Investment Policies

Each mutual fund has a specified investment policy, which is described in the fund's prospectus. For example, money market mutual funds hold the short-term, low-risk instruments of the money market (see Chapter 2 for a review of these securities), while bond funds hold fixed-income securities. Some funds have even more narrowly defined mandates. For example, some fixed-income funds will hold primarily Treasury bonds, others primarily mortgage-backed securities.

Management companies manage a family, or "complex," of mutual funds. They organize an entire collection of funds and then collect a management fee for operating them. By managing a collection of funds under one umbrella, these companies make it easy for investors to allocate assets across market sectors and to switch assets across funds while still benefiting from centralized record keeping. Some of the most well-known management companies are Fidelity, Vanguard, Putnam, and Dreyfus. Each offers an array of open-end mutual funds with different investment policies. There were nearly 7,800 mutual funds at the end of 1999, which were offered by only 433 fund complexes.

Some of the more important fund types, classified by investment policy, are discussed next.

Money Market Funds These funds invest in money market securities. They usually offer check-writing features, and net asset value is fixed at $1 per share, so that there are no tax implications such as capital gains or losses associated with redemption of shares.

CHAPTER 4 Mutual Funds and Other Investment Companies 109

Equity Funds Equity funds invest primarily in stock, although they may, at the portfolio manager's discretion, also hold fixed-income or other types of securities. Funds commonly will hold between 4% and 5% of total assets in money market securities to provide liquidity necessary to meet potential redemption of shares.

It is traditional to classify stock funds according to their emphasis on capital appreciation versus current income. Thus, income funds tend to hold shares of firms with high dividend yields, which provide high current income. Growth funds are willing to forgo current income, focusing instead on prospects for capital gains. While the classification of these funds is couched in terms of income versus capital gains, it is worth noting that in practice the more relevant distinction concerns the level of risk these funds assume. Growth stocks and therefore growth funds are typically riskier and respond far more dramatically to changes in economic conditions than do income funds.

Fixed-Income Funds As the name suggests, these funds specialize in the fixed-income sector. Within that sector, however, there is considerable room for specialization. For example, various funds will concentrate on corporate bonds, Treasury bonds, mortgage-backed securities, or municipal (tax-free) bonds. Indeed, some of the municipal bond funds will invest only in bonds of a particular state (or even city!) in order to satisfy the investment desires of residents of that state who wish to avoid local as well as federal taxes on the interest paid on the bonds. Many funds will also specialize by the maturity of the securities, ranging from short-term to intermediate to long-term, or by the credit risk of the issuer, ranging from very safe to high-yield or "junk" bonds.

Balanced and Income Funds Some funds are designed to be candidates for an individual's entire investment portfolio. Therefore, they hold both equities and fixed-income securities in relatively stable proportions. According to Wiesenberger, such funds are classified as income or balanced funds. Income funds strive to maintain safety of principal consistent with "as liberal a current income from investments as possible," while balanced funds "minimize investment risks so far as this is possible without unduly sacrificing possibilities for long-term growth and current income."

Asset Allocation Funds These funds are similar to balanced funds in that they hold both stocks and bonds. However, asset allocation funds may dramatically vary the proportions allocated to each market in accord with the portfolio manager's forecast of the relative performance of each sector. Hence these funds are engaged in market timing and are not designed to be low-risk investment vehicles.

Index Funds An index fund tries to match the performance of a broad market index. The fund buys shares in securities included in a particular index in proportion to each security's representation in that index. For example, the Vanguard 500 Index Fund is a mutual fund that replicates the composition of the Standard & Poor's 500 stock price index. Because the S&P 500 is a value-weighted index, the fund buys shares in each S&P 500 company in proportion to the market value of that company's outstanding equity. Investment in an index fund is a low-cost way for small investors to pursue a passive investment strategy—that is, to invest without engaging in security analysis. Of course, index funds can be tied to nonequity indexes as well. For example, Vanguard offers a bond index fund and a real estate index fund.

