PRELIM Module
MUTUAL FUNDS
When a small investor cannot decide as to what kind of equity and debt securities to invest in
he, would prefer to invest in an optimum combination thereof. However, with his limited funds
and lack of expertise in, or time for investment management, he would prefer to combine his
resources with those of other investors and delegate the task of investing and managing the
investment to one of them who may be qualified to do so. This practice gave rise to the
existence of investment companies some of which are classified as mutual funds.
Investment Company Defined
An investment company is defined in the Investment Company Act or ICA (Republic Act
2629, June, 1960) as “ any issuer which or holds itself out as being engaged primarily or
proposes to engage primarily, in the business of investing, reinvesting or trading in securities”.
It may therefore be defined also as stock corporation that pools money from numerous
investors by issuing its shares and investing the pooled funds in accordance with its objectives
and policies.
An investment company should not be confused with an investment house because the
latter, as defined in PD 129, refers to an enterprise engaged in the underwriting of securities of
other corporations. Underwriting is the act or process of guaranteeing the distribution and sale
of securities of any kind issued by another corporation.
Classifications of Investment Companies
An investment company may ethier be an open-end or a closed-end company. An open-end
company is also known as mutual fund.
*Open-end company or Mutual fund. It is an investment company that continuously issues its
redeemable shares and stands ready to redeem them back at net asset value per share (NAVPS)
should investors decide to pull out their investments.
*Closed-end companies. It is an investment company that issues a limited number of non-
reedemable shares so that they are listed in the stock exchange to provide liquidity to its
shareholders.
Open-End Company or Mutual Fund
Inasmuch as an open-end company or mutual fund is an open-end investment company,
it may also be defined as a stock corporation that pools investors’ money by continuously
issuing redeemable shares of stock, investing the proceeds in a portfolio of securities and
undertaking to redeem its shares at their net asset value. Consequently, the number of its
outstanding shares fluctuates depending on the issuances and redemptions everyday.
Each share in a mutual fund represents a proportionate part of every portfolio security
of the fund and shares in its earnings accordingly.
Example: A mutual fund has 20,000 shares outstanding and its portfolio securities are
commercial papers, bonds,stocks and treasury bills. An investors, Lucio Tamparan owns 200
shares. This implies that Lucio Tamparan’s shares represent 200/20,000 ownership in all the
portfolio securities of the fund. Accordingly, his share in the fund earnings (which may be in the
form of dividends, interest and capital gains) is also 200/20,000. Should Lucio decide to pull out
his investment, his 200 shares shall be paid for at the prevailing net asset value for the day
minus any exit (or redemption) fee.
Right of Redemption
Right of redemption is unique on the part of investors in a mutual fund because the
latter stands ready to pay for any share returned by its shareholders. The fund is required by
law to pay for redeemed shares within seven banking days from date of redemption rquest.
Waiver of Pre-emptive Right
Pre-emptive right as defined in the preceding chapter refers to a stockholder’s right to
subscribe to new issuance of the shares of stock of an investee corporation, Inasmuch as new
issuance of the shares of stock of an investee corporation. Inasmuch as new shares are issued
on a continuing basis by a mutual fund, it would be impracticable to require shareholders to
buy new shares everything there are issuances. Thus, the SEC’s implementing rules for the ICA
require mutual funds to provide for a waiver of pre-emptive rights in their Articles of
Incorporation.
Mutual Fund, a Long Term Investment
Investment in a mutual fund is a long-term investment with holding period preferably of
more than three years. There may be highs and lows in its performance and a long-term basis,
positive results in some years may more than offset performance during bearish periods.
Differences Between Open-End and Closed-End Companies
The differences between mutual funds and closed-end investment companies are as
follows:
Open-End Companies Closed-End Companies
Number of shares offered for Unlimited. Limited.
sale:
Outstanding number of Variable. Fixed.
shares:
Listing in the stock exchange: Not Listed. Listed.
Purchase price on the part of At net asset value per share At initial offering price and
investors: plus fee. thereafter, at market price
plus commission.
Sales price on the part of At net asset value per share At market price less
investors: minus back-end sales load* or commission and tax.
commission and VAT.
