Financial market
KM007
MutualFundIndustryW6.pptxFinancial Markets
BCO224
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Financial Markets
Overview
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Primary classes of mutual funds available to investors
Stock funds, bond funds, hybrid funds, money market funds
Index funds and ETFs
Net asset value (NAV)
Fee structure and expense ratio of investment funds
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Primary classes of mutual funds available to investors
Indirect Investments
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Investors make indirect investments when participating in pooled investments of securities’ companies, trusts and partnerships that do make direct investments. There are several indirect investment vehicles:
Shares in mutual funds and exchange- traded funds
Limited partnership interests in hedge funds
Asset- backed securities, such as mortgage- backed securities
Interests in pension funds
Source: CFA(2014)
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Primary classes of mutual funds available to investors
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Types of Investment Vehicles
Main investment vehicles are investments in securities issued by entities that represent ownership in the underlying assets held by those entities. These include:
Open-end funds. This type of fund issue news shares continuously as investors buy them. Investors redeem their shares directly to the fund, which in turn must buy them back. Thus, these funds provide daily liquidity to their shareholders.
Closed-end funds. Issue a fixed number of shares that the funds may redeem only upon termination of their trusts. Shareholders in a closed-end fund may, however, sell their shares through a broker on the secondary market to other investors, but not back to the fund. Almost all closed- end funds use active management strategies
Exchange-Traded Funds (ETF). ETF are in organized secondary markets just like common stocks. Most exchange- traded funds use passive indexing strategies, but some are actively managed.
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Primary classes of mutual funds available to investors
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Comparison of the main investment vehicles
Source: CFA(2014)
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Primary classes of mutual funds available to investors
Liability and Assets of Mutual Funds
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Mutual Funds are investment companies that pool small savings to provide access to large, diversified portfolios which can be liquid.
| Type of Intermediary | Primary Liability (Sources of Funds) | Primary Assets (Use of Funds) |
| Commercial banks | Deposits | Business and consumer loans, mortgages, US govt., and municipal bonds |
| Life Insurance Companies | Premium from policies | Corporate bonds and mortgages |
| Pension Funds | Employer and Employee contributions | Corporate bonds and stock |
| Mutual Funds | Shares | Stocks, bonds, money market funds |
| Hedge Funds | Partnership participation | Stocks, bonds, loans , foreign currencies, and other assets |
Source: Cecchetti et al. (2015)
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Primary classes of mutual funds available to investors
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Advantages of Mutual Funds
Retail investors benefit from pooling assets through mutual fund thanks to:
Economies of scale: Mutual funds provide the convenience of investing in a basket of securities.
Standardization. Mutual funds are ready-made portfolios of securities designed to achieve specific investment goals.
Expertise. They have the advantage of professional management, diversification
Liquidity. Shares are easy to transfer to other funds in the same family should your investment goals change.
Transparency. All mutual funds come with a prospectus that gives you all the details you need to know in order to make an informed investment decision.
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The prospectus is used to inform prospective retail investors about the funds’ investment policies, deposit and redemption procedures, fees and expenses, and past performance statistics in an official offering document. Also it discloses:
Disclosure of he Risk
Relevant historical performance
Description of the eligible investment universe
Information on how to open an account
Dividends, distributions and taxed
Policy of management fees
Procedure to purchase or redeem shares
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Primary classes of mutual funds available to investors
The Prospectus of Mutual Funds
Stock funds, bond funds, hybrid funds, money market funds
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Types of Mutual Funds by product
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Stock funds, bond funds, hybrid funds, money market funds
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Money Market Funds (MMF)
Source: Bodie et al. (2014)
Money market mutual funds issue shares that are redeemable at a fixed price (usually $1) by writing checks.
Investable assets: Treasury bills, negotiable certificates of deposit, commercial paper with maturity below 1-year
Although money market fund shares effectively function as checking account deposits that earn interest, they are not legally deposits and so are not subject to reserve requirements or prohibitions on interest payments. Thus, MMF can pay higher interest rates than deposits at banks.
