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Mutual Funds and Other Investment Companies
 

Mutual Funds and Other Investment Companies

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    Mutual Funds and Other Investment Companies Mutual Funds and Other Investment Companies Presentation Transcript

    • Mutual Funds and Other Investment Companies B, K & M Chapter 4
    • Investment Companies
      • Financial intermediaries that collect money from individual investors and invest these funds in a wide range of securities or other assets
      • Perform important functions for individual investors including:
            • Diversification and Divisibility
            • Lower Transaction Fees
            • Record Keeping and Administration
            • Professional Management
    • Investment Companies
      • Value of each share is called the Net Asset Value or NAV (equals assets minus liabilities expressed on a per-share basis):
    • Types of Investment Companies
      • Open-end Investment Companies
          • - Commonly known as Mutual Funds
          • - Stands ready to redeem or issue shares at NAV
          • - May have “front-load” or “rear-end” sales charges (capped at 8.5% by NASD)
          • - Number of shares constantly changes
    • Types of Investment Companies
      • Closed-end Funds
          • - Number of shares is fixed - Does not redeem or issue shares
          • - Typically, newly issued shares sell for a premium over the NAV
          • - Shortly after being issued, many shares sell at a discount from NAV
          • - A puzzle that much recent financial research has focused on
          • - Usually traded on organized exchanges
    • Types of Investment Companies
      • Unit Investment Trusts
          • - Pools of money invested in a portfolio that is fixed for the life of the fund
          • - Units (also called redeemable trust certificates) sold by a sponsor (brokerage firm) to individual investors
          • - Most unit trusts hold fixed-income securities (bonds, etc.) and expire at their maturity
          • - Most unit investment trusts are invested in tax-exempt securities (municipal bonds)
          • - Individuals may sell units back to trustee at NAV
    • Types of Investment Companies
      • Commingled Funds
          • - Used by trust departments among others
          • - Partnership of investors that pool their funds with a management firm (e.g., bank)
          • - Similar to open-end funds except units are traded rather than shares
    • Types of Investment Companies
      • Real Estate Investment Trusts (REITs)
          • - Similar to a closed-end fund
          • - Invest in real estate or loans secured by real estate
          • - Exempt from taxes as long as at least 95% of their taxable income is distributed to shareholders; however, these distributions (dividends) are taxable as personal income
    • Mutual Funds Types
      • Money Market Funds
      • Equity Funds:
            • Maximum Capital Gain
            • Growth
            • Growth and Income
            • Income
            • Income and Security
    • Mutual Funds Types
      • Fixed-Income Funds
      • Balanced and Income Funds
      • Asset Allocation Funds
      • Index Funds
      • Special Sector Funds
      • International Funds
    • Mutual Fund Returns
    • Taxation of Mutual Fund Income
      • Granted “pass-through status” (i.e., taxes paid by investor in the fund, but not by the fund itself) if the fund meets certain requirements including :
            • At least 90% of all income is distributed to shareholders (in order to avoid “excise tax”, fund must distribute 98% of income in the calendar year in which it was earned)
            • Fund receives less than 30% of its gross income from sale of securities held for less than three months
            • Fund must meet diversification criteria
    • Mutual Fund Performance Benchmark
      • Benchmark for the performance of equity fund managers is the rate of return on the Wilshire 5000 Index (a value-weighted index of about 7000 stocks that trade on the NYSE and Amex stock exchanges, and the Nasdaq stock market
      • Useful benchmark to evaluate professional fund managers because it corresponds to a simple passive investment strategy; however, an imperfect comparison due to:
            • Risk Differential : the risk of the Wilshire 5000 Index may differ significantly from the risk of a specific fund
            • Expenses : a specific fund will incur expenses (e.g., transaction costs, etc.) that the Wilshire 5000 Index is not exposed to
    • Mutual Fund Performance Benchmark
      • Over the past two decades, passively managed (indexed) equity funds would have outperformed the average actively managed fund
    • Mutual Fund Performance Benchmark
      • Is superior performance in a given year random (based on luck) or consistent (due to skill of fund manager)?
          • Goetzmann and Ibbotson (1994) : using an equity fund sample from 1976-85, find that at least a portion of mutual fund returns can be attributed to manager skill
          • Malkiel (1995) : using an equity fund sample from 1971-91 and dividing the time horizon by decade (i.e., into the 1970s and the 1980s), finds that manager skill explains a portion of the 1970s’ results, but not the 1980s