*These are charges made by the mutual fund.Front-end sales loads are charged on sales of
shares to investors; back-end sales loads are charged on sales od shares by investors to the
mutual fund or upon their redemption.
Mutual Funds and Common Trust Funds
Although both mutual fund and common trust fund are investment pools, they diifer as
follows:
Mutual Fund Common Trust Fund
Issuing entity: Investment company. Trust department of a bank.
Instruments issued: Common shares. Units of participation.
Primary government Securities and Exchange Bangko Sentral ng Pilipinas
regulatory body: Commission. (BSP)
Are assets required to be held Yes. No.
by an independent custodian?
Minimum investment P 5,000 P 100,000
required:
Are they subject to full Yes. No.
disclosure requirement?
Are they required to give Yes. No.
prospectus to investors?
Are they subject to reserve No. Yes. Just like bank deposits,
requirements? they are subject to reserve
requirements.
Inasmuch as mutual fund investors receive shares of stock, they have all the rights of a
stockholder such as the right to vote at stockholders’ meeting, the right to inspect books of the
fund and the right to receive interest and dividends. Common trust investors do not have these
rights.
Net Asset Value per Share of Mutual Funds
When investing in mutual funds, the price per share is equal to its net asset value plus
fee. Net asset value refers to the excess of assets at current value over liabilities. Its fluctuations
are primarily due to changes in interest rates, in market value of the portfolio securities and in
the level of operating expenses.
Mutuals funds compute for their net asset value per share (NAVPS) on a daily basis and
have them published in at least two newspaper. Accordingly, all mutual fund expenses are
accrued on a daily basis so that these may be reflected on the daily NAVPS. The practiceof
computing for net asset value per share every trading after the close of the stock market at
mid-day is called forward pricing (Hall,103). On a per share basis, it is computed as follows:
Assets*-- Totallibilities
Net asset value per share= ---------------------------------------------------------
No. of shares outstanding
The computation for NAVPS is illustrated on the next page.
Assets
Cash and near cash items
(time deposits and money market placements) P 350,000
Stock investments(at market prices at which
they were last traded) 35,500,000
Bond investments (at market prices at which
they were last traded) 50,200,000
Interest receivable 50,000
Dividends receivable 35,000
--------------------------
Total assets at current value P 86,135,000
-------------------------
Liabilities
Payables- management fees ( accrued on a daily basis) P 90,000
Payables- purchase of investments 80,000
Payables- redemptions 50,000
Accrued expenses (custodial fees, audit fees, etc.) 15,000
--------------------------------------
Total Liabilities P 235,000
--------------------------------------
Net Assets P 85,900,000
--------------------------------------
Number of shares outstanding 500,000
Net asset value per share P 171.80
--------------------------------------
With NAVPS equals to P171.80 as of a particular date, it is the used as the basis in pricing all shares
issued or redeemed on the same date.
Investor’s Transaction Code
A mutual fund charges fees to investors and they are classified as follows.
a. Sales fee (or front-end load). This is a charge made based on NAVPS of shares issued or
investors.It has the effect of Increasing purchase cost per share.
b. Redemption or exit fee (deferred sales load or back-end load). This is charged to the investor
upon redemption of his shareholdings. It reduces net proceeds from redemption on the part of
investor.
c. Reinvestment fee. This charged to the investor upon reinvestment of his earnings from the
mutual fund. In most cases, this is not charged anymore by the fund.
d. Value Added Tax (VAT). This is computed at 10% of fees charged. It is generally included in the
fee percentage when the latter is based on the public offering price.
A mutual fund that charges fees on transactions with investors is called a load fund while a fund does
not make these charges is called a no-load fund. All mutual funds in the Philippines are load funds.
Offering and Redemption Prices
A load mutual fund offers its shares to the public at a price equal to its NAVPS for the day plus
sales fee. The latter may be based on the issue price or on the NAVPS. The computation are illustrated
below.