MMF are vulnerable to a run on assets. For instance, during economic crisis, retail investors may rush to redeem their shares before the NAV falls. These actions can be destabilizing because they force funds to sell portfolio securities when the market is falling.
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Stock funds, bond funds, hybrid funds, money market funds
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Considerations when investing in Mutual Funds
The structure of open‐end funds makes it easy for them to grow in size, but it does pose the following problems: (1) portfolio manager needs to manage cash inflows and outflows, (2) an inflow of new investment requires the manager to find new investments, (3) Funds need to keep cash for redemptions.
Pooled investment vehicles generally distribute the income (e.g. interest and dividends) that they receive from holding securities as cash dividends to their investors. Funds also distribute any short- and long- term capital gains realized (i.e. profits from selling a security at a higher price than paid for it) on their portfolio security trades as cash dividends.
Mutual funds may also be classified into (1) Load funds that charge a percentage fee for investing in the fund and/or for redemptions from the fund on top of an annual fee, (2) No‐load funds that only charge an annual fee based on a percentage of the fund’s NAV.
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Stock funds, bond funds, hybrid funds, money market funds
Wrap-up of Mutual Funds
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State whether the following statements are true or false . Then justify your answer :
| Statement | True / False | Rationale |
| An investor with preference for direct investments will prefer investing in a mutual fund rather than in a stock. | ||
| b) Compared to hedge funds, mutual funds are subject to more regulation as most of its clients are retail investors | ||
| c) Compared with shares of open-end funds, shares of closed- end mutual funds trade at net asset value. | ||
| d) Money market funds generally invest in very short- term, low- risk debt securities issued by entities with very high- quality credit | ||
| e) Hybrid funds invest in a debt-equity mix that allows to reduce return volatility of the fund, typically with investment horizon between 3 to 5 years |
F
T
F
T
T
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Index funds and ETFs
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Active vs Passive Investing
Active portfolio management aims to outperform a benchmark portfolio or index by tilting the individual weights of stocks in the portfolio away from their weights in the benchmark. On the other hand, passive management (followed by index funds) aims to track the performance of a benchmark portfolio by attaching the same weights to individual stocks as prescribed by the benchmark.
Active management entails higher management fees to compensate managers for the research conducted to select mispriced securities. Further, it results in a higher turnover of portfolio securities, which leads to greater capital gains tax liabilities and transaction costs relative to index funds.
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Index funds and ETFs
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Index Funds
Index funds are constructed to match the return profile of a market index. The fund buys as much shares as to mimic the proportion to each security’s representation in that index.
Index funds are a cost-efficient investment vehicle for retail investors that want exposure to the market index (passive investment strategy).
Full replication. When the fund is invested in every security in the benchmark index
Sampling replication. If full replication is difficult or too costly, index fund managers might invest in only a representative sample of the index securities
Representative Index Funds and equivalent Mutual Funds & ETF
Vanguard 500 Index Fund is a mutual fund that tracks the composition of the Standard & Poor’s 500 stock price index by purchasing shares in each S&P 500 company in proportion to the market value of that company’s outstanding equity.
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Index funds and ETFs
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Exchange-Traded Funds
Each share of an ETF represents a fractional ownership interest in a portfolio of securities, commodities or other instruments. As of May 2018, total ETF assets under management (AUM) reached $5 trillion globally.
ETFs are listed on one or more stock exchanges. Like mutual funds, ETFs are available on a wide range of both broad and narrow indices or they can be actively managed.
An ETF purchases a large number of shares in the same proportion as the index it tracks and issues shares in the ETF to investors who want to track the same index.
