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fees as well as phone numbers to contact funds. To illustrate the range of information avail-
able about funds, we consider Morningstar™s report on Fidelity™s Magellan fund, reproduced
in Figure 4.5.
Some of Morningstar™s analysis is qualitative. The top box on the left-hand side of the page
provides a short description of fund strategy, in particular the types of securities in which the
fund manager tends to invest. The bottom box on the left (“Analysis”) is a more detailed
discussion of the fund™s income strategy. The short statement of the fund™s investment policy
is in the top right-hand corner: Magellan is a “large blend” fund, meaning that it tends to
Bodie’Kane’Marcus: I. Elements of Investments 4. Mutual Funds and Other © The McGraw’Hill
Essentials of Investments, Investment Companies Companies, 2003
Fifth Edition




119
4 Mutual Funds and Other Investment Companies




F I G U R E 4.5
Morningstar report
Source: Morningstar Mutual Funds. © 2002 Morningstar, Inc. All rights reserved. 225 W. Wacker Dr., Chicago, IL . Although data are gathered from reliable
sources, Morningstar cannot guarantee completeness and accuracy.
Bodie’Kane’Marcus: I. Elements of Investments 4. Mutual Funds and Other © The McGraw’Hill
Essentials of Investments, Investment Companies Companies, 2003
Fifth Edition




Shorter, Clearer Mutual-Fund Disclosure
May Omit Vital Investment Information
What™s in the fund: If you™re about to put your re-
Mutual-fund investors will receive shorter and clearer
tirement nest egg in a fund, shouldn™t you get to see
disclosure documents, under new rules adopted by the
what™s in it first? The zippy new profile prospectus de-
Securities and Exchange Commission.
scribes a fund™s investment strategy, as did the old-style
But despite all the hoopla surrounding the improve-
prospectus. But neither gives investors a look at what
ments”including a new “profile” prospectus and an
the fund actually owns. To get the fund™s holdings, you
easier-to-read full prospectus”there™s still a slew of
have to have its latest semiannual or annual report.
vital information fund investors don™t get from any dis-
Most people don™t get those documents until after they
closure documents, long or short.
invest, and even then it can be as much as six months
Of course, more information isn™t necessarily better.
old. Many investment advisers think funds should begin
As it is, investors rarely read fund disclosure docu-
reporting their holdings monthly, but so far funds have
ments, such as the prospectus (which funds must pro-
resisted doing so.
vide to prospective investors), the semiannual reports
A manager™s stake in a fund: Funds should be
(provided to all fund investors) or the statement of ad-
required to tell investors whether the fund manager
ditional information (made available upon request).
owns any of its shares so investors can see just how
Buried in each are a few nuggets of useful data; but for
confident a manager is in his or her own ability to pick
the most part, they™re full of legalese and technical
stocks, some investment advisers say. As it stands now,
terms.
many fund groups don™t even disclose the names and
So what should funds be required to disclose that
backgrounds of the men and women calling the shots,
they currently don™t”and won™t have to even under the
and instead report that their funds are managed by
SEC™s new rules? Here™s a partial list:
a “team” of individuals whose identities they don™t
Tax-adjusted returns: Under the new rules, both
disclose.
the full prospectus and the fund profile must contain a
A breakdown of fees: Investors will see in the profile
bar chart of annual returns over the past 10 years, and
prospectus a clearer outline of the expenses incurred by
the fund™s best and worst quarterly returns during that
the fund company that manages the portfolio. But
period. That™s a huge improvement over not long ago
there™s no way to tell whether you are picking up the
when a fund™s raw returns were sometimes nowhere to
tab for another guy™s lunch.
be found in the prospectus.
The problem is, some no-load funds impose a so-
But that doesn™t go far enough, according to some
called 12b-1 marketing fee on all shareholders. But
investment advisers. Many would like to see funds re-
they use the money gathered from the fee to cover the
port returns after taxes”using assumptions about an
cost of participating in mutual-fund supermarket dis-
investor™s tax bracket that would be disclosed in foot-
tribution programs. Only some fund shareholders buy
notes. The reason: Many funds make big payouts of
the fund shares through these programs, but all share-
dividends and capital gains, forcing investors to fork
holders bear the expense”including those who pur-
over a big chunk of their gains to the Internal Revenue
chased shares directly from the fund.
Service.




