Slide4 - Chapter
4
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Unformatted text preview: Chapter
4
 Mutual
Fund
and
Other
Investment
 Companies
 4.1
Investment
Companies
 Func:ons
of
Investment
Companies
 a.
Administra:on
&
record
keeping
 •  Periodic
report
on
performance,
capital
gain,
 dividend
etc
 b.
Diversifica:on
&
divisibility
 c.
Professional
management
 •  •  Research
analysis
 PorGolio
managed
according
to
specific
 objec:ves
 Func:ons
of
Investment
Companies
 •  Professionals
to
find
undervalued
securi:es
 and/or
engage
in
asset
alloca:on
 d.
Lower
transac:on
cost
 e.
Inves:ng
for
re:rement
 •  Some
funds
can
be
set
up
as
an
IRA
 Permit
small
investors
to
“team
up”
to
obtain
 the
benefits
of
large
scale
of
inves8ng
 4.2
Types
of
Investment
Companies
 Organiza:onal
Forms
 1.
Unit
Investment
Trusts
(UITs):
unmanaged,
 fixed
composi1on
por3olios
  Any
interest
and/or
dividends
are
distributed
 immediately
to
trust
cer:ficate
holders.

  Provide
diversifica1on
within
one
sector
or
 area
and
low
cost
entry.

 Organiza:onal
Forms
 •  Unit
Investment
Trusts
(UITs):
unmanaged,
fixed
 composi1on
por3olios
 •  Managed
Investment
Companies:
porGolios
is
 periodically
updated
 –  Open
end
fund:
shares
are
bought
from
the
fund
and
 redeemed
by
the
fund
at
NAV
or

 –  Closed
end
fund:
shares
may
not
be
redeemed
by
the
 fund,
but
instead
are
traded
among
investors
in
the
 marketplace
(NASDAQ
or
an
exchange),
at
prices
 different
from
NAV.
 Performance
of
Closed
End
Funds
 PREMIUM/DISCOUNT=(Market
Price
–
NAV)
/
NAV,
 Where

 Open
End
vs
Closed
End
 Most
funds
are
open
end:

 The
advantage
of
the
open
end
form
is

 •  

Liquidity
for
the
investor

 •  Fund’s
ability
to
grow
(advantage
for
the
fund
or
 sponsor)
 The
disadvantage
of
the
open
end
form
is

 •  The
need
to
keep
a
cash
reserve

 •  Vulnerable
to
panics
 Other
Investment
Organiza:ons
 ‐‐
Less
formally
organized
or
regulated
 –  Commingled
funds
 •  Partnerships
of
investors
that
pool
their
funds.
Designed
 for
trusts
or
re:rement
accounts
to
get
professional
 management
for
a
fee.
 •  Issued
by
banks,
insurance
companies.
Operates
similar
to
 a
mutual
fund.
 •  Similar
to
closed
end
fund.
Invest
in
real
estate
and
real
 estate
loans.
 •  Similar
to
mutual
funds,
but
not
registered
and
not
subject
 to
SEC
regula1ons.
 •  Available
to
ins1tu1onal
and
high
net
worth
investors
 •  Can
pursue
investment
strategies
that
are
not
allowed
for
 mutual
funds.

 •  Grew
from
about
$50
billion
in
1990
to
about
$2
trillion
in
 2008.
 –  REITs
 –  Hedge
Funds
 4.3
Mutual
Funds
 Mutual
Fund
Types
 •  •  •  •  •  •  •  Money
market
funds
 Equity
funds
 Sector
funds
 Bond
funds
 Interna8onal
funds
 Balanced
funds
 Index
funds
 Net
Asset
Value
 Used
as
a
basis
for
valua:on
of
investment
 company
shares
 –  Selling
new
shares
 –  Redeeming
exis:ng
shares
 Calcula:on
 How
Funds
Are
Sold
 •  Directly
marketed
 –  May
avoid
front
end
load
 •  Front
end
load
is
an
up
front
cost
(fee)
to

 purchase
a
share
of
a
mutual
fund.
 •  Sales
force
distributed
 –  Recommended
by
a
broker
or
planner
   Usually
will
have
a
front
end
load
 –  May
be
revenue
sharing
on
sales
force
distributed
 •  Poten:al
conflict
of
interest
 •  Financial
supermarkets
 4.4
Costs
of
Inves:ng
in
Mutual
Funds
 Costs
in
mutual
fund
investment
 •  Fee
Structure
 –  Front‐end
load
 –  Back‐end
load
(con:ngent),
 
