Chapter 12

SOURCES OF INFORMATION ON MUTUAL FUNDS

With about 8,000 funds being offered for sale in the United States, and some 50,000 globally, it is easy to get lost. Fortunately, there are some excellent sources of information and screening tools to help you find funds that may meet your investment objectives. Each of these sources has a slightly different approach to grouping funds into categories.

In this chapter, we look at the most important sources of information for the mutual fund industry: Investment Company Institute, Lipper Analytical Services, and Morningstar.

Investment Company Institute (ICI) is the association for the mutual fund industry, representing the vast majority of mutual funds and fund assets under management in the United States. In addition to its many publications, including the annual Mutual Fund Fact Book, ICI operates a very useful web site, www.ici.org, which provides a great deal of statistical information on trends in the fund industry.

Investment Company Institute Classification of Types of Funds

The ICI groups mutual funds into four broad classes: stock funds, bond and income funds, money market funds, and hybrids. The classes are further subdivided into a total of 33 categories of funds. Following is a brief description of the investment style of each of the 33 ICI categories.

Stock Funds

Stock funds include nine subcategories. The first four of these could be looked at as part of a spectrum, ranging from the near-total focus on capital gains of the aggressive growth fund to the near-total focus on income of the income equity fund. In between, growth focuses primarily on capital gains, while growth and income funds look for a balance between capital gains and income. The latter five subcategories are different in kind.

stock fund

A mutual fund that invests primarily in stock.

• Aggressive growth funds seek to maximize capital growth without any emphasis on current income. The aggressive label indicates a willingness to take on a significant degree of risk by investing in stocks that are either unknown or currently out of favor. Potential investments include IPOs, companies undergoing significant restructuring, or selected stocks within out-of-favor industries.

In addition to the riskiness of the stocks that such funds invest in, aggressive growth funds will also tend to employ more aggressive investment strategies (e.g., higher turnover rates and/or increased use of leverage). Such strategies further augment both the potential for return and the riskiness of these funds.

• Growth funds are more risk-averse than their aggressive brethren; while they also de-emphasize current income, they tend to invest in mainstream companies with a track record.

It is worth noting that sometimes “growth” is used as a contrast to “value” as an investment style, but ICI does not subscribe to this distinction. In fact, some of the “aggressive growth” funds are managed by value-oriented managers.

• Growth and income funds strive to benefit both from capital gains and current income. They tend to concentrate stock prices of companies that have risen and have an established history of paying dividends.

• Income-equity funds invest primarily in the stocks of companies that have good records for paying dividends.

• International equity funds are growth-oriented funds that invest primarily in stocks of companies domiciled outside of the United States.

• Global equity funds are growth-oriented funds that invest in stocks globally, including the United States. Examples:

• Emerging market equity funds participate in companies based in, or otherwise linked to, emerging markets such as the BRIC countries of Brazil, Russia, India, and China.

• Regional equity funds focus on a particular part of the world, for example, Asia, Europe, Latin America, or even specific countries.

• Sector equity funds aim for capital appreciation by investing in companies focused on specific industries or groupings of industries, such as financial services.

Bond and Income Funds

Bond and income funds include some subcategories that invest in both stocks and bonds and other subcategories that restrict themselves to fixed-income securities.

Strategic income funds strive to achieve a high level of income, investing in corporate and government bonds.

Government bond funds are divided into three subcategories: general funds, intermediate-term funds, and short-term funds. All invest at least 80 percent of their portfolios in U.S. government securities. General funds have no maturity restrictions, while intermediate-term funds have an average maturity between 5 and 10 years and short-term funds have a maturity of between 1 and 5 years (less than 1 year is considered a money market fund; see “Variable Annuities”).

Mortgage-backed funds invest at least 80 percent of their portfolios in mortgage-backed securities (MBS).

Global bond funds are divided into two further subcategories: general and short-term. Both invest in worldwide debt securities, with no more than 25 percent of their portfolio invested in U.S. companies. General funds have either no stated maturity or an average maturity greater than 5 years, whereas global short-term funds have an average maturity of between 1 and 5 years.

Corporate bond funds seek high income. They invest at least 80 percent of their portfolio in corporate bonds. They are subcategorized as “general” (no stated average maturity), short-term (1 to 5 year average maturity) or intermediate-term (5 to 10 year average maturity).