Sales Fee (Front-end load) Based on Issue Price. Issue price is considered as equal to 100% so
that the equivalent percentage of NAVPS must be ( 1-Sales fee %) of offering price. The offering price is
therefore arrived at as follows:
Net asset value per share
Public offering price (POP) = -------------------------------------------------------------------
1 – Front-end load on fee rate
Assuming that the NAVPS as of February 5,2002 is P 171.80 and that front-end load rate os 3%
(including VAT), the days’s offering price is arrived at as follows:
P 171.80 P 171.80
Offering price (POP) = ------------- = ------------ = P 177.11
1-3% 97%
The sales charge rate is arrived at as follows:
POP- NAVPS P177.11- 171.80
Sales charge = -------------------- = ------------------------ = 3.09%
POP P 171.80
It may be noted that the rate arrived at is higher than 3% when it is based on the public offering
price (POP).
Sales Fee (Front-end load) Based on NAVPS . NAVPS is equal to 100% so that offering price ust
be equal to ( 1+Sales fee %) of NAVPS. Using the given example, the offering price and the sales charge
rate are arrived at as follows:
Public offering price (POP) = P171.80 x (1+3%) = P176.95
POP – NAVPS P 176.95 – 171.80
Sales charge % = ------------------------- = ---------------------------= 3%
NAVPS P 171.80
Redemption Price. This is equal to the NAVPS on date of redemption request minus redemption fee.
Assuming that the NAVPS on date of redemption id P180 and the fund charges redemption fee of 2%.
The computation for net proceeds must be as follows:
NAVPS on redemption date P 180.00
Less –Redemption fee and VAT
(2% x P 180) + 10% 3.96
---------------------------
Net proceeds P 176.04
Comparing net proceeds upon redemption of P 176.04 and purchase cost of P 177.11, it may
appear that there is a loss of P1.07. However, there may have been distribution of earnings in between .
The computation for gain or loss is taken up later in this chapter.
Earnings from Mutual Funds
Investor’s earning from mutual fund may be in the nature of (a) distribution of dividends earned
on its stock investment ,(b) distribution of interest earned on the fund’s investment and (d) the
investor’s capital gain or his gain from sale of his shareholdings in the fund.
Capital gain is applied to investment in securities refers to the gain on sale thereof. Prior of their
sale, the increment in NAVPS is unrealized capital gain.
The fund earns interest, dividends and capital gains on its investments. Prior to their distribution
to fund’s shareholders, they are placed by the portfolio manager in near cash securities (treasury bills
and short-term commercial papers) until their regularly scheduled of payment date. Upon their
distribution, the decrease in assets cause a decrease in the NAVPS. In case the shareholder decides to
reinvest his share in the earnings, he may use the amount in buying new shares at their NAVPS. Some
mutual funds provide for an automatic reinvestment of the fund’s earnings.
Example: Oscar Quintos bought 200 shares of a fund’s shares for P 103 each. During the holding period
of three years, the fund earnings raised the NAVPS to P 120. Thereafter, it distributed earnings subject
to automatic reinvestment and Oscar was given 20 additional shares. Said Distribution resulted in a
decline in NAVPS to P 109.
The increase in value of Oscar’s investment is arrived at as follow:
Current investment value (220 shares x P109) P 23,980
Purchase Cost (200 shares x P 103) 20,600
-------------
Increase in investment value P 3,380
-------------
Based on the foregoing computation, the return on Oscar’s investment must be 16.4% (or P
3,380/ P 20,600). With an increased number of shares, Oscar’s share in the fund’s future earnings
increased also.
Mutual Fund Operating Expenses
Mutual fund operating expenses consist primarily of management fees, selling and distribution
expenses, smaller fees such as the fees of the fund custodian, transfer agent and external auditor. As
provided in Section 15 of the Investment Company Act, a mutual fund’s expenses should not exceed
10% of its total investment fund or total net worth.
It may be noted that broker’s commissions are not included in the operating expenses of the
mutual fund. The reason for this is that they are charged to investors upon sale and or upon
redemption.
Classifications of Mutual Funds
Mutual funds may be classified as follows:
A. Based on charging of fees:
1. Load funds. They charge to investors upon sale and redemption of shares. All mutual funds
in the Philippines are load funds.
