CFP

Characteristics, Uses and Taxation of Investments - Mutual Fund Advantages/Disadvantages and Evaluation


4. Advantages/Disadvantages
      1. Diversification - funds within a particular category manage a selection of investments in an effort to add return and manage risk.
      2. Professional Management - investors in mutual funds allow a qualified professional with advanced training and expertise to manage their money.
      3. Easy Access - investors typically do not need to put up a lot of money to begin investing in a mutual fund. Subsequent purchases are smaller.
      4. Liquidity - redemption can be accomplished quickly.
      5. Services - mutual funds make numerous investment services available to their shareholders.
      6. Tax status - mutual funds can generate taxable gains independent of any activity undertaken by the fund holder.
      7. Manager Risk - investors typically lack the tools necessary to evaluate the manager's skill and business process.
5. Evaluation - investment manager research is a discipline all of its own. Planners need to be able to recognize certain areas in the management of a fund where change could potentially be material in a decision to retain or dismiss the manager.
    1. Change in assets under management - growth in assets would appear favorable, unless the manager has difficulty investing the additional funds. Referred to as capacity, this challenge is frequently encountered with managers of small capitalization stocks which are in smaller supply than their larger capitalization brethren. A marked decline in assets would be a clear indication of any number of things including poor performance and resultant asset outflows.
    2. Asset turnover - turnover generates costs and taxes. While it may be appropriate for a fund with an aggressive growth style, one should watch for more frequent turnover if little or none had previously existed and inquire as to the reasons why this is so.
    3. Style shift - is a manager dedicated to a certain style or is the manager pursuing a strategy that looks to add alpha, pursuing a 'go anywhere' approach?
    4. Manager turnover - a change in investment manager is often a clear warning sign to investors that something may be wrong. Turnover may be due to (un)forseen death, departure, a team liftout (industry parlance for the defection of the asset management team), retirement or change of responsibility within the organization. Does the manager has a strong succession plan in place? How deep are the resources of the organization to ensure as seamless a transition as possible?
    5. Capital gain exposure - more frequent turnover exposes the investor to more capital gains. Moreover, in a mutual fund, capital gains may be generated in the funds and passed along to the investor, creating a greater tax liability beyond the investor's control.



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