FINA 4310 Spring 2002 Chapter 4: Mutual Funds and Other ...
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  • 1. FINA 4310 Spring 2002 Chapter 4: Mutual Funds and Other Investment Companies
  • 2. Investment Companies
    • Unit Investment Trusts
    • Managed Investment Companies
      • Open-end funds ( Mutual Funds )
      • Closed-end funds
    • Real Estate Investment Trusts (REITs)
    • Exchange-Traded Funds (ETFs)
    • Commingled Funds
    • Hedge Funds
  • 3. Unit Investment Trusts
    • Portfolio is fixed for the life of the trust
    • Fixed-Income UIT
      • Government securities
      • Corporate bond
      • Municipal bond
      • International bond
    • Equity UIT
  • 4. Mutual Funds
    • Open-end funds
      • Invest by sending money directly to the fund
      • New units are created as new money flows in
      • Units retired as money flows out
      • Go in and out at Net Asset Value (NAV)
    • Management companies – “Families”
      • Fidelity
      • Vanguard Many Others
  • 5. Types of Mutual Funds
    • Equity Funds
    • Fixed-Income Funds
    • Money Market Funds
    • Balanced Funds
    • Asset Allocation Funds
    • Index Funds
    • Specialized Funds
  • 6. Equity Mutual Funds
    • Aggressive Growth /Capital Appreciation
      • Small companies/Narrow market sectors
    • Growth
      • Firms with good revenue & earnings potential
    • Blend (Growth and Income)
      • Combination of Growth and Value Stocks
    • Value
      • Profitable, Dividend-paying stocks
      • Stocks with low P/E ratios
  • 7. Balanced Funds
    • Invests in both equities and fixed income securities
    • Proportion of stocks and bonds fairly stable over time
    • Designed to be an investor’s entire portfolio
    • Example: ARK Balanced Fund
  • 8. Asset Allocation Fund
    • Like Balanced Funds, hold both stocks and bonds
    • Proportion of stocks vs. bonds varies substantially over time
    • Manager tries to increase returns by timing the market
    • Example: Preferred Asset Allocation Fund
  • 9. Index Funds
    • Passive Management
    • Goal is to match the performance of a benchmark index
    • Low expenses
    • Most Popular Benchmark: S&P 500 Index
    • Example: Vanguard Index Funds
  • 10. Specialized Funds
    • Focus on a particular sector or industry
      • Real Estate
      • Technology
      • Health Care
      • Utilities
      • Financial Services
  • 11. Closed-end Funds
    • Do not create or redeem shares
    • After initial offering, shares trade on secondary market
    • To invest, buy shares on the exchange
    • May trade above or below NAV
      • Above: Premium
      • Below: Discount
  • 12. Real Estate Investment Trusts
    • Like a closed-end fund
      • Buy it on an exchange
    • Equity REITS
      • Buy investment property
    • Mortgage Trusts
      • Buy mortgage loans
  • 13. Exchange-traded Funds
    • Like closed-end funds, they trade on an exchange
    • Like index funds, they tend to be passively managed
    • A variety of legal forms:
      • Unit Investment Trusts ( SPDRs , HOLDRs )
      • Open-end Mutual funds ( iShares )
      • Traditional mutual fund share class ( Vipers )
  • 14. Commingled Funds
    • Partnerships of investors that pool their funds
    • Similar to open-end mutual fund
    • Typically, small institutional investors
      • Most commonly pension plans
      • Larger than typical individual investor
      • Too small to warrant individual management
  • 15. Hedge Funds
    • Limited partnership of investors
      • Accredited investors (high net worth)
      • Restricted to 499 partners
      • Cannot advertise
      • Less regulated than mutual funds
        • Manager has freedom to follow a wider variety of investment strategies
        • fewer reporting requirements
  • 16. Mutual Fund Fees
    • Front-end load
    • Back-end load
    • 12b-1 charges
    • Operating Expenses
    • Broker Commissions
  • 17. Front-end Load
    • This is a sales charge, or “commission” charged to enter a fund
    • Paid as a percentage of investment
    • Can be as large as 8.5%
    • Rarely higher than 6.25%
    • Often much lower, down to zero
    • “No Load Fund” means no front-end load
  • 18. Back-end Load
    • Also called:
      • Redemption Fee
      • Contingent Deferred Sales Charge
    • This is a fee charged when you exit the fund
    • Charged in percentage terms
    • Some funds have no back-end load
    • If they do, it often drops off gradually to zero the longer you hold the fund
    • Discourages investors with short horizons
  • 19. 12b-1 charges
    • Managers can use up to 1% of the fund’s assets each year to pay for...
      • Advertising
      • Annual reports and prospectuses
      • Commissions paid to brokers
    • Because these fees come straight from the fund’s assets, they are “hidden” costs to the investor
  • 20. Operating Expenses
    • Administrative Expenses
    • Advisory fees paid to manager
    • Should be less than 2% per year
    • Again, this comes out of the funds assets. (You don’t see them explicitly, but pay for them in the form of lower returns)
    • Measured by “expense ratio”
  • 21. Brokerage Commissions
    • If your broker does not have an arrangement with the mutual fund management company, they will charge you a commission to invest for you.
    • But, you do not need to go through a broker at all. You can buy (and redeem) shares directly from the mutual fund.
  • 22. Classes of Mutual Fund shares
    • One fund can have multiple classes with different fees
      • Class A: Front-end load
      • Class B: Back-end load and 12b-1
      • Class C: Higher 12b-1 fees
    • Investor class and premium class shares
      • Example: Vanguard “ Admiral ” Shares