McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All ...


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McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All ...

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