It used to be difficult to read a mutual fund prospectus. Truth be told, no one ever read them. They were written in legalese and were boring. You had to look very hard to find any of the information you really wanted to know. The most important details were written in fine print that you could barely see without a magnifying glass. The SEC changed all that.
You can actually read a prospectus easily and quickly learn what you want to know now because they are written in “plain language”..
So what do you want to know?
You want to know: the investment objective, the investment policies, costs and fees and you want to know about the management of the fund.
Take them one at a time:
Investment objective and policies: Do you want a growth fund or an income fund? If you want a growth fund do you want large, perhaps “Blue Chip” companies in the portfolio or smaller companies with possible high growth prospects and perhaps more risk. Is it okay with you that the manager may invest in companies outside the US and add currency risk to the equation? If you want an income fund do you want strictly bonds or do you want dividend paying stocks? Is it okay with you if the fund manager buys foreign debt? All the answers to those questions are in the prospectus.
Cost and fees: In the old days this was all in “fine print” now it is required that costs and fees be clearly displayed.
Management: They are not required to and they are not going to tell you the names of the people managing the fund but they will tell you about the company. For example they’ll tell you how long it has been in existence and some background on management’s education and experience.
Here is some history that will elucidate how some of the above has developed over time.
Although this is what many investors look for first. Historical performance is probably the least important information in a mutual fund prospectus. The caveat: HISTORICAL PERFORMANCE IS NOT TO BE CONSTRUED AS INDICATIVE OF FUTURE PERFORMANCE really is true.
The worst performing fund last year is hardly likely to be the worst performing fund this year. In fact the manager of the worst performing fund last year probably got fired and the new manager is eager to turn things around. It’s true. In fact a British investor once wrote that on that assumption alone he invested all his money each year in last year’s worst performing mutual fund and made a fortune.
You should know that the old Investment Company Act had no limit on how much a fund could charge as a sales load only that such charge should be reasonable. The NASD cleared that up by making 8.5% the limit a fund could charge. The only mutual fund ever at least in recent memory to be cited for charging excessive fees was Fidelity Magellan. Back in the 80s, Magellan was such an unbelievably successful fund that they closed the fund to new investors. When they reopened the fund they piled on the fees and Fidelity was actually cited and fined for excessive charges.
Historically mutual funds have had three classes of shares:
a. Front end load shares known as A shares
b. Back end load shares known as B shares
c. No load shares or C shares for large institutional size investors of $1MM or more.
The A shares typically involved a 7% commission to the brokerage for soliciting the order. The B shares paid a 5% commission and the investor was locked in for five years or he would have to pay a 5% contingent deferred sales charge. The C shares were only available to persons or entities that could make a minimum investment of a Million Dollars and they were offered on a no-load basis.
Getting back to the Magellan Fund now:-
It didn’t matter that Fidelity was charging a big front end load, so much money piled into Magellan that it had to change its investment strategy. Prior thereto the Magellan fund had only about One Hundred Million Dollars. With that kind of money it could buy lots of positions in small hyper-growth companies without becoming burdened by Rule 144 regulations on resale because it could stay under the 4% rule. But with Hundreds and Hundreds of Millions of Dollars Magellan had to look at bigger companies and in fact had most of its money in US treasury bonds, notes and bills at the end of the year after it reopened.
So, for purposes of this article let’s look at the Magellan prospectus.
The first thing you notice is that Magellan Fund is managing Twenty-Two Billion Dollars now and is investing in Large Capital Growth Stocks both domestic and foreign. That’s no surprise. They still have to stay under 5% of the shares outstanding in any company they invest in or they will be restricted in the liquidation of that position.
The fee table of the Magellan Fund is clearly highlighted in the index and if you pull the prospectus up on-line you can just click on Fee Table and it pops right up.
Right away you can see that there is no sales charge front end or back end for the Magellan Fund. Then you look at the charges for managing and operating the fund, selling or distributing the fund i.e. 12b-1 fees and other costs. The management fee is in part performance based and a very clear example of how the fee can vary is given both as a percent of the fund share value and in dollars and cents. There are no distribution fees and the other costs are also indicated in both percentage and dollar terms.
Twenty years ago you would have gone blind trying to find that information in the prospectus.
You can contrast the Magellan Fund with another very large fund with the same investment objective. That’s the Lord Abbett Affiliated Fund. It’s one of the oldest and largest mutual funds in the US. It used to be run by a guy named Jack McCarthy a very colorful guy probably dead now. The Affiliated Fund manages Ten Billion Dollars and it still has A, B and C shares. The maximum front end load is 5.75%.
Mutual fund prospectuses are the only place you can find the important details that have real meaning for you as an investor. They are easy to read and generally available on-line.