2. No-loads funds. They do not charge fees to investors upon sales or redemption of shares.
The implies that charges that are directly related to sales and redemptions such as brokers’
commissions are treated as part of the fund expenses.
B. Based on securities invested in:
1. Equity or Stock Funds. They invest primarily in shares of stock.
a. Equity income funds. They are after current income so that they invest primarily in
stocks that regularly declare relatively high dividends.
b. Growth funds. They invest in growth stocks or those which have sales, earnings and
market share growing at rates higher than the average company or the company. They
generally reinvest the greater portion of their earnings so that they are expected to
grow more rapidly.
c. Aggressive growth funds. They invest primarily in smaller and younger companies
wherein there is more potential for growth but which are subject to greater volatility in
prices and therefore can result in bigger profit but entail greater risk.
d. Index funds. They invest in stocks that are included in the market index.
e. Global stock funds. They invest in stocks I different countries.
2. Bond funds. Their investment is primarily in bonds.
a. Government bond fund. Their primarily investment is in government bonds.
b. Commercial bond fund. They invest primarily in bonds issued by private corporations.
3. Balanced (or hybrid) funds. Their investment are primarily in stocks and bonds.
4. Money market funds. Their primary investment is in short-term money market instruments
such as treasury bills, commercial papers, banker’s acceptances, and negotiable certificates
of deposit.
Another term often used in relation to funds is value fund. This refers to the investment practice
of buying quality securities the market prices of which for some reasons have dropped to
attractive levels.
Advantages in Investing in Mutual Funds
Investing in mutual funds is undertaken for the following advantages:
Professional management. Mutual funds hire full-time investment managers, strategists and
analysts who are better qualified in choosing and managing investments. Very few direct
investors can match their skill and experience.
Diversification of investments. A mutual fund invests in different kinds of securities. Even if
one’s investable cash is not significant in amount, he can still be assured of having proportionate
ownership in different classes of securities which he cannot afford to buy alone. The existence of
different securities in a fund’s portfolio reduces the volatility of its investments and
consequently, minimizes losses. It enables an investor to avoid exposure to risks arising from
“putting all eggs in one basket”.
Smaller investable cash requirement. Direct investments in different securities require
significant amount of investments. In mutual funds, the minimum investment requirement of
P5,000 can give an investor interest in different securities on a proportionate basis.
Liquidity of investment. Investment in mutual funds are closely regulated by the SEC in
enforcing the Investment Company Act and its implementing rules. However, there is no
guarantee that the NAVPS will not decline because part of the fund portfolio can be affected by
price changes. The Safety features adopted for mutual funds are taken up in the next topic.
Lower purchase cost. Mutual fund investments entail lower acquisition cost due to its greater
purchasing power and the brokers’ tiered basis of charging commissions.
Convenience. Mutual fund shares can be bought directly from a fund or through a broker, bank
or agent, by mail, over the phone and over the internet. Aside from monthly or quarterly
statement and tax information, most of them provide 24-hour phone or computer access to
fund and account information.
Safety Features of Mutual Funds
The Investment Company Act or ICA of 1960 and the implementing rules adopted by the SEC
provide for safety features for the protection of the investing public. Among these are given below.
Required capitalization. Investment companies are required to have at least P50M subscribed
and paid-in capital. The significant amount of capital required provides the fund with greater
purchasing power, liquidity and ability to survive economic crises.
Common stock with voting rights only. Only common shares with voting rights can be issued by
mutual funds. This implies that fund shares of stock participate in the fund earnings on equal
basis and that all shareholders have a voice on matters that must be presented to them for
approval.
Required liquidity. The SEC requires that at least 10% of the fund should be invested in
liquid/semi-liquid assets in the form of short-term government securities (such as treasury bills
and certificate of indebtedness by the BSP ) the servicing and repayment of which are fully
guaranteed by the government.
Unallowed investments. An investment company is not allowed to sell securities short or invest
in any of the following:
a. Margin purchase of securities
b. Commodity futures contracts
c. Precious metals
d. Unlimited liability investments
Custody of securities and investments. Sec.16 of the ICA requires every registered investment
company to place and maintain its securities and similar investments in the custody of a local
commercial bank of good repute or company which is a member of a securities exchange.
