Intelligent Investor Chapter 9 Summary : Investing in Investment Funds

Investing in Investment Funds

  • Good for defensive investor.
  • Registered under SEC. Not legal to sell if not registered.
  • Redeemable at any point of time at net asset value are open end funds(mutual funds). These are actively sold by sales people.
  • Non redeemable shares are closed end and their number remains constant.Fluctuate in the market like common stock.
  • Balanced funds invest in both bonds and stocks, stock funds have an all stock portfolio.
  • Load funds add a selling charge to the value. Non-load funds have no such fee and hence are less in number as sales people can't be paid commissions.
  • Most of them need to pay all their virtual income - dividends, interest, less expenses, pay any long term profits and avoid double taxing on investors.

Investment fund performance as a whole:

  • Promotes saving and investing, protects against costly mistakes, less temptations to trade. This makes them better than stocks in the end even though direct investment in stocks may fetch good returns.
  • What happens to market as a whole must necessarily happen to the sum of their funds. 
  • Check for performance over a period of years in the past - at least 5, provided that the data doesn't represent upward movement of market itself.

Performance Funds:

  • Small section of funds that attract disproportionate attention- seeking better than DJIA averages.Huge speculation, becomes highly difficult as the fund size grows, manipulations happen, manger and managee's results vary, letter stocks under undisclosed regulations- all these abuses pave the way for more regulations. But new subtle ways of manipulations keep coming up.
  • Large funds managed well fetch better than average results over the years. Large funds managed unsoundly fetch spectacular results followed by huge losses.
  • Funds that are closed to new investors perform well for the existing investors - this reduces fees for management though.

Closed End vs Open End:

  • Open End shares provide ways to cash in at any time and sell new shares.
  • Closed end funds are available for less prices, but perform equally well as open ended. So it's great to buy closed end shares at a discount(10-15%) instead of paying premium on open ended funds. Even if the discount widens by the time you sell a closed end fund, it still won't perform worse than open ended fund.
  • Small/No load funds also have the above advantage though lesser than the closed end funds.

Balanced Funds:

  • Suggested to invest directly in bonds like US Savings bond, A-rated corporate bonds, tax free bonds.


  • Cheap, diversified, professionally managed and tightly regulated but can overcharge, under-perform the market, tax a lot and suffer swings.
  • Average fund doesn't pick stocks well enough to cover expenses, higher expenses and frequent trading lead to lower returns, volatile funds stay volatile, high past returns likely to remain winners for long.
  • Problems when a fund performs better:
    • Migrating managers: Good managers are in high demand
    • Asset elephantiasis: High returns make many investors to pour in money. All this excess money leads to few choices -all bad. Keeping money safe for rainy day fetches low returns, money in existing stocks makes them dangerously high priced, money in new stocks that aren't so likeable dilutes the fund and manager's attention.
    • Incubation: Money managers start with a private group(employees/affiliates) testing all risky strategies on this small fund. Such private returns are publicized and fees are waived off drawing many investors and raising the returns. Once the returns are high, fees are slapped. These perform badly with such large size fund.
    • Expenses: It'd difficult to trade large sized fund blocks, so they incur a heavy trading fee. Operating cost remain same or rise. This means that the fund needs to beat the market by (trading + operating) expenses just to break even.
    • Sheepish: Managers who took risks and thus got better returns hesitate once the fund becomes large. This leads to herding- all large funds imitating each other.
  • Index funds will beat most fund over long run(20 years).
  • Better performing funds have these characteristics:
    • Managers are their biggest shareholders, which means no conflict of interest.
    • Cheap. High returns are temporary,but high fees are permanent and eat into returns.
    • Managers are daring enough to try something which other fund managers aren't doing.
    • Managers are willing to close the doors on new investors which isn't beneficial to them, but beneficial to the fund earnings. This also avoids asset elephantiasis.
    • No advertisement.
  • Consider these factors in the quoted order:
    • Fund expenses
    • Risk -check the worst loss and if you cant afford to lose that much in 3 months, then this isn't for you.
    • Manager's reputation-major shareholders, dare to be different, don't hype their returns, willingness to shut down.
    • Past performance- yesterday's winners often become tomorrows losers, but yesterdays losers almost never become tomorrows winners.
  • Closed end funds that provide diversification aren't available at discounts mostly. Closed end bond funds at discounts and less fee are good.
  • ETFs are good, but recurrent deposits may incur fees.
  • When to fold-some funds under-performed in 12/29 years, but still fetched profits overall. If you don't want to stick with a fund through at least 3 lean years, don't buy. So fold only when there is an unexpected change in investing strategy, increase in expenses, large and frequent tax, sudden erratic returns. If you are not prepared to stay married, you shouldn't get married.


See Intelligent Investor Summary for other chapters summary.


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