Specialized Sector Funds Some funds concentrate on a particular industry. For example, Fidelity markets dozens of "select funds," each of which invests in a specific

Table 4.1 Classification of Mutual Funds as of December 31, 1999

Assets

% of

($ Billion)

Total

Common stock

Aggressive growth

$ 623.9

9.1%

Growth

1,286.6

18.8

Growth and income

1,202.1

17.6

Equity income

139.4

2.0

International

563.2

8.2

Emerging markets

22.1

0.3

Sector funds

204.6

3.0

Total equity funds

4,041.9

59.0

Bond funds

Corporate, investment grade

143.0

2.1

Corporate, high yield

116.9

1.7

Government and agency

78.8

1.2

Mortgage-backed

60.0

0.9

Global bond funds

23.6

0.3

Strategic income

114.2

1.7

Municipal single state

127.9

1.9

Municipal general

143.7

2.1

Total bond funds

808.1

11.8

Mixed asset classes

Balanced

249.6

3.6

Asset allocation and flexible

133.5

2.0

Total hybrid funds

383.2

5.6

Money market

Taxable

1,408.7

20.6

Tax-free

204.4

3.0

Total money market funds

1,613.1

23.6

Total

$6,846.3

100.0%

Note: Column sums subject to rounding error.

Source: Mutual Fund Fact Book, Investment Company Institute, 2000.

Note: Column sums subject to rounding error.

Source: Mutual Fund Fact Book, Investment Company Institute, 2000.

industry such as biotechnology, utilities, precious metals, or telecommunications. Other funds specialize in securities of particular countries.

Table 4.1 breaks down the number of mutual funds by investment orientation as of the end of 1999. Figure 4.2 is part of the listings for mutual funds from The Wall Street Journal. Notice that the funds are organized by the fund family. For example, the Vanguard Group funds are listed beginning at the bottom of the first column. The first two columns after the name of each fund present the net asset value of the fund and the change in NAV from the previous day. The last column is the year-to-date return on the fund.

Often the fund name describes its investment policy. For example, Vanguard's GNMA fund invests in mortgage-backed securities, the municipal intermediate fund (MuInt) invests in intermediate-term municipal bonds, and the high-yield corporate bond fund (HYCor) invests in large part in speculative grade, or "junk," bonds with high yields. You can see that Vanguard offers about 25 index funds, including portfolios indexed to the bond market (TotBd), the Wilshire 5000 index (TotSt), the Russell 2000 Index of small firms (SmCap), as well as European- and Pacific Basin-indexed portfolios (Europe and Pacific).

CHAPTER 4 Mutual Funds and Other Investment Companies 111

Figure 4.2 Listing of mutual fund quotations.

MUTUAL FUND QUOTATIONS

Mel YTD

Name NAV Cha Vet Van Kämpen Funds C:

AesßrC 120.50 - 0.67 +u:. AggrEQC t21.97 -0.40 +20.5 AmVsiC 131.71 —0.37 + 9,i AsianGi C 110.53 -0.« -MO.-' CmstCt 15.40 -0.21 ~ l.< EmgMktC t 9.20 -0.03 +36.1 EmCrC 157.1? -1.78 +25,4 ElltC t 20.20 -0.47 + 1.3 EqlncC t 7.65 -0,10 + 0,4 GEqAllC 116.24 -0.14 + 3.8 GlEqFdCt 11.05 -0.11 - 0,7 GrlncCt 18.55-0.31 + 1,5 Grwth C t 23,80 -0.66 + 7.2 GtfScC t 9,71 +0.04 - 2,9 HICpCi 5.58-0.01 + 1.0 HYAAuC t11.14 ...-0,3 HlHMägC f 14.IS - 0.G3 + 9.5 LallrAmCt 1D.«2 -0.Q6 -i-21,3 PaceCi 14.52-0.34 + 0.1 ReEslCt 11.15-Q.05 - 1.8 Techc f 11.48 "0.42 N5 TxFHCt 13.92 ... - i.c Vall/e C t-9,22 -0.16 - 3.7 WldHFIncC 19.75 +0.02 + 7.5 van wagoner Funds:

EmergGrot>».n -0.17+139.1 NicroCap b 23.24 -0.08 +105.7 MidCgp p 20.30 -0.16 +62.5 PostVent p 2SJ84 -0.32 +113.9 Tech p 36.73 - 0.34 +109.2 Vanguard Fds: AdmIT 10.18+0.04 2.5 AdmLT 10.36 +0.07 - 6.4

