Like common stockholders, mutual fund shareholders are granted 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 valuable insight. Their primary role is to represent shareholder interests.
The BOD oversees the fund’s overall operation and helps ensure compliance with securities regulations. If something goes wrong (for example, the fund isn’t complying with the law or the portfolio isn’t aligned with the fund’s objectives), the BOD is responsible for addressing the issue.
Additionally, the BOD nominates and oversees the fund’s investment adviser (the company responsible for investing the fund’s assets). The investment adviser employs the fund manager, the person responsible for making the day-to-day investment decisions. These roles matter because they control shareholder money.
Once the investment adviser is appointed, shareholders must approve* the initial advisory contract. The initial contract can last no more than two years. After that, the contract is subject to annual renewal, and approval can come from either the BOD or a majority of shareholder votes (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” doesn’t necessarily mean a majority of shareholders. For example, assume one shareholder owns 51% of the fund’s value and a million other shareholders own the remaining 49%. If the 51% shareholder votes to approve an item and the million other shareholders vote against it, the approval passes. The outcome depends on voting power, 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. To be considered independent (also called non-interested), 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 more likely to do so because they have fewer ties to the organizations involved.
Shareholders are typically asked to vote on a variety of fund-specific matters each year. Similar to common stockholders, shareholders can vote by proxy (using voting materials) or attend the annual shareholder meeting (if one is held). The most common matters requiring a vote include:
*12b-1 fees are marketing fees, which we will discuss later in this unit.
Most mutual funds make distributions to shareholders each year.
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 equaling roughly $0.30 per share.
The fund also made a capital gain distribution of roughly $0.62 per share. This type of distribution occurs when the fund manager sells a security in the portfolio at a gain and then distributes the profit to shareholders. For example, assume the Schwab fund establishes a $10 million position in Coca-Cola Co. stock (ticker: KO) and sells the position for a total of $15 million a few years later. The fund could then distribute the $5 million gain to shareholders. These distributions are made once per year, typically in December.
Shareholders have the right to receive dividend and capital gain distributions, but they don’t vote on whether distributions are made. Instead, the BOD approves dividend payments. It’s common for the BOD to approve these 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. Common mutual fund disclosures include:
The prospectus (sometimes called a statutory prospectus) discloses important fund information to potential investors and current shareholders. It must be delivered:
In practice, many investors receive electronic access to the prospectus (for example, a link during an online purchase or an emailed document).
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 less than 10 years old, it must disclose as much of the typical requirements as possible, 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. 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 real-world examples of these documents, use 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 designed for investors who want to understand the fund’s operations in depth.
Information in the SAI includes micro-details on:
The SAI doesn’t have to be delivered to investors, but it must be made available upon request.
Click this link to view the SAI for the Fidelity Value Fund, a real-world example of this disclosure.
Funds must file annual Securities and Exchange Commission (SEC) reports, which the SEC makes publicly available upon receipt. These reports include:
Click this link to view the SEC annual report for the Fidelity Value Fund, a real-world example 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 example of this disclosure.
Sign up for free to take 5 quiz questions on this topic