invest in large firms, and not to specialize in either value versus growth stocks”it holds a
blend of these.
The table on the left labeled “Performance” reports on the fund™s returns over the last few
years and over longer periods up to 15 years. Comparisons of returns to relevant indexes, in
this case, the S&P 500 and the Wilshire top 750 indexes, are provided to serve as benchmarks
in evaluating the performance of the fund. The values under these columns give the perfor-
mance of the fund relative to the index. For example, Magellan™s return was 1.87% below the
S&P 500 over the last three months, but 0.55% per year above the S&P over the past 5 years.
The returns reported for the fund are calculated net of expenses, 12b-1 fees, and any other fees
automatically deducted from fund assets, but they do not account for any sales charges such
as front-end loads or back-end charges. Next appear the percentile ranks of the fund compared
to all other funds (see column headed by All) and to all funds with the same investment
objective (see column headed by Cat). A rank of 1 means the fund is a top performer. A rank
of 80 would mean that it was beaten by 80% of funds in the comparison group. You can see
120
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Essentials of Investments, Investment Companies Companies, 2003
Fifth Edition




Nice, Light Read: the Prospectus
Plain English
Old Language
A signature guarantee helps protect against fraud.
Dreyfus The Transfer Agent has adopted
You can obtain one from most banks or securities
example standards and procedures pursuant to
dealers, but not from a notary public.
which signature-guarantees in proper
form generally will be accepted from
domestic banks, brokers, dealers,
credit unions, national securities
exchanges, registered securities
associations, clearing agencies and
savings associations, as well as from
participants in the New York Stock
Exchange Medallion Signature
Program, the Securities Transfer
Agents Medallion Program
(“STAMP”) and the Stock Exchange
Medallion Program.

T. Rowe Price Total Return. The Fund may advertise Total Return. This tells you how much an investment
example total return figures on both a in a fund has changed in value over a given time
cumulative and compound average period. It reflects any net increase or decrease in the
annual basis. Cumulative total return share price and assumes that all dividends and capital
compares the amount invested at the gains (if any) paid during the period were reinvested in
beginning of a period with the additional shares. Therefore, total return numbers
amount redeemed at the end of the include the effect of compounding.
period, assuming the reinvestment of Advertisements for a fund may include cumulative
all dividends and capital gain or average annual total return figures, which may be
distributions. The compound average compared with various indices, other performance
annual total return, derived from the measures, or other mutual funds.
cumulative total return figure,
indicates a yearly average of the
Fund™s performance. The annual
compound rate of return for the Fund
may vary from any average.
Sources: Adapted from Vanessa O™Connell, “Shorter, Clearer, Mutual-Fund Disclosure May Omit Vital Investment Information,” The Wall Street
Journal, March 12, 1999. Reprinted by permission of Dow Jones & Company, Inc., via Copyright Clearance Center, Inc. © 1999 Dow Jones &
Company, Inc. All Rights Reserved Worldwide. “A Little Light Reading? Try a Fund Prospectus,” The Wall Street Journal, May 3, 1999. p. R1.
Reprinted by permission of Dow Jones & Company, Inc., via Copyright Clearance Center, Inc. © 1999 Dow Jones & Company, Inc. All Rights
Reserved Worldwide.




from the table that Magellan has had below-par recent (three month to three year) performance
compared to other growth and income funds, but excellent longer-term performance. For ex-
ample, over the past 15 years, its average return was higher than all but 13% of the funds in its
category. Finally, growth of $10,000 invested in the fund over various periods ranging from
the past three months to the past 15 years is given in the last column.
More data on the performance of the fund are provided in the graph at the top right of the
figure. The bar charts give the fund™s rate of return for each quarter of the last 10 years. Below
the graph is a box for each year that depicts the relative performance of the fund for that year.
The shaded area on the box shows the quartile in which the fund™s performance falls relative
to other funds with the same objective. If the shaded band is at the top of the box, the firm was
a top quartile performer in that period, and so on.
121
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Essentials of Investments, Investment Companies Companies, 2003
Fifth Edition




