CHAPTER 4leeds-courses.colorado.edu/FNCE4030/MISC/slides/... · INVESTMENTS | BODIE, KANE, MARCUS Types of Investment Companies • Other investment organizations –Commingled funds:

INVESTMENTS | BODIE, KANE, MARCUS

Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

CHAPTER 4

Mutual Funds and Other

Investment Companies


Investment Companies

• Pool funds of individual investors and invest in a wide range of securities or other assets.

• Services provided:

– Administration & record keeping

– Diversification & divisibility

– Professional management

– Reduced transaction costs

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Net Asset Value - Calculation

4-3

Market Value of Assets

Number of Shares Outstanding

- Liabilities

Net Asset Value (NAV) =


Types of Investment Companies

• According to Investment Company Act of 1940:

• Unit Investment Trusts

• Managed Investment Companies

– Closed-end

– Open-end (aka Mutual Funds)

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• Unit Trusts

– Fixed portfolio of uniform assets

– Unmanaged

– Cash out by selling back to Trustee, which will

disinvest or find new buyer

– Total assets have declined from $105bn in 1990

to $29bn in 2009 (recovered to ~60bn in 2012)

Q. When was the first one created?1868: created to give smaller investors access to the new stock markets of the USA. Also used to bankroll expansion (such as railway lines) in the New World, hence names such as Foreign & Colonial. Many were formed in Scotland, still a centre of investment trusts.

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Managed Investment Companies• Closed-End

– No change in shares outstanding; old investors

cash out by selling to new investors

– Priced at premium or discount to NAV

• Open-End (Mutual Funds)

– Fund issues new shares when investors buy in,

and redeems shares when investors cash out

– Priced at Net Asset Value (NAV)

– Transactions are executed after market closes

and NAV is computed (more about this later)

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• Other investment organizations

– Commingled funds: partnership of investors

that pool money. Resemble mutual funds (units

instead of shares).

– REITs: similar to closed-end fund. Most are

leveraged. Equity and Mortgage trusts.

– Hedge Funds: pools of assets actively managed.

Lock-up periods. Leverage and risk. More later in

the textbook.

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Mutual Funds types

• Money Market

• Equity

• Sector

• Bond

• International

• Balanced and funds of funds

• Asset Allocation and Flexible

• Index

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INVESTMENTS | BODIE, KANE, MARCUS 4-9

Table 4.1 U.S. Mutual Funds by Investment Classification

9

Table 4.1 - U.S. Mutual Funds by Investment Classification (Investm. Company Inst. 2009)


10

Table 4.1 U.S. Mutual Funds by Investment Classification

Table 4.1 - U.S. Mutual Funds by Investment Classification (Investm. Company Inst. 2012)


Mutual Funds Market

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(Year-end 2011)

Source: http://www.icifactbook.org/fb_ch2.html

http://www.icifactbook.org/fb_ch2.html


Mutual Funds Market

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(Year-end 2013)




Mutual Funds Flows($bn)

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How Funds Are Sold

• Direct-marketed funds (mail, phone, internet)

• Sales force distributed (about half)

– Revenue sharing on sales force distributed (you ultimately pay for it)

– Potential conflicts of interest

– SEC: “Must tell prospective investors”

• Financial Supermarkets

– No charge, but fee split with MF company

– Unified reporting

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Costs of Investing in Mutual Funds

• Fee Structure – Four types:

1. Operating expenses

2. Front-end load

3. Back-end load (contingent deferred sales fee)

4. 12 b-1 charge (From SEC rule #, includes misc.

costs, broker commissions)

• Fees must be disclosed in the prospectus

• Share classes with different fee combinations

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INVESTMENTS | BODIE, KANE, MARCUS 4-16

Example 4.2: Fees for Various Classes(Dreyfus Worldwide Growth Fund)


Fees and Mutual Fund Returns example

• Initial NAV = $20

• Income distributions of $0.15

• Capital gain distributions of $0.05

• Ending NAV = $20.10:

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$20.10 - $20.00 + $.15 + $.05Rate of Return = 1.5%

$20.00

1 0

0

N AV N AV Incom e C apital G ain

N AVR


Table 4.2 Impacts of Costs on Investment Performance

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All grow 12% p.a.


Late Trading and Market Timing

• Late trading – accepting buy or sell orders after the market closes and NAV is determined

• Market timing – rapid in-and-out trading on stale net asset values

• Net effect is to transfer value from ordinary shareholders to privileged traders

Q. Why should MF managers allow this?

• Mutual funds penalized for improper trading. New rules to prevent these practices

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Taxation of Mutual Fund Income

• Pass-through status under the U.S. tax code

– Taxes are paid only by the investor (you)

– Fund investors do not control the timing of the

sales of securities from the portfolio

Q. What is the tax difference between short and long

term capital gain(loss)?

• Turnover = fraction of portfolio replaced

• High portfolio turnover (60% on average) leads to tax inefficiency

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Exchange Traded Funds (ETFs)

• Examples: “spiders”, “diamonds” and “cubes”

• Potential advantages:

– Trade continuously like stocks

– Can be sold short or purchased on margin

– Lower costs

– Tax efficient

• Potential disadvantages:

– Prices can depart by small amounts from NAV

– Must be purchased from a broker

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Total Net Assets, Number of ETFs

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$bn, year-end 2002-2013



Fig 4.2 Growth of U.S. ETFs, per type

0

100,000

200,000

300,000

400,000

500,000

600,000

700,000

800,000

900,000

1,000,000

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

ET

F a

ssets

($ m

illio

n)

Bond

Commodities

Global/int'l equity

U.S. equity: sector

U.S. equity: broad index


Mutual Fund Investment Performance: A First Look

• Performance of actively managed funds:

– below the return on the Wilshire index in 23 of

the 41 years from 1971 to 2011

– Evidence for persistent superior performance

(due to skill, and not just good luck) is weak, but

suggestive

– Bad performance more likely to persist

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Figure 4.4 Diversified Equity Funds versus Wilshire 5000 Index (see here)

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

19

71

19

75

19

79

19

83

19

87

19

91

19

95

19

99

20

03

20

07

20

11

Ra

te o

f R

etu

rn

Active funds Wilshire 5000

http://en.wikipedia.org/wiki/Wilshire_5000


Information on Mutual Funds

• Fund’s prospectus describes:

– investment objectives

– Fund investment adviser and portfolio manager

– Fees and costs

• Statement of Additional Information (SAI)

– List of securities, etc. You must ask for it.

– aka Something Always Ignored

• Fund’s annual report

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Information on Mutual Funds

• Wiesenberger’s Investment Companies

• Morningstar (www.morningstar.com)

• Yahoo (biz.yahoo.com/funds)

• Investment Company Institute (www.ici.org)

• Directory of Mutual Funds

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http://www.morningstar.com/

http://de.biz.yahoo.com/funds/

http://www.ici.org/


Table 4.3 ETF Sponsors and Products

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Let’s move to the next chapter

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Documents

CHAPTER 4leeds-courses.colorado.edu/FNCE4030/MISC/slides/... · INVESTMENTS | BODIE, KANE, MARCUS Types of Investment Companies • Other investment organizations –Commingled funds: