mutual fund companies make this information readily available on Web sites and in
prospectuses. You should always make the extra effort to be sure you know what’s in
your fund. In addition, mutual funds are widely followed by many performance analysts.
Rating agencies such as Philippine Rating Services Corporation and investment
publications such as Barron’s and Forbes track, analyze, and report the performance of
mutual funds. That information is available online or in print and provides comparisons of
mutual funds that you may find helpful in choosing your fund.
In print and online newspapers, mutual fund performance is reported daily in the form of
tables that compare the average returns of funds from week to week. Reported average
returns are based on the net asset value per share (NAVPS). Investors can use this
information to choose or compare funds and track the performance of funds they own.
In conclusion, since a mutual fund may be made up of any kind or many kinds of securities
(e.g., stocks, bonds, real estate, and commodities), it is not really another kind of
investment. Rather, it is a way to invest without specifically selecting securities, a way of
achieving a desired asset allocation without choosing individual assets.
Compared to actively managed funds, passively managed or index funds offer similar
diversification but with lower management fees and expense ratios because you aren’t
paying for market timing or security selection skills. The turnover ratio shows how passive
or active the fund management is. About half of all equity mutual funds have a turnover
ratio of less than 50 percent.
Performance history has shown that actively managed funds, on average, do not
necessarily outperform passively managed funds.
Since they usually have higher fees, any advantage created by active management is
usually canceled out by their higher costs. Still, there are investors who believe that some
mutual funds and mutual fund managers can, on average, outperform the markets or the
indexes that provide the benchmarks for passively managed funds.

*** END of LESSON ***