fina 4310 spring 2002 chapter 4: mutual funds and other
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FINA 4310Spring 2002
Chapter 4: Mutual Funds and Other Investment Companies
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Investment Companies
Unit Investment Trusts
Managed Investment CompaniesOpen-end funds (Mutual Funds)
Closed-end funds
Real Estate Investment Trusts (REITs)
Exchange-Traded Funds (ETFs)
Commingled Funds
Hedge Funds
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Unit Investment Trusts
Portfolio is fixed for the life of the trust
Fixed-Income UITGovernment securities
Corporate bond
Municipal bond
International bond
Equity UIT
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Mutual Funds
Open-end fundsInvest by sending money directly to the fundNew units are created as new money flows inUnits retired as money flows outGo in and out at Net Asset Value (NAV)
Management companies – “Families”FidelityVanguard Many Others
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Types of Mutual Funds
Equity Funds
Fixed-Income Funds
Money Market Funds
Balanced Funds
Asset Allocation Funds
Index Funds
Specialized Funds
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Equity Mutual FundsAggressive Growth/Capital Appreciation
Small companies/Narrow market sectors
GrowthFirms with good revenue & earnings potential
Blend (Growth and Income)Combination of Growth and Value Stocks
Value Profitable, Dividend-paying stocksStocks with low P/E ratios
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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
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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
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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
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Specialized Funds
Focus on a particular sector or industryReal Estate
Technology
Health Care
Utilities
Financial Services
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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 NAVAbove: Premium
Below: Discount
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Real Estate Investment Trusts
Like a closed-end fundBuy it on an exchange
Equity REITSBuy investment property
Mortgage TrustsBuy mortgage loans
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Exchange-traded Funds
Like closed-end funds, they trade on an exchangeLike index funds, they tend to be passively managedA variety of legal forms:
Unit Investment Trusts (SPDRs, HOLDRs)Open-end Mutual funds (iShares)Traditional mutual fund share class (Vipers)
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Commingled Funds
Partnerships of investors that pool their funds
Similar to open-end mutual fund
Typically, small institutional investorsMost commonly pension plans
Larger than typical individual investor
Too small to warrant individual management
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Hedge Funds
Limited partnership of investorsAccredited 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
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Mutual Fund Fees
Front-end load
Back-end load
12b-1 charges
Operating Expenses
Broker Commissions
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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
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Back-end LoadAlso called:
Redemption FeeContingent Deferred Sales Charge
This is a fee charged when you exit the fundCharged in percentage termsSome funds have no back-end loadIf they do, it often drops off gradually to zero the longer you hold the fundDiscourages investors with short horizons
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12b-1 charges
Managers can use up to 1% of the fund’s assets each year to pay for...
AdvertisingAnnual reports and prospectusesCommissions paid to brokers
Because these fees come straight from the fund’s assets, they are “hidden” costs to the investor
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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”
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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.
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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 sharesExample: Vanguard “Admiral” Shares