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chap004-1.pptxMutual Funds and Other Investment Companies
4
Bodie, Kane, and Marcus
Essentials of Investments, 9th Edition
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
4.1 Investment Companies
Functions
Record keeping and administration
Diversification and divisibility
Professional management
Lower transaction costs
Definitions
Investment company: Financial intermediaries
Net asset value (NAV): Assets minus liabilities per share
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4.2 Types of Investment Companies
Unit Investment Trusts
Money pooled from many investors is invested in portfolio fixed for life of fund
Managed Investment Companies
Open-end fund: Issues or redeems shares at net value
Closed-end fund: Shares can’t be redeemed, are traded at prices different than NAV
Load: Sales commission charged on mutual fund
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4.2 Types of Investment Companies
Open-End and Closed-End Funds: Key Differences
Shares Outstanding
Closed-end: No change unless new stock offered
Open-end: Changes when new shares are sold or old shares are redeemed
Pricing
Open-end: Fund share price = Net asset value (NAV)
Closed-end: Fund share price may trade at premium or discount to NAV
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Figure 4.1 Closed-End Mutual Funds
| Fund | NAV | Mkt Price | Prem/Disc % | 52 Wk Return % |
| Adams Express Company (ADX) | 12.89 | 11.11 | −13.81 | 26.13 |
| Advent/Clay Enhcd G&I (LCM) | 12.16 | 11.58 | −4.77 | 23.52 |
| BlackRock Equity Div (BDV) | 10.65 | 10.03 | −5.82 | 27.39 |
| BlackRock Str Eq Div Achv (BDT) | 11.8 | 10.68 | −9.49 | 26.17 |
| Cohen & Steers CE Oppty (FOF) | 14.64 | 13.46 | −8.06 | 25.17 |
| Cohen & Steers Dvd Mjrs (DVM) | 14.70 | 13.82 | −5.99 | 49.28 |
| Eaton Vance Tax Div Inc (EVT) | 18.75 | 17.19 | −8.32 | 29.89 |
| Gabelli Div & Inc Tr (GDV) | 18.64 | 16.58 | −11.05 | 43.52 |
| Gabelli Equity Trust (GAB) | 6.08 | 6.10 | 0.33 | 48.48 |
| General Amer Investors (GAM) | 32.71 | 28.26 | −13.60 | 30.93 |
| Guggenheim Enh Eq Inc (GPM) | 9.58 | 9.65 | 0.73 | 38.93 |
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4.2 Types of Investment Companies
Other Investment Organizations
Commingled Funds
Partnership of investors pooling funds; designed for trusts/larger retirement accounts to get professional management for fee
Real Estate Investment Trusts (REITs)
Similar to closed-end funds, invests in real estate/real estate loans
Hedge Funds
Private speculative investment pool, exempt from SEC regulation
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4.3 Mutual Funds
Investment Policies
Money market funds
Commercial paper, repurchase agreements, CDs
Equity funds
Invest in stock, some fixed-income, or other securities
Specialized sector funds
Concentrate on particular industry
Bond funds
Specialize in fixed-income (bonds) sector
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4.3 Mutual Funds
Investment Policies
International funds
Global funds invest in securities worldwide, including U.S.
International funds invest outside U.S.
