The rate of return on an investment in a mutual fund is measured as the increase or decrease in net asset value plus income distributions such as dividends or distributions of capital gains expressed as a fraction of net asset value at the beginning of the investment period. If we denote the net asset value at the start and end of the period as NAV0 and NAV1, respec- tively, then

Rate of return

NAV1 NAV0 Income and capital gain distributions

NAV0

For example, if a fund has an initial NAV of $20 at the start of the month, makes income distributions of $.15 and capital gain distributions of $.05, and ends the month with NAV of $20.10, the monthly rate of return is computed as

Rate of return $20.10 $20.00 $.15 $.05 $20.00

Notice that this measure of the rate of return ignores any commissions such as front-end loads paid to purchase the fund.

On the other hand, the rate of return is affected by the funds expenses and 12b-1 fees. This is because such charges are periodically deducted from the portfolio, which reduces net asset value. Thus the rate of return on the fund equals the gross return on the underly- ing portfolio minus the total expense ratio.

To see how expenses can affect rate of return, consider a fund with $100 million in assets at the start of the year and with 10 million shares outstanding. The fund invests in a portfolio of stocks that provides no income but increases in value by 10%. The expense ratio, in- cluding 12b-1 fees, is 1%. What is the rate of return for an investor in the fund?

I. Introduction 4. Mutual Funds and Other

Investment Companies

The McGraw−Hill

Companies, 2001

114 PART I Introduction

Table 4.2

Impact of Costs on Investment Performance

Cumulative Proceeds

(All Dividends Reinvested)