The Fund Industry: How Your Money is Managed, 2nd Edition

CHAPTER 6

Portfolio Management of Stock Funds

For many, the capstone of the investment process is the management of stock funds. The performance of these funds often garners headlines—soaring when the business news is good and dropping in times of financial crisis. While their average returns are usually strong—at least when looked at over the long term—stock funds can show significant losses in any single period.

If stock fund returns are volatile, that's because the stocks they own participate directly in the ups and downs of the economy. Buy a stock, and you're buying a proportional share, or an equity stake, in a company. (The terms stock, share, and equity are used interchangeably.¹) Own 100 shares in a company that has 10,000 shares outstanding, and you own rights to 1 percent of that firm's assets and 1 percent of its profits. If the company does well, whether because of a booming economy or astute management decisions or a favorable regulatory environment, you as an investor do well, too.

Ownership of stock carries voting rights. Shareholders are empowered to elect a board of directors; in turn, the board hires the firm's top executives and oversees its business. Shareholders also vote on other significant matters, such as the implementation of a stock option plan or a merger proposal. (Chapter 10 has a detailed discussion of shareholder voting.)

Most firms sell their stocks to the public—after having registered the securities offering and filed a prospectus with the SEC, ...