Prospectus Analysis

A prospect analysis can help you choose the type of fund: The best place to learn about a particular fund is the prospect. SEC requires investors to get a prospect to start investing or immediately after doing so.

The prospect is a formal written document that shows relevant information about the fund, its objectives, strategies to achieve goals, securities owned by the fund, risks, historical returns, fees being charged and financial information.

A prospect has the following information:

  • Objectives
  • Strategies to achieve goals
  • Total risks
  • Performance
  • Fees

Objectives: Funds objectives can be very broad. The most common are:

  • Look for a long-term capital appreciation through the growth of the value of the fund in a fixed period of time.
  • Look for current income through investments that produce dividends and interest income in order to preserve investor?s capital.

Strategies: The strategy of a fund reveals the steps followed by the executive in charge or manager to meet fund?s objectives. For example, a stock fund manager could buy growth stocks or company’s value stocks with a particular size capitalization (small, medium or large cap stocks).

Bond-fund strategies show the type of bonds the fund buys (e.g. treasury, agency, corporate, municipal, foreign and zero-coupon bonds), bond maturity, and credit ratings or quality of these.

Overall risk: Fund objectives describe the type of securities in which it invests, additional to those risk factors linked to them.  For example if the prospect specifies that its fund invests in growth securities, you shouldn’t be surprised if you found out that most of the stocks have a large part of P / E; and that they can include riskier small-cap stocks. Consequently, a slow-down in stocks price increase could cause investors of these funds to lose money.

A fund investment policy will outline and tell the fund manager up to what point to invest on other type of securities, including trading future contracts, writing options to hedge bets (oriented towards interest rates or the market). It will also guide the fund manager on investing in derivative securities to raise fund performance.

Many conservative funds that supposedly only keep blue-chips stocks have occasionally turned to small-companies and offshore stocks to increase their return. While larger the rank of investments of these types of securities by fund managers, greater the risk. The type of securities that a fund invests in outlines the total risk in which it incurs.

Another risk measure would be how diversified is the fund. If the fund can’t invest more than 5% of its assets in the securities of a company it is a diversified fund. Nevertheless, if a fund has no limits, the manager of the fund can choose whether to invest in a few securities, which probably could greatly increase the loss risks in case one of these investments falls significantly.