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  • 1. Mutual Funds and Other Investment Companies CHAPTER 4
  • 2. Investment Companies
    • Investment companies offer:
      • Administration & record keeping
      • Diversification & divisibility
      • Professional management
      • Reduced transaction costs
  • 3. Investment Companies
    • Investment companies are exempt from corporate earnings ________________.
    • Investors must pay tax on income earned from investment companies. Funds with high turnover result in high taxes (low tax efficiency).
    • Purchasing a mutual fund late in the year can result in taxes on earnings you did not receive.
  • 4. Investment Companies: Net Asset Value
    • Net Asset Value
      • Used as basis for valuation of investment company shares
      • Selling new shares
      • Redeeming existing shares
    • Calculation:
    • Market Value of Assets - Liabilities
    • Shares Outstanding
  • 5. Types of Investment Companies
    • Unit Trusts
      • Pools of money fixed for the life of the fund
      • Little active management
  • 6. Managed Investment Companies: Open-End and Closed-End
    • Open-End
      • Sold at Net Asset Value (NAV)
      • # of shares changes when new shares are sold or old shares are redeemed
    • Closed-End
      • Sold at premium or discount to NAV
      • No change in # of shares unless new stock is offered
  • 7. Types of Investment Companies
    • REIT: Real Estate Investment Trust
    • Types of REITs:
    • Equity REIT: invests in real estate
    • Mortgage REIT: invests in mortgages
  • 8. Types of Investment Companies
    • Hedge Funds: little regulation
    • Limited to qualified (high net worth/high income) investors:
    • Net worth > $1 mil
    • Income > $200K
    • Annual fees are typically 2% of assets plus 20% of profit
  • 9. Types of Investment Companies
    • ETFs are closed-end funds
    • Examples - SPDRs and Webs
    • Potential advantages
      • Trade continuously
      • Lower taxes
      • Lower fees
    • Potential disadvantages
      • Must pay brokerage commission
      • Price can differ from NAV
  • 10. Types of Mutual Funds
    • Money Market
    • Equity
    • Specialized Sector
    • Bond
    • Balanced
    • Index
  • 11. Mutual Fund Fee Structure
    • Loads:
      • Front-end load
      • Back-end load
    • Management fees range from < 0.1% to > 2% of assets annually
    • 12 b-1 charges
      • Distribution costs paid by the fund
      • Alternative to a load
    • Fees and performance
  • 12. Trading Scandal with Mutual Funds
    • Late trading – allowing some investors to purchase or sell after the market closes
    • Market timing – allowing investors to buy or sell on stale net asset values
    • Net effect is to transfer value from other shareholders to privileged traders
      • Reduction in the rate of return of the mutual fund
  • 13. Potential Reforms
    • Strict 4:00 PM cutoff with late orders executed the following trading day
    • Fair value pricing with net asset values being adjusted for trading in open markets
    • Imposition of redemption fees
  • 14. Mutual Fund Performance
    • Evidence shows that average mutual fund performance is generally less than broad market performance
    • Evidence suggests that over certain horizons some persistence in positive performance
      • Evidence is not conclusive
      • Some inconsistencies
  • 15. Figure 4.2 Diversified Equity Funds Versus Wilshire 5000 Index
  • 16. Table 4.4 Consistency of Investment Results
  • 17. Sources of Information
    • Wiesenberger’s Investment Companies
    • Morningstar ( www.morningstar.com )
    • Yahoo ( finance.yahoo.com/funds )
    • Investment Company Institute
    • Popular press
    • Investment services (Value Line)
  • 18. How to Pick a Mutual Fund
    • In comparing mutual funds, look for:
    • ________________________________
    • Low ________________ (including 12b-1)
    • Matches your investment _____________ & __________________ tolerance
    • Tax efficiency (unless IRA or 401k)
    • Good recent performance (several yrs)
    • Same portfolio manager