Waiver of pre-emptive right. A mutual fund is required to include a provision on waiver of pre-
emptive right in its Articles of Incorporation. The implies that shareholders need not worry
about dilution of their proportionate interest in the fund’s net asset and earnings which may
arise from their failure to exercise their right while other shareholders do.
Bonded employees. Any officer or employee having access to securities or funds is required to
be bonded by a reputable fidelity insurance company against larceny and embezzlement.
Limitation on expenses. As provided in Sec.15 of the ICA , expenses of an investment company
shall not exceed ten percent (10%) of its total investment fund or total net worth.
Limited debt and borrowings. An asset coverage of 300% is required for all the fund’s debts
and borrowings.
Disclosure requirements. In addition to annual and quarterly reports required by the SEC,
investment companies are required to submit monthly reports to the SEC on the following:
a. Number of shares sold during the month and the total amount received from sale thereof.
b. Number of shares redeemed during the month and total amount thereof.
c. No. of shares outstanding at the beginning and end of the month.
d. The percentage of shares owned by Filipinos.
Fund Prospectus
A fund prospectus is a document whereby it informs a prospective investor of its important
features such as its investment objectives and policies, the securities held in the fund, the custodian of
its funds and securities, its investment manager, its transfer agent, fee structure, the purchase and
redemption procedures, and investment risks.
Measuring Mutual Fund Performance
The performance of a mutual fund may be measured by using the total return approach. The
formula for total return is as follows:
NAVPS, end + Distributed Earnings – NAVPS, beg.
Total return = -----------------------------------------------------------------------------------------------------
NAVPS, beg
Using the given example wherein purchase cost is P 177.11 and net proceeds upon redemption
amount P 176.04 and assuming that the fund distributed earnings amounting to P 22 per share, the
increase in investment value is arrived at as follows:
Net proceeds upon redemption P 176.04
Distributed earnings per share 22.00
Purchase cost (177.11)
-------------------------------
Increase in value of investment P 20.93
-------------------------------
Percentage ( P 20.93/P 177.11) 11.8%
-------------------------------
If the holding period is nine (9) months, the effective rate of increment in investment value
would be 15.73% or [ 11.8%(9/12].
In case there is reinvestment of earnings from the mutual fund, the amount so reinvested
should be substituted for distributed earnings.
Based on Total Value of Investment. Instead of using NAVPS, an investor may use the total value of his
investment in a mutual fund in determining the unrealized return on his investment . It is still unrealized
based on the assumption that the shares are not yet redeemed.
Example: An investor bought 10 shares of a mutual fund at P118. After nine months, the number
of his shares has increased to 12 shares because of automatic reinvestment of earnings. The year-end
NAVPS is P104.
The computation is as follows:
Investment Distributed Investment
Value, end + earnings + value, beg.
Total return = ---------------------------------------------------------------------------------------------
Investment value, beg.
(12 shares x P104) + P0 – ( 10 shares x P118)
= -------------------------------------------------------------------------------------------
(10 shares x P118)
P 1,248 – 1,180 P68
= ----------------------- = ------------ = 5.76%
P 1,180 P 1,180
With 5.76% return in nine months, the effective rate of investment value increment must be
7.68% [ or 5.76% (9/12)].
The rate of return on investment in mutual funds is not always positive because it is affected by
changes in market prices and interest rates brought about by changes in the economy. To minimize the
effects of the latter, most of the fund managers invest more in debt instruments.
Risk in Mutual fund Investments
As in any kind of investment, there is no assurance that an investment in a mutual fund will
always result in an increase in its value. Sometimes, redemption price may even be lower than purchase
cost. This may be due to changes in market conditions, general or political situations, and changes in
performance of investee corporations. These changes can affect the prices of stocks of investee
corporations and the yields on debt instruments favorably or un favorably. However, on long-term basis,
investments in mutual funds may be more profitable depending on the ability of the fund manager in
selecting securities and shifting investment emphasis.
