Structure and Operation of Open-End Funds

The following parties do not work for free. Who pays their expenses? The shareholders of the fund do, ultimately, as the following parties are paid through the deduction of operating expenses against the assets of the fund. The higher the expenses, the lower the dividend distributions to the shareholders of the fund, and vice versa.

Board of Directors
A mutual fund has a board of directors that oversees operations and policies of the fund or family of funds. The board's responsibilities include:
  • establish investment policy
  • select and oversee the investment adviser, transfer agent, custodian
  • establish dividends and capital gains policy
  • approve 12b-1 plans
As with a public company, the shareholders of the fund elect and re-elect the board members. Shareholders also vote their shares to approve the investment adviser's contract and 12b-1 fees. Independent board members have no other connection to the mutual fund sponsor or investment adviser, while the other board members either currently or recently had such a connection.

Investment Adviser
Each fund has an investment adviser, whose job is to manage the fund portfolio according to its stated objectives. For example, Capital Research and Management Company is the investment adviser for the American Funds. The board of directors sets the policies for investing, but it is Capital Research and Management making each purchase and sale for the portfolio.

Shareholders and the board vote to hire and retain investment advisers, who are paid a percentage of the fund's net assets. That's why they try so hard. The more valuable the fund, the more they get paid. Their fee is typically the largest expense to a mutual fund. Investment advisers must advise the fund (select the investments) in keeping with federal securities and tax law they must also base their investment decisions on careful research of economic/financial trends.

The fund also keeps its securities and cash under the control of a custodian. Keeping track of all the dividends received from common and preferred stock held in the portfolio, interest payments from the bonds and money market instruments owned by the fund, purchases and sales, etc., is a big job, and the custodian performs it. The custodian is responsible for the payable/receivable functions involved when the portfolio buys and sells securities. That means they release the money and receive the securities purchased, and they accept the money and deliver the securities sold by the portfolio manager. When a security in the portfolio pays a dividend, the custodian receives it.

Transfer Agent
The transfer agent is the party that issues new shares to buyers and cancels shares that sellers redeem. Most of these shares are electronic files (book entry), but it takes a lot of work to issue and redeem them. While the custodian receives dividends and interest payments from the portfolio securities, it is the transfer agent that distributes income to the investors in the fund. The transfer agent acts as a customer service rep for the fund and often sends out those semi-annual and annual reports that investors must receive. Investors can purchase and redeem shares directly with the transfer agent. The transfer agent also handles name changes when, for example, mutual fund shares are re-titled in the name of the estate for a now deceased investor.
So, if it concerns portfolio securities, that's the custodian. If it concerns shareholders of the fund, that's the transfer agent.

Funds are sponsored by broker-dealers acting as underwriters, who bear the costs of distributing the fund up front and are then compensated by the sales charge that they either earn themselves or split with the broker-dealers who make the sales. Underwriters/distributors also prepare sales literature for the fund, since they're the ones who will be selling the shares, either directly to the public or through a network of broker-dealers. If a fund acts as its own distributor, it usually covers the distribution costs through a 12b-1 fee, as we mentioned. The fund can call itself "no load" if the 12b-1 fee does not exceed .25% of net assets. To call itself "100°/0 no-load" the fund could have neither a sales charge nor a 12b-1 fee.
These are the methods of distribution for mutual fund shares:
•    Fund/to underwriter/to dealer/to investor
•    Fund/to underwriter/to investor
•    Fund/to investor (no-load funds)


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