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MGT604 - Management of Financial Institutions - Lecture Handout 27

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Mutual Funds

Investing In International Mutual Funds

Investing in international mutual funds has two faces:

  • First is buying funds from US based companies that buy and manage portfolio in internationally listed stocks/securities. These companies are governed by regulations of SEC (Securities and Exchange Commission)
  • Second is buying mutual funds from international non US companies.

A word of caution before investing even in best international mutual funds - Unlike domestic mutual funds investment, international investments entail additional risk factors such as economic and political in addition to risk of FOREX value (simply put: foreign currency exchange value) fluctuations.

Why Should You Invest In International Opportunities?

The number of funds in international investing is on the rise. We can cite a few reasons for this.

  • Removal of trade barriers and expanding of economies have sparked off growth in many non-US companies.
  • Some of the major industries of the world are dominated by non US companies.
  • Over 72% of the world stocks are listed out side US.
  • Greater and true diversification and opportunity to capitalize on best overseas companies.

Investing in international mutual funds is gaining popularity for various reasons. Rising political stability merging or opening of borders and currencies are some of the reasons. Vibrant and upcoming economies and non US corporations becoming financially stronger by the day are some of the reasons. In addition you get true diversification, balance and
opportunities.

Best guide for selecting the right mutual funds

Selecting best mutual funds mean a lot more than deciding by indices and their past performances. However, you need to remember one thing that there is no quick gratification in investments of any kind. This article tells you regarding:

  • How can you select a mutual fund for investment?
  • Is it important to pick up companies that are performing above average?
  • Is it advisable to compare mutual funds across category?

When your investment purpose is for saving for retirement, then risk minimization should be your mantra. And one of the best avenues for you to invest now is mutual funds as they have an average of 50 stocks in each portfolio for diversification and cushioning the risks . Selecting best mutual funds mean a lot more than deciding by indices and their past performances. However, you need to remember one thing that there is no quick gratification in investments of any kind.

Let us discuss the dos and don'ts of selecting the best mutual funds. These points should serve as guidelines for making decision on whether your pick is among the best in the industry or not.

Dos in Selecting the Best Mutual Fund

  1. Draw down your investment objective. There are various schemes suitable for different needs. For example retirement plan, capital growth etc. Also get clear about your time frame for investment and returns. Equity funds are not advisable for short term because of their long term nature. You can consider money market and floating
    rate funds for short term gains. This equals asking - What kind of mutual fund is right for me?
  2. Once you have decided on a plan or a couple of them, collect as much information as possible on them from different sources offering them. Funds' prospectus and advisors may help you in this.
  3. Pick out companies consistently performing above average. Mutual funds industry indices are helpful in comparing different funds as well as different plans offered by them. Some of the industry standard fund indices are Nasdaq 100, Russel 2000, S&P fund index and DSI index with the latter rating the Socially Responsible Funds only. Also best mutual funds draw good results despite market volatility.
  4. Get a clear picture of fees & associated cost, taxes (for non-tax free funds) for all your short listed funds and how they affect your returns. Best mutual funds have lower cost out go.
  5. Best mutual funds maximize returns and minimize risks. A number called as Sharpe Ratio explains whether a fund is risk free based on its expected returns compared against a risk free money market fund.
  6. Some funds have the advantage of low minimum initial investments. You can start investing even with $250 a month. This is advisable for building asset bases over a long period with small regular investments.

Best Tips to do an Analysis of Mutual Funds

Before investing in mutual funds a proper analysis is required. While all analyses' efforts are aimed at maximizing returns and minimizing risks, it is the latter that gains importance as the single most fundamental criterion to compare mutual funds. This article makes you aware of:

  • How can you do a mutual fund analysis?
  • Important is the risk factor analysis?
  • Why is it important to track the record of mutual fund companies?