Global ETF AUM historical trends by region ($Billion)
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Index funds and ETFs
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Exchange-Traded Funds
Global ETF (AUM in $ Billion)
Americas ETF (AUM in $ Billion)
Source: JP Morgan (2018)
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Index funds and ETFs
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Advantages of using Exchange-Traded Funds
Costs and Benefits of Index Strategies. For instance, an average mutual funds in US equities may have an expense ratio of almost 100 bps higher than that of a comparable ETF. The cost savings are explained by the low management cost of implementing passive investment strategies. Cost advantage also stems from have a middlemen (broker) who bears cost of client management such as handling inquiries, distribution, record-keeping, etc.
Access. ETF shares are designed to offer intraday liquidity, and continuous, real-time trading and pricing. In many instances, ETFs can be sold short and can be purchased on margin by an investor seeking leverage. Retail investors can have access to these benefits through the brokerage account, regardless of their size, investment horizon, etc.
Transparency. Most mutual funds or hedge funds disclose the portfolio on a quarterly basis (if at all), which may render them propense to stray a from the benchmark targets (style drift). This hidden exposure problems rarely arise for ETFs as providers display the entire portfolio on a daily basis.
Liquidity and Price Discovery. ETF are traded on organized secondary markets just like a stock. The transparency along with the regulatory protection increases allows investors to trade confidently the ETFs shares increasing its liquidity.
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Index funds and ETFs
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Comparison between ETFs and Mutual Funds
Source: CFA (2014)
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Net asset value (NAV)
Calculating the NAV
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The Minerva Fund portfolio has the structure shown below. Consider that the fund did not borrow any funds, but its accrued management fee with the Portfolio Manger total $30 000. This fund has 4 million shares outstanding.
What is the net asset value of the fund?
| Stocks | Shares | Price ($) |
| A | 200,000 | 35 |
| B | 300,000 | 40 |
| C | 400,000 | 20 |
| D | 600,000 | 25 |
Source: Bodie et al(2014)
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Net asset value (NAV)
Calculating the NAV
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| Stocks | Shares | Price ($) | Market Value in thousands $ |
| A | 200,000 | 35 | 7000 |
| B | 300,000 | 40 | 12000 |
| C | 400,000 | 20 | 8000 |
| D | 600,000 | 25 | 15000 |
Source: CFA (2014)
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Net asset value (NAV)
Turnover ratio
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For Minerva Fund (see previous exercise), if during the year the portfolio manager sells all the holdings of stock D and replaces it with 200,000 shares of stock E at $50 per share and 200,000 shares of stock F at $25 per share, what is the portfolio turnover rate?
| Stocks | Shares | Price ($) |
| A | 200,000 | 35 |
| B | 300,000 | 40 |
| C | 400,000 | 20 |
| D | 600,000 | 25 |
| E | 200,000 | 50 |
| F | 200,000 | 25 |
Source: Bodie et al(2014)
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Net asset value (NAV)
Rate of Return of Funds
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Corporate Fund started the year with a net asset value of $12.50. By year-end, its NAV equaled $12.10. The fund paid year-end distributions of income and capital gains of $1.50. What was the (pretax) rate of return to an investor in the fund?
Source: Bodie et al(2014)
With income or capital gain distributions, it is possible that the pre-tax rate of return of a fund can be positive despite that a downtrend of NAV
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Fee structure and expense ratio of investment funds
Operating Expenses
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An open-end fund has a net asset value of $10.70 per share. It is sold with a front-end load (sales commission) of 6%. What is the offering price?
Source: Bodie et al(2014)
Given that the retail investor pays a sales commission, to purchase a share in the fund it will have to pay an offering price > NAV
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Fee structure and expense ratio of investment funds
Expense Ratios
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The Right Fund had average daily assets of $2.2 billion last year. The fund sold $400 million worth of stock and purchased $500 million during the year. If New Fund’s expense ratio was 1.1% and the management fee was 0.7%,
1. What were the total fees paid to the fund’s investment managers during the year?
2. What were other administrative expenses?
Source: Bodie et al(2014)
Administrative expenses
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Do NOT get premium account!!!
