- 1. Chapter 10 Investment Companies Mutual Fund Characteristics
Other Pooled Investments Managing Fund Investments
2. Student Learning Objectives
- Open-end vs. closed-end funds
- Managing mutual fund investments
3. Forming a Mutual Fund
- Investment company forms the fund and advertises its investment
objectives, fees, and fund manager.
- Interested parties buy shares (of beneficial interest) at a
preset price (NAV).
- Fund manager then invests the proceeds of the share sale in a
variety of stocks.
- Thereafter, NAV set by stock prices
-
- Value of mutual fund assets minus liabilities divided by number
of outstanding shares
- Regulatory requirements for Investment Companies
4. Types of Mutual Funds
-
- Investment Company stands ready to buy and sell
-
- Price based on NAV (sales charge possible)
-
- Active or Passive management
-
- May have multiple classes (fee schedules)
-
- One time issuance of shares
-
- Tend to trade at a discount to NAV
5. Types of Mutual Funds
- Stock Funds (common, preferred)
- Bond Funds (short-, intermediate- or long-term)
- Balanced Funds (stocks and bonds)
- Index Funds (SP500, Nasdaq, Russell, Wilshire )
- Sector Funds (Energy, Utility, Transportation)
- Global Funds (Europe, Far East, Emerging)
- Exchange Traded Funds (ETF)
6. Types of Mutual Funds
-
- Real estate applications: commercial, residential
-
- Largely consist of short-term debt securities
-
- Typically organized as offshore limited partnerships for
qualified investors
-
- Maximum investment flexibility
-
- Mutual fund type of instrument originating at insurance
companies
7. 8. Fund Operating Details
- Distribution Requirements
-
- IRS (Subchapter M) requires funds to distribute no less than
90% of interest and dividends received.
-
- The same applies to net realized capital gains
-
-
- Realized = result of buying and selling
-
- Sales charges may vary according to fund
-
-
- Front-end vs. Back-end (tied to holding period or class)
-
-
- Sales charges tend to discourage timing or frequent
trading
-
-
- May also involve break-points
- Management (Advisory) Fees, 12b-1 Fees
9. Fund Operating Details
-
- Direct marketing (Vanguard, Fidelity, etc., websites)
-
- Retirement fundjobbers(Planco Div of HIG)
-
- Investor purchase must be followed by receipt of fund
prospectus
-
- Annual reports required, may receive quarterly reports
10. Pros & Cons of Mutual Funds
-
- Professional portfolio management
-
- Diversification (risk reduction)
-
-
- Examples: liquidity, minimal investment requirements,
regulation
11. Pros & Cons of Mutual Funds
-
- Management fees, expenses, and loads for load funds reduce
their returns.
-
- Large investors, such as mutual funds, sometimes adversely
affect the market when they trade.
-
- Institutions usually restrict their analysis to a small
percentage of traded stocks (i.e., the larger ones).
12. Net Asset Value (NAV)
- Per-share market value of mutual funds portfolio:
- NAV = (total assets total liabilities) number of shares
outstanding
-
- Price Appreciation:Increase in NAV
-
- Dividends and Interest:Pass-through of dividends and interest
received on portfolio
-
- Capital Gain Distribution:Payment of net capital gain
recognized by fund during year
-
- Reinvestment Strategies: auto-reinvest, cash distribution
13. Load Charges
- Contingent deferred sales charge (CDSC)is a back-end load that
declines over time
- Back-end loads discourage trading by investors
- Front-end loads compensate the broker
- No-load funds tend to be most popular
-
- Class A:Usually large front-end load, and minimal or no 12b-1
fee . Best if plan long holding period
-
- Class B:Back-end load and 12b-1 fees, usually convertible to
Class A after load waived
-
- Class C:Minimal or no front-end or back-end load, but
substantial 12b-1 fee. Best if plan short holding period
14. Operating Expenses
- Management or advisory fees and other operating expenses
-
- 12b -1 fees cover distribution costs
- Paid out of investment income as percent of NAV
- Compare loads and operating expenses for varying time periods
in evaluating funds
- No evidence that higher fees or load charges bring superior
performance
15. Performance and taxes
- Mutual funds are not taxed directly on income or capital gains
as these are passed on to the shareholders
- Returns can be broken down into distributions and change in
NAV
- Portfolio turnover relates to higher capital gains
distributions and unrealized capital gains
- Dont purchase just before a distribution
16. Managing Fund Investments
- Personal objectives may change over time
- Dollar-cost averaging results from investing equal dollar
amounts at regular intervals
-
- Can be beneficial when prices fluctuate, but
-
- if prices continually rise, buying more earlier is better
- Rebalancing Investment Portfolio
-
- Adjusting allocations to desiredrisk-return target
17. Regulations and Taxation
- The SEC regulates U. S. fund operations through Mutual Fund Act
of 1940.
