Chapter 4 investments mutual funds and other investment companies
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Chapter 4
Mutual Funds and Other Investment Companies
4.1 Investment Companies
4-2
Investment Companies
Financial intermediates that collect funds from individual investors and invest those funds in a wide range of securities or
other assets.
Net Asset Value (NAV)
•
Used as a basis for valuation of investment company shares
- Selling new shares
- Redeeming existing shares
•
Calculation
4-3
gOutstandin Shares
sLiabilitieAssets of ValueMarket
NAV
−
=
NAV calculation
ABC Fund ($Millions except NAV)
Market Value Securities
+ Cash & Receivables
- Current Liabilities
NAV Total
÷ # Fund Shares
NAV
$550.00
75.00
(20.00)
$605.00
20.00
$ 30.25
4-4
Services of Investment Companies
a. Administration & record keeping
: Issue periodic status reports, keeping track of capital gains distributions, dividends, investments, and redemptions.
b. Diversification and divisibility
: By pooling their money, investment companies enable investors to hold fractional shares of many different securities.
c. Professional management
: Lower research costs, Portfolio managed according to specific objectives, and Professionals to find undervalued securities
d. Lower transaction costs
: Achieve substantial savings on brokerage fees and commissions.
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4.2 Types of Investment Companies
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Unit Investment Trusts (UITs)
- Pools of money invested in a portfolio that is fixed for the life of the fund.
- Unmanaged, fixed composition portfolios
- Any interest and/or dividends are
distributed immediately to trust certificate
holders.
4-7
Managed Investment Companies
- Managed, usually changing composition portfolio.
- The fund's board of directors typically hires an
investment advisor
to select and manage the f
und assets according to some specific goal(s) set by the board and any regulatory requirements
.
- The
investment advisor
usually creates the fund and selects the investments. Most funds are
of this type.
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Managed Investment Companies
Open-end funds
: A fund that issues or redeems its shares at net asset value.
- When investors in open-end funds wish to cash out their
shares, they sell them back to the fund at NVA.
- Commonly call mutual funds
Closed-end funds
: A fund that do not redeem or issue shares.
- Investors in closed-end funds who wish to cash out must sell
their shares to other investors.
- Shares of close-end funds are traded on organized exchanges
and can be purchased through brokers just like other common
stock.
- Prices therefore can differ from NAV.
4-9
4-10
Managed Investment Companies
•
-
•
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-
$%
Figure 4.1 Closed-End Mutual Funds
Fund
NAV Mkt Price Prem/Disc % 52 Wk Return %
Adams Express Company (ADX)
12.89 11.11 −13.81 26.13
Advent/Clay Enhcd G&I (LCM)
12.16 11.58 −4.77 23.52
BlackRock Equity Div (BDV)
10.65 10.03 −5.82 27.39
BlackRock Str Eq Div Achv (BDT)
11.8 10.68 −9.49 26.17
Cohen & Steers CE Oppty (FOF)
14.64 13.46 −8.06 25.17
Cohen & Steers Dvd Mjrs (DVM)
14.70 13.82 −5.99 49.28
Eaton Vance Tax Div Inc (EVT)
18.75 17.19 −8.32 29.89
Gabelli Div & Inc Tr (GDV)
18.64 16.58 −11.05 43.52
Gabelli Equity Trust (GAB)
6.08 6.10 0.33 48.48
General Amer Investors (GAM)
32.71 28.26 −13.60 30.93
Guggenheim Enh Eq Inc (GPM)
9.58 9.65 0.73 38.93
Other Investment Organizations
•
Real Estate Investment Trusts (REITs)
-
Similar to closed end fund. Invest in real estate and real estate loans.
-
Highly leveraged for most of them, a debt ratio of 70%.
-
Equity trusts invests in real estate directly.
-
Mortgage trusts invest in mortgage and construction loans.
4-12
•
Hedge Funds
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4.3 Mutual Funds
The common name for an open-end investment company
The dominant investment company, 90% of investment company assets in the U.S.
Assets under management in the U.S. mutual fund industry were closely $12 trillion in early 2011.
4-13
4.3 Mutual Funds
Investment Policies
•
Money market funds
- Commercial paper, repurchase agreements, CDs
•
Equity funds
- Invest in stock, some fixed-income, or other securities
•
Specialized sector funds
- Concentrate on particular indust
ry
•
Bond funds
- Specialize in fixed-income (bonds) sector
4.3 Mutual Funds
Investment Policies
•
International funds
-
Global funds invest in securities worldwide.
- International funds invest outside U.S.
-
Regional funds focus on particular part of world
- Emerging market funds invest in developing nations
4.3 Mutual Funds
Investment Policies
•
Balanced funds
-
Hold both equities and fixed-income securities in
stable proportion
-
Life-cycle funds: Asset mix ranges from aggressive
to conservative
Static allocation funds maintain stable mix across
stocks and bonds
Targeted maturity funds become more conservative
as investor ages
-
Funds of funds: Mutual funds that primarily invest
in other mutual funds
4.3 Mutual Funds
Investment Policies
•
Asset allocation and flexible funds
-
Stocks and bonds—proportion varies according to
market forecast
•
Index funds
- Try to match performance of broad market index
-
Buy shares in securities included in particular index
in proportion to security’s representation in index
Table 4.1 U.S. Mutual Funds by Investment Classification
Assets
($ billion) Percent of Total Assets Number of Funds
-
' 8(768 89+8: ;(5;<
=> 6(??5 6;+@: 7?@
A 6(745 6?+8: <?8
A-' ?(488 49+8: 9(<?<
B
;56 8+4: 87;
1 64< 6+;: 85?
= @9 5+<: 688
2" 85; 6+<: ;56
4?5 9+<: ;<5
64? 6+;: 946
86@ 6+@: 889
A)' 6(?<7 69+5: 6(7?<
1)#)>&' <6; 4+7: 9@@
C'
AD) 8(?98 88+5: 49@
ADD 9?4 ;+7: 847
A' ;(65< 84+@: @5<
A 68(586 655+5: @(587
4.4 Costs of Investing in Mutual Funds
4-19
Operating expenses
-
A)''("D"'
"+
Front-end load
-
$+
Back-end load
-
$(.D/('+
12b-1 charges
-
'68)6''
')"
+
4.4 Costs of Investing in Mutual Funds
•
Avoiding the Load
- Choose different class of fund shares
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+
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4.4 Costs of Investing in Mutual Funds
•
Fees and Mutual Fund Returns
(This measure of the rate of return ignores any commission.)
•
E.G.) Initial NAV = $20, Income distributions = $0.15
Capital gains = $0.05, NAV at the end = $20.10
Rate of return = 1.5%
0
01
NAV
ondistributi gains CapitalIncomeNAVNAV
return of Rate
++−
=
Table 4.2 Impact of Costs on Investment Performance
: An investor who starts which $10,000 and three funds with an annual 12% return
on investment before fees but with different fee structures.
$+4:D(B6+4:D(@:
6:D+2'68:)'D+
G$''('+
4.6 Exchange Traded Funds
Offshoots of mutual funds that allow investors to trade index portfolios like shares of stock
Potential advantages
•
Unlike mutual funds, trade continuously throughout the day
•
Can be sold short or purchased on margin
•
Potentially lower taxes
•
Lower costs (No marketing; lower fund expenses
Potential disadvantages
•
Small deviations from NAV are possible because ETFs trade as securities.
•
Must pay a brokerage commission such as bid-ask spread to buy an ETF
4-23
Table 4.3 ETF Sponsors and Products
Figure 4.2 Assets in ETFs
