Funds

Mutual Funds

• Easy way to get diversification

• Can also perhaps benefit from professional active management

• Can usually invest directly with no need for a brokerage account

• Over 7,000 U.S. mutual funds \(∼\) number of U.S. stocks

• Mutual funds for stocks, bonds, international stocks, real estate, …

Net Asset Value

• NAV (net asset value per share) is calculated daily after close of trading.
• Equals value of portfolio less any expenses not yet paid divided by number of shares outstanding
• Invest money \(\rightarrow\) get shares in fund at next end-of-day NAV
• Withdraw money \(\rightarrow\) sell shares at next end-of-day NAV

Example

• Invest $10,000 Thursday end-of-day NAV = $250, get 40 shares

• # of shares can be fractional

• Fund \(\uparrow\), withdraw $6,000, next end-of-day NAV = $300

  • $6,000 / $300 = 20 shares that are redeemed
  • Still have 20 shares, worth 20 \(\times\) $300 = $6,000

Active and Passive Funds

Evidence on active funds

• There is some evidence that active fund managers can beat the market before payment of fees.

• But there is little evidence of extra returns to investors, after payment of managers’ fees.

• There is also little evidence of repeat performance, except that the worst funds after fees tend to remain the worst.

Some U.S. Stock Indexes

• Dow Jones = 30 stocks
• S&P 100 ~ 50% of U.S. stock market capitalization
• S&P 500 ~ 80% of U.S. stock market capitalization
• Russell 1000
• Russell 3000
• Russell 2000 = Russell 3000 excluding Russell 1000, small-cap index
• Wilshire 5000

How do stock indexes work?

• % change in index is % increase/decrease in total value of companies in the index (except for Dow)

• % change in index does not include dividend return

Exchange Traded Funds (ETFs)

• ETFs were invented in 1990. Now ~ 3,000 U.S. ETFs.

• ETFs are listed on stock exchanges and trade like stocks. You buy/sell them through your broker.

• Another easy way to get diversification. And lower fees than mutual funds.

• There are ETFs for stocks, bonds, international stocks, real estate, currencies, commodities

• ETFs calculate NAVs daily, but you do not buy/sell at the NAV. You buy/sell at the price determined by the market.

How do ETFs work?

• ETFs are not open to new cash investments.
• Neither can anyone withdraw cash from them.
• They are open to exchanges with authorized participants (APs).
  • APs deliver baskets of assets and receive ETF shares when ETF market price is higher than NAV.
  • APs deliver shares and receive baskets of assets when ETF market price is lower than NAV.
  • This activity moves the ETF market price towards NAV.

Futures based ETFs

• Commodity ETFs generally hold futures contracts on the commodity instead of the physical commodity.
• An example is USO (U.S. Oil). A counter-example is GLD.
• There are also ETFs that take positions in stock index futures to deliver
  • multiples (2-to-1 or 3-to-1) of the stock index return (levered ETFs)
  • the negative of the stock index return (inverse ETFs) or multiples of the negative (levered inverse ETFs)

Transparency of ETF Strategies

• Because of the mechanism for APs to redeem or acquire shares, an ETF’s portfolio must be transparent.

• ETFs either hold an index or follow an algorithmic strategy.