- State approval is also required to sell shares
- Most funds are taxed asregulated investment companies :
-
- All investment income must be distributed to shareholders each
year
-
- All tax liability falls to individual shareholders
18. Mutual Fund Services
- Automatic reinvestment of distributions
- Automatic investment plans
- Check writing (money market funds)
- Exchange privileges within fund families
19. Why Mutual Funds?
-
- Most funds under perform the indexes
-
- Fund performance depends on fund manager and market
conditions
20. Special Issues in Closed-End Funds
- May have tax liabilities (liquidation)
- May be leveraged (additional risk)
- May have liquidity problems (thinly traded)
- Possibility of conversion to open-end
- Different distribution structures (managed)
- Tends to trade at less than NAV
21. Real Estate Investment Companies
- Real Estate Investment Trust (REIT)
-
- Min of 75% invested in RE
-
- Required to pay out 90% of income
-
- Equity REITs: income producing
-
- Mortgage REITs: making loans
- Real estate Limited Partnerships (RELP)
-
- May have a liquidation time set
-
- May involve sales charges
22. Real Estate Investment Companies
- RE Mortgage Investment Conduits (REMIC)
-
- Created by breaking up interest and principal streams
-
- Different maturity packs to match investor needs
-
- Bear Stearnswasmajor player in this market (> JPM)
23. Unit Investment Trust
-
- Bond UIT have fixed lives.
-
- Purpose: provide known income stream
-
- Funds invested in Equities
-
- All have termination date: liquidation > distribution
-
- Negligible fees, tax efficient, convenient
-
- Sales charges, lack of marketability
24. Exchange Traded Funds
- Alternative to Mutual Funds
-
- No minimum holding period
-
- Can mimic indexes, sector, countries, etc.
-
- Many are very liquid 51 traded more than 500,000 shares (April,
2008), another 60 at least 100,000 shares
-
- Even more are thinly traded: 259 ETF had daily volumes under
100,000 shares (April, 2008)
25. Other Investment Vehicles
-
-
- Derivatives: options and futures
-
- Performance suspect backfilling
-
- Losses can be significant e.g. LTCM
-
- Industry is still evolving trying to increase returns
26. Other Investment Vehicles
-
- Operating or holding companies:Some operating or holding
companies hold such large portfolios that their performances are
more closely related to their security holdings than to their
operations.
-
- Partnerships:Some investment companies choose the partnership
form, often a limited partnership, because of its greater
flexibility and/or tax advantages.
-
- Blind pools:Investors bankroll enterprises whose purposes will
later be revealed; these pools are sometimes involved in takeover
financing.
27. Selecting and Evaluating Funds
- Evaluate Historic Performance
-
- Against a benchmark like the S&P 500 over time
-
- Morningstar or Weisenberger publications
- Assess Future Performance
-
- Some believe that past performance is a poor predictor since
funds do not (over the long term) post better risk-adjusted
performance than the broad market averages
-
- Others feel that past performance is a reasonable, though
imperfect, predictor because past performance reflects more than
mere luck
28. Selecting and Evaluating Funds
- Evaluate services offered by the fund
-
- Automatic dividend reinvestment
- Examine fees and expenses