Investing in mutual funds is not a child's play unless one does a mutual funds' analysis. At least it is not as easy as picking top performers going by indices and investing in them. While all analyses' efforts are aimed at maximizing returns and minimizing risks, it is the latter that gains importance as the single most fundamental criterion to compare mutual funds.

Look At the Portfolio of Your Pick of Funds

Most of the plans will have invested in multiple stocks or securities for diversification. Critical point here is in what proportion they have invested in different stocks. Giving a higher weight-age to a high returning stock leaves less opportunity for broader allocation and may back fire when market is bearish (plummeting steadily). Also higher returning
stocks carry high element of risk.

The Optimum Portfolio Size

What should be the optimum portfolio size (assortment investments under one plan) for your pick of fund? Well, opinions are divided about this, but it is crucial to look into the specifics of stock bets and sectors you will be exposed to. Higher exposure to specific sectors may see you loosing out on broad based rallies in the bourses (stock markets). Optimally 65 % to 85% may be allocated in stocks from different sectors for diversification plus growth and the balance being in typical bond and money market instruments.

Is Your Pick of Funds Really Diversified

Notice that the competing plans, though from different fund companies, perform almost on par as if they have a correlation. They indeed have. So, does it mean you have diversified by spreading your money amongst them? Well, think again. Similar plans have similar pattern of their holdings of stocks and with a similar portfolio. This means, in actual effect you are not diversifying. They all go up and down almost as if they do it in tandem. For clear diversification, pick those with different portfolios though they are similar plans (ex: growth, index, or dividend paying etc).

Check Out the Facts before Jumping into Mutual Funds

If you thought for a moment, you will see an enormous growth in mutual fund industry in the United States in recent years. A fact sheet gives you a bounty of information about the fund. It helps you decide on a particular fund and how to tell an ethical mutual fund from a non ethical one. This article covers:

  • What are the points that help you in pre-selecting the mutual funds?
  • Are the parameters that help you in comparing the performance of the mutual funds?
  • What are the points to be analyzed while comparing the risk factors of various mutual funds?

If you thought for a moment, you will see an enormous growth in mutual fund industry in the United States in recent years. This is enticing more individuals to invest either directly or through retirement funds like 401(k) plans (a savings plan for retirement to be funded by the employees and employers in equal proportions. These funds are tax free till they are with drawn and also the contributions are deducted before tax). But come to think of it, for a number of innocent investors, the brochures are just the reminders of their investments. And the case is no different with fact sheets too. They elicit a quick check of their investment necessities, status or the like. In fact it needs to be regarded as a communication of better
and more information that concerns the nature of investments the funds make.

The U.S. Securities and Exchange Commission (SEC) has some clause about the need for communicating facts by a fund to all its share holders.

What is a Fact Sheet for Buying Mutual Funds

A fact sheet gives you a bounty of information about the fund. It helps you decide on a particular fund and how to tell an ethical mutual fund from a non ethical one. Given below are some important facts that you should know as an investor in Mutual Funds.

How to Pre-Select a Mutual Fund

Before you zero in for investment, make a short list of funds that are broadly doing well. For doing this assessing following points may help:

  • Try to match your financial profile to a fund's characteristics and risk or reward history. Your profile may not permit you to invest in high paying funds if they have a high risk element. Reading the funds' prospectus in detail will give an insight into their portfolio and investment pattern. It is obvious that high returns are almost always associated with risky investments. Any down turn of fortune can see you loosing your principle haplessly.
  • Find out whether the fund's investment philosophy satisfies yours. If you have an inclination for social causes or looking for a steady build up of principle without much risk, look for funds that are socially responsible and/or investing in government bonds and T-Bills. Assess whether the fund's costs, fees and loads are too much or in line with your estimation.

You may not need a portfolio of more than 8-10 funds from different companies to sufficiently diversify your fund allocation objectives. This helps you average out and to a certain extent stabilize returns (especially when your objective is regular income). Select specific funds in your chosen categories to meet your needs.