Mutual Fund Companies in the Philippines
At the time of this writing the mutual fund companies operating in the Philippines are the
following:
Abacus Growth Fund ECC Growth and Income Fund
All Asia Fixed Income Fund Far East Fund
All Asia Fund First Galleon Family Fund
Ayala Life Fixed Income Fund First Private Fund
Citisec Growth and Income Fund GSIS Mutual Fund
Mutual Fun Co. of the Phil. Sunlife of Canada Prosperity
Pacific Fund Balanced Fund
Philam Bond Fund Sunlife of Canada Prosperity
Philam Fund Bond Fund
Philam Strategic Growth Fund Sunlife of Canada Prosperity
Philequity Fund Philippine Equity Fund
United Fund
Day-to-day NAVPS are published in The Manila Bulletin Today and Business World.
How Does One Invest in a Mutual Fund?
Anybody interested in mutual funds may call up the offices of the fund itself and request for a
prospectus. After going over its content, he may interview the manager in charge for additional
information. In case he decides to go on with his investment, he will be required by the fund’s salesman
to fill up an Investment Application Form and signature cards. Upon receipt of his check, the salesman
issues a Provisional Receipt and the payment is turned over to the fund’s custodian. As soon as the
check is cleared, the custodian issues a Confirmation Receipt or Official Receipt to the investor. The
investor may request for his Stock Certificate which he may expect to receive within fifteen days.
Fund Aspects to be Looked Into
Aside from the investment objectives and policies as contained in a prospectus, an investor
should look into some aspects of mutual funds as given below to be better assured of relatives safety
and profitability of his investments.
A. Level of transaction costs and mutual fund operating expenses. Both transactions costs (sales,
redemption and reinvestment fees) and mutual fund expenses should be as low as possible.
Although transaction costs amount to an insignificant percentage of transaction value, they
affect profitability of investments in mutual funds specially when the investor’s turnover rate is
very high. Their percentage are presented in the prospectus. Although investors prefer no load
funds, the latter does not mean that they are completely cost-free because the non-existence of
transaction costs can be more than offset by bigger operating expenses.
B. Track record of mutual funds. Investment in mutual funds is long-term with advisable holding
period of three to ten years so that an investor should look into their track records rather than
give undue emphasis on short-term achievements. How do they perform in bearish markets?
Oftentimes, funds that over perform others in times of bullish markets incur significant losses at
other times thereby wiping out all previous gains.
C. Track record of fund managers. An investors in a fund buys not only its share per set but also
the expertise of the fund manager who may be an individual or a team. Although a fund
manager is qualified with so many academic degrees and so many years of experience, how
good is he or she at picking securities? What investing style or analysis does he or she apply in
evaluating and making selection? How is his or her track record in times of bearish market in
comparison with the others?
D. Periodic Performance of Mutual Funds. An investor should periodically determine how his
investee mutual fund is performing relative to the market and other funds. This may be done by
keeping track of the NAVPS as published daily in the newspapers and by reading the fund’s
periodic reports. If it is doing worse, what must have caused the same? What course of action
should he take? He has the following options:
Suspend all additional investments in mutual funds leaving the money already invested
therein.
Make additional investments to take advantage of price declines.
Sell all his shareholdings and realize his loss.
Mutual funds issue statements of operations quarterly as required by the SEC and these may
serve as a basis in evaluating performance.
A decline in value of investments in times of a bearish market is unrealized loss but if the
investor decides to sell his shareholdings, the loss becomes a realized loss. If instead of selling, the
investment buys more shares , he is able to lower the average cost of his shareholdings . This practice is
called down averaging.
Procedure for Redemption
When an investor wants to have his shareholdings redeemed by the mutual fund, he informs
the fund, he informs the fund’s salesman of his intention to do so. The latter would then ask him to fill
up a Redemption Request form. If he received a stock certificate for his investment, he would be
required to endorse (by affixing his signature at the back) and surrender it. The fund s expected to pay
the investor within seven (7) banking days from the time the redemption request is received by the fund
and in most cases, they are able to do it in two or those days.