122 Part ONE Elements of Investments


The table below the bar charts presents historical data on characteristics of the fund. These
data include return, return relative to appropriate benchmark indexes such as the S&P 500, the
component of returns due to income (dividends) or capital gains, the percentile rank of the
fund compared to all funds and funds in its objective class (where, again, 1% is the best per-
former and 99% would mean that the fund was outperformed by 99% of its comparison
group), the expense ratio, and the turnover rate of the portfolio.
The table on the right entitled Portfolio Analysis presents the 25 largest holdings of the
portfolio, showing the price“earnings ratio and year-to-date return of each of those securities.
Investors can thus get a quick look at the manager™s biggest bets.
Below the portfolio analysis table is a box labeled Current Investment Style. In this box,
Morningstar evaluates style along two dimensions: One dimension is the size of the firms held
in the portfolio as measured by the market value of outstanding equity; the other dimension is
a value/growth continuum. Morningstar defines value stocks as those with low ratios of mar-
ket price per share to various measures of value. It puts stocks on a growth-value continuum
based on the ratios of stock price to the firm™s earnings, book value, sales, cash flow, and divi-
dends. Value stocks are those with a low price relative to these measures of value. In contrast,
growth stocks have high ratios, suggesting that investors in these firms must believe that the
firm will experience rapid growth to justify the prices at which the stocks sell. The shaded box
for Magellan shows that the portfolio tends to hold larger firms (top row) and blend stocks
(middle column). A year-by-year history of Magellan™s investment style is presented in the se-
quence of such boxes at the top of the figure.
The center of the figure, labeled Risk Analysis, is one of the more complicated but inter-
esting facets of Morningstar™s analysis. The column labeled Load-Adj Return rates a fund™s re-
turn compared to other funds with the same investment policy. Returns for periods ranging
from 1 to 10 years are calculated with all loads and back-end fees applicable to that investment
period subtracted from total income. The return is then divided by the average return for the
comparison group of funds to obtain the Morningstar Return; therefore, a value of 1.0 in the
Return column would indicate average performance while a value of 1.10 would indicate re-
turns 10% above the average for the comparison group (e.g., 11% return for the fund versus
10% for the comparison group).
The risk measure indicates the portfolio™s exposure to poor performance, that is, the
“downside risk” of the fund. Morningstar bases its risk measure in part on the overall volatil-
ity of returns. However, it focuses more intently on episodes of underperformance relative to
Treasury bills. The total underperformance compared to T-bills in those months with poor
portfolio performance divided by total months sampled is part of the measure of downside
risk. The risk measure also is scaled by dividing by the average risk measure for all firms with
the same investment objective. Therefore, the average value in the Risk column is 1.0.
The two columns to the left of the Morningstar Risk and Return columns are the percentile
scores of risk and return for each fund. The risk-adjusted rating, ranging from one to five stars,
is based on the Morningstar return score minus the risk score. The stars each fund earns are
based on risk-adjusted performance relative to other funds in the same style group. To allow
funds to be compared to other funds with similar investment styles, Morningstar recently in-
creased the number of categories; there are now 18 separate stock fund groups and 20 fixed
income categories.
The tax analysis box on the left provides some evidence on the tax efficiency of the fund
by comparing pretax and after-tax returns. The after-tax return, given in the first column, is
computed based on the dividends paid to the portfolio as well as realized capital gains, as-
suming the investor is in the maximum tax bracket at the time of the distribution. State and lo-
cal taxes are ignored. The “tax efficiency” of the fund is defined as the ratio of after-tax to
pretax returns; it is presented in the second column, labeled % Pretax Return. Tax efficiency
will be lower when turnover is higher because capital gains are taxed as they are realized.
Bodie’Kane’Marcus: I. Elements of Investments 4. Mutual Funds and Other © The McGraw’Hill
Essentials of Investments, Investment Companies Companies, 2003
Fifth Edition




123
4 Mutual Funds and Other Investment Companies


The bottom of the page provides information on the expenses and loads associated with in-
vestments in the fund, as well as information on the fund™s investment adviser. Thus, Morn-
ingstar provides a considerable amount of the information you would need to decide among
several competing funds.




SUMMARY

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