High-yield bond funds seek high income while accepting greater credit risk. They invest at least 80 percent of their portfolios in corporate bonds with lower credit ratings (Baa or lower Moody’s rating/BBB or lower by S&P).

National municipal bonds strive to achieve income that is exempt from tax by the federal government. They do this by investing “predominately” in bonds issued by state and local governments whose income is exempt from federal taxation. They are further subcategorized as general funds or short-term funds.

State municipal bonds, long term, attempt to generate income that is exempt from both federal and state taxes. They do this by investing in bonds issued by a single state government. As in the case of national municipal bonds, they are subcategorized into general funds and short-term funds.

Hybrid Funds

Flexible portfolio funds strive for high total return; they can be invested in any combination of stocks, bonds, and short-term money market instruments, according to the portfolio managers’ judgment of market conditions.

Balanced funds are funds that attempt to accomplish three goals: (1) provide current income; (2) provide long-term growth; and (3) invest conservatively in a fixed ratio of stocks (common and preferred) and bonds.

Income-mixed funds strive to achieve a high level of current income through a mix of stock and bond investments.

Asset allocation funds, like flexible portfolio funds, strive for high total return and invest in stock, bonds, and money-market instruments. However, they must “maintain a precise weighting” to the respective asset classes.

Money Market Funds

Taxable money market funds seek income with stability of the fund’s net asset value, normally set at $1 per share. They accomplish this by investing in short-term, high-credit-quality money market instruments. There are two subcategories: (1) government funds, which invest primarily in U.S. government Treasury bills, other short-term U.S. government obligations and/or short-term obligations of U.S. government agencies or “instrumentalities”; (2) nongovernment funds, which invest in other money-market instruments, including certificates of deposit of large banks and commercial paper. Tax-exempt money market (national) funds invest in short-term municipal debt securities whose income is exempt from federal taxation.

Tax-exempt money market (state) funds invest in short-term municipal debt securities issued by a particular state whose income is exempt from federal and state taxation.

Variable Annuities

Take a mutual fund, wrap it up in an expensive insurance contract, and voilà, you have a typical variable annuity. The insurance part of the variable annuity confers tax-advantaged status to an otherwise taxable mutual fund. According to the Life Insurance Marketing and Research Association (LIMRA), about $156 billion of these heavily marketed investments were sold in 2008, down 15 percent from the previous year.

 

The tax status of variable annuities makes these products tempting to many investors. Unfortunately, that status is paid for with fees that are extremely high, on top of the fees that the underlying mutual fund charges. These fees are in addition to sales commissions that can take 7 percent of your investment on day one. For these reasons, Forbes magazine does not rate variable annuities; it considers most of them to be bad investments for 95 percent of investors. For further information on annuities, see “Annul the Annuity?” in the September 30, 2004 issue of Forbes. It is available at www.forbes.com.

Lipper Analytical Services

Lipper Analytical Services (www.lipperweb.com) provides detailed data on the global mutual fund industry. Many fund management companies, brokers, and financial publishers use Lipper’s data and analytical capabilities in the course of business. Founded in 1973, Lipper was acquired in 1998 by Reuters. It began by providing analytical information to the independent directors of mutual funds to help them assess fund performance. Today it offers comprehensive information on over 37,500 funds all over the world. Collectively, these funds contain assets of nearly $7 trillion.

Forbes

Forbes offers a free web-based service, the 2009 Forbes Mutual Fund Guide (www.forbes.com/finance/funds). Drawing on the considerable data resources of Lipper Analytical Services, the Guide provides daily updates of the Lipper Indexes that serve as performance benchmarks, in-depth information on many thousands of mutual funds, their distributors, and managers. Forbes also puts out an annual mutual fund survey.

Morningstar

Morningstar provides a vast amount of free mutual fund and other financial data and research on its web site (www.morningstar.com). Information is grouped into categories including:

• Portfolio

• Stocks

• Options

• Funds

• ETFs

• Hedge Funds

• Markets

• Tools

• Personal Finance

• Discussion Forums

Premium service is available for $16.95 per month There is also a site map, and a decent online glossary.