MUTUAL FUNDS AND OTHER

INVESTMENT COMPANIES
REMAR ALLEN M. BAUTISTA, CPA, CTT, MRITAX
 NET ASSET VALUE
• Investors buy shares in investment companies.
• Ownership is proportional to the number of shares purchased.
• The value of each share is called “ Net Asset Value” or “ NAV”.
• Calculation:
NET ASSET VALUE
Consider a mutual fund that manages a portfolio of
securities worth $120 million. Suppose the fund owes $4
million to its investment advisers and owes another $1
million for rent, wages due, and miscellaneous expenses.
The fund has 5 million shares outstanding.
THE EXPENSE RATIO: THIS ONGOING FEE IS
IN EVERY MUTUAL FUND

• sometimes called a management fee or an

operating expense
• is deducted from the total assets of the fund before
your share price is determined.
THE EXPENSE RATIO: THIS ONGOING FEE IS
IN EVERY MUTUAL FUND
• sometimes called a management fee or an operating expense
• is deducted from the total assets of the fund before your
share price is determined.
• Let’s say you own a mutual fund that is valued at $10 per
share. It has a gross return of 10. If there were no fees, the
fund share would be valued at $11, but the fund manager
deducts 1% in fees, so your actual investment return is .89
cents instead of the full $1, and after fees, your share is worth
$10.89.
THE EXPENSE RATIO: THIS ONGOING FEE IS
IN EVERY MUTUAL FUND
• Actively managed funds have higher operating expenses than
passive funds or index funds.
• International funds have higher fees than domestic funds.
• Small-cap funds have higher fees than large-cap funds.
• Index funds or passively managed funds typically have the
lowest fees, and finding these types of funds has been proven
to be a strong indicator of good future fund performance.
• Different companies may charge widely varying expense ratios
for similar funds.
SALES CHARGE OR COMMISSION: AN
UPFRONT FEE YOU PAY
• When you buy an “A share” mutual fund, you will pay a
commission when you purchase the shares. This type of
fee is sometimes referred to as a sales charge or a "front-
end load.“
• Let’s say you are buying a fund that is valued at $10 per
share and has a 5% front-end sales charge or load. You will
pay approximately $10.50 for each share purchased, as a
5% sales fee will be added on to the initial purchase price
of your shares.
REDEMPTION FEES: A FEE YOU PAY WHEN
YOU SELL SHARES
• When you buy a “B share” mutual fund, if you sell shares of
your fund within a specified time frame you will pay a
redemption fee, also referred to as a "back-end load," a
contingent deferred sales charge, or a surrender charge.
• Let’s say you are buying a fund that is valued at $10 per share
and has a 5% contingent deferred sales charge. If you sell your
shares within one year of purchase, you would receive $9.50
per share. Usually, this fee goes down each year, so in year 2,
it may drop to a 4% fee, in year 3, 3%, and so on.
SHORT-TERM TRADING FEES
• Mutual funds are designed to be long-term investments;
short-term trading fees have been imposed on some
funds to discourage investors from trading in and out of
funds.
• Short-term trading fees are imposed when you purchase
shares and then sell them again within 30-90 days. In this
scenario, the mutual fund may charge you a fee of 1 to 3%
upon the sale of the recently purchased shares.
12(B)1 FEE, SERVICE FEE, OR DISTRIBUTION
FEE
• Many funds have an ongoing service or marketing fee,
also called a 12(b)1 fee, which is paid to a financial advisor
or financial services company as compensation for
marketing the fund.
• If you purchase a “C share” mutual fund it will typically
have an extra 1% 12(b)1 fee, in addition to an expense
ratio. Just like the expense ratio, this service fee will be
deducted out of the total fund assets before your share
price is determined.
MUTUAL FUND RETURNS
The rate of return on an investment in a mutual fund
• = (change of NAV+ income distributions + capital gains
distributions)/initial net asset value)
• This measure ignores any commissions such as front-end
loads paid to purchase the fund.
• Moreover, the return is affected by the fund’s expenses and
12b-1 fees.
• This expenses are deducted from the portfolio, which reduces
the net asset value.
• The rate of return of the fund = gross return on the underlying
portfolio minus the total expense ratio
Initial NAV = $20
Income distributions = $.15
Capital gain distributions = $.05
Ending NAV = $20.10
Calculate Rate of Return
A mutual fund had NAV per share of $16.75 on January 1, 2009. On
December 31 of the same year the fund's rate of return for the year
was 26.6%. Income distributions were $1.79 and the fund had
capital gain distributions of $2.80. Without considering taxes and
transactions costs, what ending NAV would you calculate?
• Consider a fund with $100 million in assets at the start of the year
and with 10 million shares outstanding. Suppose the share
number does not change.
• The fund invests in a portfolio of stocks that provides no income
but increases in value by 10%.
• The expense ratio, including 12b-1 fees, is 1%.
• What is the rate of return for an investor in the fund?
• Initial NAV = $100 million/10 million shares = $10 per share
• Without the expenses, the fund assets grow to $100*(1+10%)
=$110 million; NAV = $110M/10 million shares = $11per share.
Without the expenses, the rate of return = (11-10)/10=10%
• 1% expense ratio ($100m*1% = $1m) is deducted from the fund
to pay the fees; the portfolio net worth $109 million; NAV =
$109m/10 million shares = $10.9 per share; with expenses, the
rate of return = (10.9-10)/10 = 9%
• 10% -1% = gross return on the underlying portfolio – total
expense ratio
• The Equity Fund sells Class A shares with a front-end load of 4%.
• Class B shares with 12b-1 fees of 0.5% annually as well as back-
end load fees that start at 5% and fall by 1% for each full year the
investor holds the portfolio( until the fifth year).
• Assume the rate of return on the fund portfolio net of operating
expenses is 10% annually.
• What will be the value of a $10,000 investment in Class A and
Class B shares if the shares are sold after (1) 1 year, (b) 4 year, (c)
10 years?
• Which fee structure provides higher net proceeds at the end of
each investment horizon?
 CLASS A SHARES CLASS B SHARES

Initial $9,600 $10,000

$10,000*(1-front end load)

1 year $10,560 $10,512

4 years $14,055 $14,233

10 years $24,900 $24,782

$10,000*[(1+10%-5%)^n]*(1-back
Computation $9,600*(1+10%)^n
end load)
• You purchased shares of a mutual fund at a price of $20 per share
at the beginning of the year
• You paid a front-end load of 5.75%.
• If the securities in which the fund invested increased in value by
11% during the year.
• The fund's expense ratio was 1.25%
• What is your return if you sold the fund at the end of the year?
• Let S be the initial investment
• Therefore S*(1-5.75%) is the net investment amount considering
the front-end load.
• The investment return of the fund is 11% without expense and
the expense ratio is 1.25% therefore net investment return =
11%-1.25%
• Rate of Return = Value1– Value0/ Value0
• Therefore, RoR = [S*(1-5.75%) *(1+11%-1.25%)- S] /S
• RoR = 3.44%