Like common stockholders, mutual fund shareholders have certain rights. This chapter covers:
Mutual fund shareholders have the right to vote for the Board of Directors (BOD) (sometimes called the Board of Trustees). The BOD is a group of shareholder-approved board members with industry knowledge or other relevant expertise. Their main job is to represent shareholder interests.
The BOD oversees the fund’s overall operations and helps ensure the fund complies with securities laws and regulations. If problems arise (for example, the fund isn’t complying with the law or the portfolio isn’t being managed in line with the fund’s objectives), the BOD is responsible for addressing them.
Additionally, the BOD nominates and oversees the fund’s investment adviser (the firm responsible for investing the fund’s assets). The investment adviser employs the fund manager, the person who makes the day-to-day investment decisions. These roles matter because they control how shareholder money is invested.
Once the investment adviser is selected, shareholders must approve* the initial advisory contract. That initial contract can last no more than two years. After that, the contract is renewed annually, and approval can come from either:
Only one of those approvals is required (not both). If the fund performs poorly, the BOD can replace the investment adviser and fund manager.
*Approval requires a majority of shareholder votes. Like common stockholders, shareholders receive more voting power as they own more shares. In particular, a shareholder gets one vote for each dollar invested in the fund. A “majority of shareholder votes” means a majority of voting power, not a majority of individual shareholders. For example, if one shareholder owns 51% of the fund and a million other shareholders own the remaining 49%, the 51% shareholder can outvote the million shareholders. It’s the voting power that matters, not the number of people voting.
The Investment Company Act of 1940 requires at least 40% of the BOD to be independent to help keep the board as unbiased as possible. Independent board members are also called non-interested. To be considered independent, a board member must not have had related business with the fund sponsor, investment adviser, or fund affiliates within the past two years.
By contrast, interested (non-independent) board members typically do business with, or are employees of, the sponsor, investment adviser, or fund affiliates (for example, a subsidiary of the fund sponsor). Any board member should raise concerns when something needs fixing, but independent members are generally more likely to do so because they have fewer ties to the fund’s management.
Shareholders are typically asked to vote on a variety of fund-specific matters each year. Similar to common stockholders, mutual fund shareholders can vote on major issues that affect the investment. For mutual funds, this includes:
*12b-1 fees are marketing fees, which we will discuss later in this unit.
Most mutual funds make distributions to shareholders each year. Dividends represent income the fund receives from investments in its portfolio.
For example, the Schwab Dividend Equity Fund (ticker: SWDSX) primarily invests in dividend-paying stocks and makes quarterly dividend distributions to shareholders. In 2022, the fund made dividend distributions totaling roughly $0.30 per share.
Mutual funds may also make capital gain distributions. This happens when the fund manager sells a security in the portfolio for more than the fund paid for it, and then distributes the realized gain to shareholders.
For example, assume the Schwab fund buys Coca-Cola Co. stock (ticker: KO) for a total cost of $10 million and sells it a few years later for $15 million. The fund could then distribute the $5 million gain to shareholders. These distributions are typically made once per year, often in December.
Shareholders have the right to receive dividend and capital gain distributions on a pro-rata basis (in proportion to the number of shares they own). However, shareholders don’t vote on whether distributions are made. Instead, the BOD approves dividend payments. It’s common for the BOD to approve distributions because there are tax incentives to do so (covered later in this unit).
Most securities issuers must provide detailed disclosures to investors, and mutual funds are no exception. Mutual fund disclosures commonly include:
The prospectus, sometimes called a statutory prospectus, provides key fund information to potential investors and current shareholders. It must be delivered to investors at or before a solicitation (recommendation), or by the settlement of a fund purchase if the purchase is unsolicited (no recommendation from a financial professional).
In practice, many investors receive electronic access to the prospectus (for example, a link during an online purchase or a copy sent by email).
Information disclosed in the prospectus includes:
*Funds that have existed for at least 10 years must disclose the past 1, 5, and 10-year returns. If a fund is not at least 10 years old, it must disclose as much of the typical requirements, plus the life of the fund. For example, a fund in existence for 7 years would disclose the past 1, 5, and 7-year returns. Or, a fund in existence for 4 years would disclose the past 1 and 4-year returns.
**Fund policies include minimum required investment (e.g., minimum $2,500 required to invest), availability of shares (e.g., shares only available to US citizens), and excessive trading policies (restrictions imposed on investors that quickly liquidate shares).
***Financial highlights include the fund’s historical income and expenses.
A fund prospectus can be dozens of pages long and difficult to read straight through. A summary prospectus, which is a condensed version of the prospectus, may be delivered instead of the statutory prospectus.
To view a real world version of these documents, click these links:
The statement of additional information (SAI) provides detailed, “in the weeds” information about the fund. Most shareholders never read the SAI, but it’s useful if you want a deeper look at how the fund operates.
Information in the SAI includes micro-details on:
The SAI does not have to be delivered automatically to investors, but it must be available upon request.
Click this link to view the SAI for the Fidelity Value Fund, a real world version of this disclosure.
Funds must file annual Securities and Exchange Commission (SEC) reports. The SEC makes these reports publicly available after they’re received.
These reports include:
Click this link to view the SEC annual report for the Fidelity Value Fund, a real world version of this disclosure.
Funds must make semi-annual reports available to shareholders. Much of the information overlaps with the annual SEC report, including:
Click this link to view the semi-annual shareholder report for the Fidelity Value Fund, a real world version of this disclosure.
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