Ne1 YTD Namf NAV Cha

AdmST 9.97 +0.01 + 1.3 AagGr r 14.94 -0.24 + 2.8 AssetA 24.11 -0.1ft + 0.3 CAInsIT 10.55 +0.01 - 0.2 CAinsLT 10.95 +0-01 - 2.1 CapOp r T7.93 -0.24 +43.6 COnvrt T2.07 -0.22 + 8,7 Energy r 22.86 -0.21 +24.2 Eqlnc 24.24 '0.41 - 0.8 Explr 59,34 -0.91 + 3,8 FLInsLT 10.77 ... - 2,6 GlbAA r 11.41 +0.03 + 6,5 GlbEq r 13.75 -0.12 +14.0 GNMA 10.03 +0.03 + 0.6 Gold r 7,70—0.01 +16,7 Groinc 32.87 -0.71 + 7.3 HlthCare r 93,97 - T.64 - 0.5 HYCor r 7.37 +0.01 — 0.1 IntiGr 19.56 +0.02 + 4.2 IntlVal 29.29 —0.12 +12.8 ITCcrp 9.36 +0,03 - 1.8 ITTsry 10.41 +0.04 - 2.5 UteCon 14.70 — 0,O8 + T.B LlfeGro 19,35 - 0,25 + 3.5 UfeJric 12.98 -0,01 + 0.6 Llfe/l/lod 17.06 -0.1S + 2.5 LTCOrp 8.34 + 0.04 - 5.4 LTTsrv 10.07 +0.07 - 6.5 MATXEX9.34 ... NA Morg 20.69 0,44 + 8.1 MUM Y 10.32 ...-2.2 Muinlg 11.90 +0.01 - 2,3 Mulnt 12.91 ... - 0.6

Name NAV Cha Mu Long 10,54 +0.01 AtojLtd 10,62 MuSht 15,49 NJInSLT 11.29 +0.01 NYlnsLT 10.53 +0.01 OHfraLT 11.27 PA(i1SLT 10.75+0,01 Prefd 9.70 Prmcp 55.35 -1.06 RÉlTr 50.41 "0.04 SelValu 10.00 -0.11 STAR 18 01-DJB ST Cor 10.60 +0.01 ST Fed 9.99 + O.OT STCorist 10.60 +0.01 STTsry 10.11+O.OI TXMBal r 17.21 -0.21 TKNICal5tr26.il -0.74 TxMCap r 28.00 - 0.73 TxMGI r 27.76 -0.65 TüMGllStr 27.77 -0.65 TxMtn r 10.21 +0.02 TxMSC r 11.05 ■- 0.19 USCru 38.31 -1.11 Utility 15.16 —0.19 Wellsl 20.65 -0.Q5 Welltn 29.42-0.23 Wndsr 16.45 -0.22 Wndsrll 28.50 —0.48 vanguard Iflflex FdS: 500 T1B.64 —2.79 Balanced 18.63 —0.23 EmerMkt r 9,92 -0.13 Europe 24.99 +0.08

%ref

Mel YTD

Name NAV Cha %*et Exten 30.35-0.63+4.8 Extenlst3ii.38-0.63 + 4.9 GrOwtti 33.66--1.05 + 7.1 Grwthlst 33.48 -1.04 + 7,2 Instidx 117,51 -2.76 + 5,1 InstPlus 117.53 - 2.76 + 5.2 ITBond 9.75+Q.04 - 2.3 LT Bond 10.13 +0.07 - 6.2 MldCp 10.17-0.24-0.7 MidCpist 10.1?-0.24 ■ ■ 0,5 Pacific 10.66-0.01+36,0 SmCap 21.49 -0.37 + 2.2 smcapisl 21,51 -0.37+ 2,a SmGth ?.25-0.lfi- 2.9 SrnVal 8.62 -0.14 - 0.9 ST Bond 9.84 +0.02 + 1.6 TotBd 9.75 +0,04 - 0.6 Tot Bei 1st 9.75 +0.04 - 0.5 Tollrtl 12.28 ... + 9.8 TOlSi 28.35 —0.66 + 4.5 TotSt I St 28,36 -0,66+ 4.6 Value 22.30 - 0.33 + 2,9 Valuelst 22.30 - 0.33 NA vanraoejjoint Funds: SOOIdxl 10.39 -0,24 NS 5001 dxl I 9.95 -0,23 NS AsstAII 10.23 -0.10 NS AsgrOpp 11,55 -0.26 NS BrdMklldxl in.J9 -0.24 NS BrdMktldbdl 1&.05 -0,23 NS Core Bill dxl 9.6é +0.03 NS CoreBdidxll 9,tí) +0,03 NS

Source: The Wall Street Journal, September 24, 1999. Reprinted by permission of Dow Jones & Company, Inc., via Copyright Clearance Center, Inc. © 1999 Dow Jones & Company, Inc. All Rights Reserved Worldwide.

However, names of common stock funds frequently reflect little or nothing about their investment policies. Examples are Vanguard's Windsor and Wellington funds.

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Lessons From The Intelligent Investor

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