Regional funds focus on particular part of world
Emerging market funds invest in developing nations
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4.3 Mutual Funds
Investment Policies
Balanced funds
Hold both equities and fixed-income securities in stable proportion
Life-cycle funds: Asset mix ranges from aggressive to conservative
Static allocation funds maintain stable mix across stocks and bonds
Targeted maturity funds become more conservative as investor ages
Funds of funds: Mutual funds that primarily invest in other mutual funds
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4.3 Mutual Funds
Investment Policies
Asset allocation and flexible funds
Stocks and bonds—proportion varies according to market forecast
Index funds
Try to match performance of broad market index
Buy shares in securities included in particular index in proportion to security’s representation in index
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Table 4.1 U.S. Mutual Funds by Investment Classification
| Assets ($ billion) | Percent of Total Assets | Number of Funds | |||
| Equity Funds | |||||
| Capital appreciation focus | 2,912 | 24.2% | 3,037 | ||
| World/international | 1,660 | 13.8% | 968 | ||
| Total return | 1,950 | 16.2% | 762 | ||
| Total equity funds | 6,522 | 54.2% | 4,767 | ||
| Bond Funds | |||||
| Corporate | 301 | 2.5% | 293 | ||
| High yield | 157 | 1.3% | 206 | ||
| World | 84 | 0.7% | 122 | ||
| Government | 203 | 1.7% | 301 | ||
| Strategic income | 560 | 4.7% | 370 | ||
| Single-state municipal | 156 | 1.3% | 451 | ||
| National municipal | 218 | 1.8% | 224 | ||
| Total bond funds | 1,679 | 14.0% | 1,967 | ||
| Hybrid (bond/stock) funds | 713 | 5.9% | 488 | ||
| Money market funds | |||||
| Taxable | 2,642 | 22.0% | 548 | ||
| Tax-exempt | 465 | 3.9% | 259 | ||
| Total money market funds | 3,107 | 25.8% | 807 | ||
| Total | 12,021 | 100.0% | 8,029 |
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4.4 Costs of Investing in Mutual Funds
Fee Structure
Operating expenses: Costs incurred by mutual fund in operating portfolio
Front-end load: Commission or sales charge paid when purchasing shares
Back-end load: “Exit” fee incurred when selling shares
12b-1 charges: Annual fees charged by mutual fund to pay for marketing/distribution costs
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4.4 Costs of Investing in Mutual Funds
Fees, Loads, and Performance
Gross performance of load funds is statistically identical to gross performance of no-load funds
Funds with high expenses tend to be poorer performers
12b-1 charges should be added to expense ratios
Compare costs with Morningstar
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4.4 Costs of Investing in Mutual Funds
NAV and Effective Load
Cost to initially purchase one share of load fund = NAV + Front-end load (%) (if any)
Stated loads typically range from 0 to 8.5%
Load is designed to offset expenses of marketing the fund; it goes to broker who sells fund to investor
Effective load greater than stated load
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4.4 Costs of Investing in Mutual Funds
Avoiding the Load
Choose different class of fund shares
Notes:
a Depending on size of investment.
b Depending on years until holdings are sold.
c Including service fee of .25%.
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4.4 Costs of Investing in Mutual Funds
Fees and Mutual Fund Returns
Soft dollars: Value of research services brokerage house provides “free of charge” in exchange for business
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Table 4.2 Impact of Costs on Investment Performance
Notes: Fund A is no-load with .5% expense ratio, Fund B is no-load with 1.5% total expense ratio, and Fund C has an 8% load on purchases and a 1% expense ratio. Gross return on all funds is 12% per year before expenses.
* After front-end load, if any.
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4.5 Taxation of Mutual Fund Income
General Tax Rules
Fund not taxed if diversified and income distributed
Investor taxed on capital gain and dividend distributions
Turnover: Ratio of trading activity to assets of portfolio
Portfolio turnover may affect investor’s tax liability
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4.5 Taxation of Mutual Fund Income
Implications of Fund Turnover
Fund pays commission costs on portfolio purchases and sales—charged against NAV
Turnover rate measured as annual total asset value bought or sold in a year divided by average total asset value
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4.6 Exchange-Traded Funds
Exchange-Traded Funds: Offshoots of mutual funds that allow investors to trade index portfolios
Potential Advantages
Trade continuously throughout day
Can be sold or purchased on margin
Potentially lower tax rates
Lower costs (no marketing, lower fund expenses)
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4.6 Exchange-Traded Funds
Potential Disadvantages
Small deviations from NAV possible
Brokerage commission to buy ETF
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Table 4.3 ETF Sponsors and Products
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Figure 4.2 Assets in ETFs
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Figure 4.3 Investment Company Assets under Management, 2010 ($ Billion)
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4.7 Mutual Fund Investment Performance
On average, mutual fund performance less than broad market performance
Evidence suggests some persistence in positive performance over certain horizons
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Figure 4.4 Average Returns on Diversified Equity Funds vs. Wilshire 5000 Index
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Rate of return (%)
Table 4.4 Consistency of Investment Results
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4.8 Information on Mutual Funds
Sources of Information on Mutual Funds
Morningstar (www.morningstar.com)
Fund prospectus
Yahoo!
The Wall Street Journal
Investment Company Institute (www.ici.org)
American Institute of Individual Investors
Brokers
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Copyright
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2013 by The McGraw
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Hill Companies, Inc. All rights reserved.
Mutual Funds and Other
Investment Companies
4
Bodie
, Kane, and Marcus
Essentials of Investments,
9
th
Edition