(redemp:on
fee)
 •  Opera:ng
expenses
 •  12
b‐1
charges
 –  Buying
and
selling
commissions,
administra:ve
expenses
 and
advisory
fees
for
the
managers
 –  Marke:ng
and
distribu:on
costs

 –  Alterna:ve
to
a
load,
but
assessed
annually
 –  Maximum
is
1%
of
assets
 An
 open‐end
 fund
 has
 a
 net
 asset
 value
 of
 $10.70
per
share.
It
is
sold
with
a
front‐end
load
 of
6%.
What
is
the
offering
price?
 NAV
is
$10.70



Front‐end
load
is
6%
 Every
dollar
paid
results
in
only
$0.94
going
toward
 purchase
of
shares.
 Offer
price
=
NAV/(1‐load)=10.7/(1‐0.06)=11.38
 If
 the
 offering
 price
 of
 an
 open‐end
 fund
 is
 $12.30
 per
 share
 and
 the
 fund
 is
 sold
 with
 a
 front‐end
load
of
5%,
want
is
its
net
asset
value?
 Offer
price
$12.30



Front‐end
load
is
5%
 Every
dollar
paid
results
in
only
$0.95
going
toward
 purchase
of
shares.
 NAV=offer
price
x
(1‐load)

 
 
=
$12.30
x
0.95

 
 
=
$11.69
 The
composi8on
of
the
Fingroup
Fund
porZolio
is
as
follows:
 Stocks
 A
 B
 C
 D
 Number
of
Shares
 200,000
 300,000
 400,000
 600,000
 Price
 $35
 $40
 $20
 $25
 The
fund
has
not
borrowed
any
funds
but
has
accrued
management
fee
with
 the
porZolio
manager
currently
totals
$30,000.
There
are
4
million
shares
 outstanding.
What
is
the
net
asset
value
of
the
fund?
 NAV
=
(Market
Value
of
Assets
–
Liabili:es)
÷
Shares
Outstanding
 A.
(200,000)x($35) 
=$

7,000,000 


 Liabili:es
 B.
(300,000)x($40) 
=$12,000,000
 $30,000
 C.
(400,000)x($20) 
=$

8,000,000
 D.
(600,000)x($25) 
=
$15,000,000





 
 
 Outstanding

 










































$42,000,000 


 Shares
 $42,000,000
–
$30,000

=

$10.49
=
NAV 

 
 4,000,000
 4,000,000
 You
purchased
1000
shares
of
the
New
Fund
at
a
price
of
$20
per
 share
at
the
beginning
of
the
year.
You
paid
a
front
load
of
4%.
 The
fund
increases
in
value
by
12%
during
the
year.
The
fund’s
 expense
ra8o
is
1.2%.
What
is
your
rate
of
return
on
the
fund
if
 you
sell
your
shares
at
the
end
of
the
year?
   As
an
ini:al
approxima:on,
your
return
equals
the
return
on
the
shares
 minus
the
total
of
the
expense
ra:o
and
purchase
costs:
 –  Return
≈
12%
‐
1.2%
‐
4%
=
6.8%
   But
the
precise
return
is
less
than
this
because
the
4%
load
is
paid
up
 front,
not
at
the
end
of
the
year.
 
To
purchase
the
shares,
you
would
have
had
to
invest:
 –  $20,000
/
(1
‐
0.04)
=
$20,833
   The
shares
net
increase
in
value
(12%
‐
1.2%)
from
$20,000
to:

 –  $20,000
×
(1.12
‐
0.012)
=
$22,160
   Your
rate
of
return
is:
(22,160‐20,833)/20,833=6.37%
 
 

 The
 investments
 Fund
 Sells
 Class
 A
 shares
 with
 a
 front‐end
 load
 of
 6%
 and
 Class
B
shares
with
12b‐1
fees
of
.5%
annually
as
well
as
back‐end
load
fees
 that
 start
 at
 5%
 and
 fall
 by
 1%
 for
 each
 full
 year
 the
 investor
 holds
 the
 porZolio
 (un8l
 the
 fibh
 year).
 Assume
 the
 porZolio
 rate
 of
 return
 net
 of
 opera8ng
expenses
is
10%
annually.
If
you
plan
to
sell
the
fund
aber
4
years,
 are
the
class
A
or
Class
B
shares
the
beder
choice
for
you?
Aber
15
years?

 a.  Sell
aJer
4
years:

Suppose
you
have
$1000
to
invest.

