The Problem

Since the beginning of 1997, the U.S.-sold Japan Fund has experienced substantial cash inflows and outflows from investors, and portfolio manager David Smith has voiced his concern recently about the volatility. He also noted that extremely large shareholder orders seem to coincide more and more with news affecting Japan, and cash flow management is taking up a large percentage of his time that might otherwise be spent selecting securities.

Smith suspects some shareholders are trying to increase their profits by “timing” the market—quickly moving their money from one fund to another within the complex. Furthermore, he speculates that these investors might be attempting to profit from the methodology that the fund complex uses to compute the daily NAV of the fund by trading on stock price information that may become available between the time when the Japanese markets close and the time the fund values its holdings. Smith has requested that someone look into shareholder activity and analyze whether the pricing of the fund has encouraged or contributed to the cash flow volatility.

Funds

Background on the Japan Fund

Introduced on October 28, 1993, the Japan Fund is a non- diversified, SEC-registered mutual fund sold with a 5% sales load and a .25% 12b-1 fee to U.S. investors. The fund’s investment objective is to achieve long-term growth primarily through investment in securities of Japanese companies. The fund may hold any type of equity or debt securities, although it is expected that equity securities normally will account for the majority of the fund’s investments. The Japan Fund may also invest in indexed and debt-like securities whose value depends on the price of foreign currencies, securities indexes, other financial indicators or underlying interests. As of August 31, 1997, the fund had assets of $125 million and 12,500 shareholders with an average account size of $10,000. Currently, the average equity trade for the Japan Fund is 2,500 shares at $40 per share, and Smith tends to hold no more than 3% of the fund’s assets in cash but occasionally may hold less for a day or two, depending on recent shareholder redemption activity.

The Japan Fund is managed by Global Management Company (”Global“), which also serves as manager of the following other mutual funds in the Global complex: Emerging Growth, Large-Cap Stock, Small-Cap Stock, S&P 500 Index, Diversified International, Emerging Markets, Europe, Latin America and High Income Bond. Shareholders of any fund in the Global complex may sell their fund shares and buy shares of other Global funds, subject to any restrictions detailed in each prospectus. The shares exchanged will carry credit for any sales charge previously paid by the investor in connection with their purchase. Each fund reserves the right to terminate or modify the exchange privilege at any time in the future.

Regional international funds, which are relatively new offerings for Global, seem to have gained in popularity. Assets in the funds increased at a fairly steady pace the prior year, and the complex now has a few funds (listed above) that each focus on a non-U.S. region or country. Although these focused funds carry higher risk than diversified international funds, they have the potential for higher returns. Because they are more concentrated than diversified international funds, country funds may appeal to investors who want to take more personal control of their investments, potentially including more active traders. As a result, Global anticipated that the Japan Fund might experience higher shareholder volatility, but the recent wave of cash that has been moving in and out of the Japan Fund seems to be especially high.

Short-Term Trading

Global has found that short-term trading is somewhat in likely to occur in aggressive or volatile funds or funds that are concentrated in one type of investment. Investors Id are looking to place a “bet” have more difficulty doing it a diversified fund, where the manager has more discretion to move money among market sectors and possibly asset classes. Since most sector and country funds have relative( small shareholder bases, a small number of shareholders making short-term trades can cause huge cash flow volatility relative to the size of the fund.

Short-term trades affect various categories of fund expenses that are paid by all shareholders in the fund. The fund’s expenses, include management fee, 12b-1 fees, transfer agent fees and other expenses, as well as brokerage commissions. Brokerage commissions are accounted for as an addition to the cost basis, or reduction in the proceeds from the sale, of the fund’s portfolio securities and therefore reduce the capital gains (or increase the loss) realized by the fund.

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