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Example of Fund of Funds
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This is an example of a portfolio with an aggressive investment mandate. Remember to include 3 funds or ETFs in each portfolio.
Recall that you need to construct 3 portfolios as mentioned in the Task Brief.
Always include the Portfolio Summary
Double-click to get in Excel
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Always include this screenshot of every fund included in each portfolio
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Type the Ticker of your fund/ETF for taking
the screenshot. Include this screenshot in the Word Document.
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In 7-days after your fictive purchase ( creation) of your portfolios, you can check the NAV price in this open source. You only need to input the ticker.
Update these cells according to your market view. Remember that each fund should be representative of the investment mandate of the portfolio.
These cells contain formulas, do not change them
NAV
0
MV
0
NAV
7
MV
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Esther's Portfolio 1
Nº
Funds
/ETF
NameTicker
$ Current
Price
Shares
Held
$ Market
Value
%
Weight
Morningstar
Rating For
Funds
$
Price in 7
days after
Purchase
Shares
Held
$ Market
Value
%
Weight
Return
(with no
exp.)
Expense
ratio
(a)(b)(a*b)(d)(b)(d*b)
1
iShares Core US Aggregate Bond ETFAGG
115,57303.467,1057%
4
115,3
303.459,0057%-0,002
?
2
PIMCO Active Bond ETFBOND
106,7101.067,0018%
3105,99
101.059,9017%-0,007
?
3
Goldman Sachs High Yield Muni PGGLPX
9,6635338,106%
510,5
35367,506%0,087
?
4
FundX Aggressive UpgraderHOTFX
48,6251.215,0020%
1
49251.225,0020%0,008
?
Aggressive6.087,20100%36.111,40100%0,44%
* It is supposed that cash will be fully reinvested during the 7-days. Neither the funds will pay distributions.
You can select Funds which buy Stocks, Bonds, Real Estate, Commodities or any other asset class
Hoja1
| Update these cells according to your market view. Remember that each fund should be representative of the investment mandate of the portfolio. | |||||||||||||
| These cells contain formulas, do not change them | |||||||||||||
| NAV0 | MV0 | NAV7 | MV7 | ||||||||||
| Esther's Portfolio 1 | |||||||||||||
| Nº Funds /ETF | Name | Ticker | $ Current Price | Shares Held | $ Market Value | % Weight | Morningstar Rating For Funds | $ Price in 7 days after Purchase | Shares Held | $ Market Value | % Weight | Return (with no exp.) | Expense ratio |
| (a) | (b) | (a*b) | (d) | (b) | (d*b) | ||||||||
| 1 | iShares Core US Aggregate Bond ETF | AGG | 115.57 | 30 | 3,467.10 | 57% | 4 | 115.3 | 30 | 3,459.00 | 57% | -0.002 | ? |
| 2 | PIMCO Active Bond ETF | BOND | 106.7 | 10 | 1,067.00 | 18% | 3 | 105.99 | 10 | 1,059.90 | 17% | -0.007 | ? |
| 3 | Goldman Sachs High Yield Muni P | GGLPX | 9.66 | 35 | 338.10 | 6% | 5 | 10.5 | 35 | 367.50 | 6% | 0.087 | ? |
| 4 | FundX Aggressive Upgrader | HOTFX | 48.6 | 25 | 1,215.00 | 20% | 1 | 49 | 25 | 1,225.00 | 20% | 0.008 | ? |
| Aggressive | 6,087.20 | 100% | 3 | 6,111.40 | 100% | 0.44% | |||||||
| * It is supposed that cash will be fully reinvested during the 7-days. Neither the funds will pay distributions. | |||||||||||||
| You can select Funds which buy Stocks, Bonds, Real Estate, Commodities or any other asset class |
Portfolio Performance Summary
Type of Portfolio Aggressive
Purchase Datexx.xxx
Average Rating 3
Market Value End Date of XX_XX6.087,20
7-day return excommision0,12%
average expense ratio???
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