The
 ini:al
investment
in
Class
A
shares
is
$940
net
of
the
 front‐end
load.

Amer
4
years,
your
porGolio
will
be
 worth:
 
$940
×
(1.10)4
=
$1,376.25
 
Class
B
shares
allow
you
to
invest
the
full
$1,000,
but
 your
investment
performance
net
of
12b‐1
fees
will
be
 only
9.5%,
and
you
will
pay
a
1%
back‐end
load
fee
if
you
 sell
amer
4
years.
 
Your
redemp:on
value
amer
4
years
will
be:
 
$1,000
×
(1.095)4
x
0.99
=
$1,423.28
 Class
B
shares
are
the
bener
choice
if
your
horizon
is
4
years.
 b. Sell
aJer
15
years:
 
With
a
15‐year
horizon,
the
Class
A
shares
will
 be
worth:
 
$940
×
(1.10)15
=

$3,926.61
 
For
the
Class
B
shares,
there
is
no
back‐end
load
 in
this
case
since
the
horizon
is
greater
than
5
 years.

Therefore,
the
value
of
the
Class
B
 shares
will
be:
 
$1,000
×
(1.095)15
=

$3,901.32
 4.5
Taxa:on
of
Mutual
Fund
Income
 General
Tax
Rules
 The
fund
itself
is
not
taxed
as
long
as
 –  Fund
meets
certain
diversifica:on
requirements
 –  Fund
distributes
virtually
all
income
earned
(less
fees
 and
expenses)
to
fund
shareholders
 The
investor
is
taxed
on
capital
gain
and
dividend
 distribu:ons
at
the
investor’s
appropriate
tax
rate.
 Distribu:on
requirements
imply
that
porGolio
 turnover
may
affect
an
investor’s
tax
liability
 Taxes
and
Mutual
Funds
  Investor
directed
por3olios
can
be
structured
 to
take
advantage
of
taxes
while
mutual
 funds
cannot
  High
turnover
leads
to
greater
tax
liability
  More
disclosure
on
taxes
was
required
in
 2002
  Amer‐tax
returns
now
reported
in
prospectus
 Implica:ons
of
Fund
Turnover
  The
fund
itself
pays
commission
costs
on
purchases
 and
sales
of
porGolio
holdings,
which
are
charged
 against
NAV.

 –  
These
commissions
are
lower
than
what
 individual
investors
pay.


 –  Total
commission
expenses
are
higher
if
the
 por3olio
has
higher
turnover.
  The
turnover
rate
is
measured
as
the
total
asset
 value
bought
or
sold


in
a
year
divided
by
the
 average
total
asset
value.

 4.6
Exchange
Traded
Funds
 Exchange
Traded
Funds
 ETFs
allow
investors
to
trade
index
porGolios
like
shares
of
 stock
 Examples:
SPDRs
and
Diamonds,
Qubes,
WEBS
 Advantages
 –  Trade
con:nuously
throughout
the
day
 –  Can
be
sold
short
or
purchased
on
margin
 –  Poten:ally
lower
taxes
 –  
 No
fund
redemp:ons
 –  
 Large
investors
can
exchange
their
ETF
shares
 
for
 shares
in
the
underlying
porGolio
 –  Lower
costs
(No
marke:ng;
lower
fund
expenses)
 Exchange
Traded
Funds
 Poten:al
disadvantages:

 •  Small
devia:ons
from
NAV
are
possible
 •  Must
pay
a
brokerage
commission
to
buy
an
 ETF
but
a
no
load
index
fund
may
be
 purchased
online
for
no
commission.
 Table
4.3
ETF
Sponsors
and
Products
 Figure
4.2
Growth
in
ETF
Assets
 4.7
Mutual
Fund
Investment
 Performance:
A
First
Look
 Figure
4.3
Diversified
Equity
Funds
 
versus
Wilshire
5000
Index
 First
Look
at
Mutual
Fund
 Performance
 First
Look
at
Mutual
Fund
 Performance
  Evidence
shows
that
average
mutual
fund
 performance
is
generally
no
bener
than
broad
 market
performance
  Evidence
suggests
that
over
certain
horizons

 some
persistence
in
posi:ve
performance
 –  Evidence
is
inconsistent.
 4.8
Informa:on
on
Mutual
Funds
 ...
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