Analysis of the Prospectus can assist in the Choice of Fund

The best place to learn more about a particular fund is from its prospectus. The SEC requires that investors receive a prospectus before investing or soon afterward. A prospectus is a formal written document listing relevant information about the fund, the goals of the fund, the strategies for achieving the goals, securities held by the fund, risk, historical returns, fees charged, and financial data. A prospectus contains the following information:
* Objectives
* Strategies for achieving the objectives
* Overall risk
* Performance
* Fees

Table 14-3
What Is a Hedge Fund?
A hedge fund is not a mutual fund. Hedge funds with fewer than 99 investors are not required to register with the SEC. Hedge funds cater to wealthy investors who have a significant net worth ($1.5 million) and are willing to invest $1 million or more. With the negative stock market returns in 2001 and 2002, hedge funds attracted large amounts of new capital and a broader-based clientele. Although returns for hedge funds were low (1 to 2 percent) or flat for 2001, they were nevertheless much better than the double-digit losses posted by most mutual funds for the same period. The reason is that hedge funds can take both long and short positions in stocks, whereas mutual fund managers can only take long positions. In addition, hedge fund managers can use borrowed money, which can increases their returns. These positive returns resulted in the introduction of mini-hedge funds in 2002, a new investment product offered by Wall Street. This type of fund requires a relatively low investment of $250,000, even though investors still must have significant assets to withstand any potential risk of loss (Clements, 2002, p. C1). However, the combination of long and short positions of hedge funds did not perform as well as mutual funds in a rising stock market.
A hedge fund is a specialized open-end fund that allows its manager to take a variety of investment positions in the market to seek higher-than-average potential gains with exposure to greater-than-average risk. U.S. hedge funds, which have been in existence for almost 50 years, typically take the form of limited partnerships. Hedge funds have numerous investment styles, such as market-neutral strategies, in addition to the high- and low-risk strategies. Hedge funds, because they are not as heavily regulated as mutual funds, do not have the same limits on the types of investments they can make and have less stringent disclosure requirements. Investors are limited in how they can withdraw funds. Many hedge funds allow investors to withdraw money only at the end of the year. Others may allow investors to withdraw money at the end the year or at the end of each quarter (Scholl and Bary, 1998, p. 19).
Before investing in a hedge fund
* Read the offering documents.
* Evaluate the hedge fund’s risk and use of leverage.
* Understand how long your money is tied up before you can redeem your funds.
* Ask whether there are any side-letter agreements that offer some investors lower fees and other benefits (Maxey, 2006, p. B4).

Objectives
A fund’s objectives can be broadly phrased; the most common are
1. To seek long-term capital appreciation through growth of the fund’s value over a period of time
2. To seek current income through investments that generate dividends and to preserve investors’ principal

Strategies
A fund’s strategy reveals the steps its fund manager might take in achieving the fund’s objectives. For example, the manager of a stock fund might buy growth stocks or value stocks of companies with a particular size capitalization (small-cap, mid-cap, or largecap stocks).

Overall Risk
A fund’s objectives describe the types of securities in which the fund invests in addition to the risk factors associated with the securities. For example, if a prospectus states that its fund invests in growth securities, you should not be surprised to find that most of the stocks will have high P/E ratios and can include riskier small-cap stocks. Consequently, a decline in growth stock prices would cause investors in this fund to lose money. A fund’s investment policies outline the latitude the fund manager has to invest in other types of securities, including options to hedge bets (on the direction of interest rates or the market) and derivative securities to boost the yield of the fund. Many conservative funds, which supposedly only hold blue-chip stocks, have resorted occasionally to investing in small-company and offshore stocks to boost returns. The greater the latitude fund managers have in investing in these other types of securities, the greater is the risk. The types of securities in which the fund invests outline the overall risk of the fund. Another measure of risk is how diversified the fund is. If the fund cannot invest more than 5 percent of its assets in the securities of one company, it is a diversified fund. However, if a fund has no limits, the fund manager can choose to invest in a few securities, which greatly increases the risk of loss if one of these investments declines significantly.

Performance
The overall performance of a fund pertains to these concepts:
* Total return
* Expenses

Funds are required by the SEC to provide annualized returns. These returns can be presented in a table or graphically, showing results for one year, five years, or ten years. New funds provide their returns from the date of inception. These returns are presented on a before-tax basis and an after-tax basis, which shows how tax efficient the fund is. Funds also must compare their returns to an appropriate market index.

Many funds can boast that they have attained the number-one position in some area of performance at some point during their existence. Note, however, that good past performance may not be indicative of good future performance. Some funds that did well in the past no longer even exist.

Several business magazines track the overall performance records of many mutual funds during up and down markets. These performance results are a better yardstick to use than the advertising messages of the mutual funds themselves. From these publications, you can see how well funds have performed in up markets and how the funds protected their capital during periods of declining prices. New funds do not have track records, which means that their performance during a period of declining prices may not be available. This statement is especially true for funds that come into existence during a bull market.

Organizations such as Morningstar (www.morningstar.com) rate a mutual fund’s performance relative to other funds with the same investment objectives. However, this rating can be misleading when you are trying to choose a fund. First, the funds may not be comparable, even though they have similar objectives. For example, one fund might have riskier assets than another. Second, past performance may not be a reliable indicator of future performance. In choosing a fund, you should look at what the fund invests in (as well as can be determined) and then try to determine the volatility in terms of up and down markets.

Total Return
Yield is a measure of a fund’s dividend distribution over a 30-day period. It is only one aspect of the fund’s total return, however. Mutual funds pass on to shareholders any gains or losses, which can increase or decrease the fund’s total return.

Another factor that affects total return is the fluctuation in NAV. When the share price increases by 6 percent, it effectively increases the total return by an additional 6 percent. Similarly, a decline in the NAV price of a fund decreases the total return. This concept explains why funds with positive yields can have negative total returns.

Interest on reinvested dividends is another factor that also might be included in the total return. When dividends paid out by a fund are reinvested to buy more shares, the yield earned on those reinvested shares boosts the overall return on the invested capital. The total return of a mutual fund includes the following three components:
* Dividends and capital gains or losses
* Changes in net asset value
* Dividends (interest) on reinvested dividends

Expenses are a key factor in differentiating the performances of different funds. By painstakingly looking for funds with the highest yields, you are looking at only half the picture. A fund with a high yield also may be the one that charges higher expenses, which could put that fund behind some lower-cost funds with lower yields. Fees reduce total returns earned by funds. You cannot count on future performance projections unless the fees and expenses charged by mutual funds are fairly consistent. A mutual fund prospectus has a separate table with a breakdown of expenses. This table typically shows the different charges paid for either directly by shareholders or out of shareholders’ earnings in the fund: load charges, redemption fees, shareholder accounting costs, 12(b)–1 fees (explained below), distribution costs, and other expenses.

The mutual fund industry has been criticized for its proliferation of fees and charges. Granted, these are all disclosed by the mutual funds, but you need to know where to look to find the less obvious fees.

Lack of Trading Plan
Planning plays a key role in the success or failure of any endeavor

Using too much Leverage
Determining the proper capital requirements for trading is a difficult task

Failure to control Risk
Refusing to employ effective risk control measures can ensure your long-term failure

Lack of Discipline
A lack of discipline can destroy even the most talented and best prepared trader

Useful Advices to Beginning Trader
You can control your success or failure

All about Stocks
Encyclopedia about Stocks. That you should know about Stocks before starting

Forex Glossary
All terms about Forex market