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McGraw-Hill/Irwin Copyright © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Mutual Funds and Other Investment Companies CHAPTER 4

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

Page 1: McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All ...

McGraw-Hill/Irwin Copyright © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

Mutual Funds and Other Investment Companies

CHAPTER 4

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4-2

Investment Companies

Investment companies offer:Investment companies offer:– Administration & record keepingAdministration & record keeping

– Diversification & divisibilityDiversification & divisibility

– Professional managementProfessional management

– Reduced transaction costsReduced transaction costs

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4-3

Investment Companies

Investment companies are exempt from Investment companies are exempt from corporate earnings ________________.corporate earnings ________________.Investors must pay tax on income earned Investors must pay tax on income earned from investment companies. Funds with high from investment companies. Funds with high turnover result in high taxes (low tax turnover result in high taxes (low tax efficiency).efficiency).Purchasing a mutual fund late in the year can Purchasing a mutual fund late in the year can result in taxes on earnings you did not result in taxes on earnings you did not receive.receive.

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Investment Companies:Net Asset Value

Net Asset ValueNet Asset Value– Used as basis for valuation of investment Used as basis for valuation of investment

company sharescompany shares– Selling new sharesSelling new shares– Redeeming existing sharesRedeeming existing shares

Calculation:Calculation:

Market Value of Assets - LiabilitiesMarket Value of Assets - Liabilities

Shares OutstandingShares Outstanding

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4-5

Types of Investment Companies

Unit TrustsUnit Trusts– Pools of money fixed for the life of the Pools of money fixed for the life of the

fundfund

– Little active managementLittle active management

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Managed Investment Companies:Open-End and Closed-End

Open-EndOpen-End– Sold at Net Asset Value (NAV)Sold at Net Asset Value (NAV)– # of shares changes when new shares are # of shares changes when new shares are

sold or old shares are redeemedsold or old shares are redeemed

Closed-EndClosed-End– Sold at premium or discount to NAVSold at premium or discount to NAV– No change in # of shares unless new stock is No change in # of shares unless new stock is

offeredoffered

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4-7

Types of Investment Companies

REIT: Real Estate Investment TrustREIT: Real Estate Investment Trust

Types of REITs:Types of REITs:

Equity REIT: invests in real estateEquity REIT: invests in real estate

Mortgage REIT: invests in mortgagesMortgage REIT: invests in mortgages

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Types of Investment Companies

Hedge Funds: little regulationHedge Funds: little regulation

Limited to qualified (high net worth/high Limited to qualified (high net worth/high income) investors:income) investors:

Net worth > $1 milNet worth > $1 mil

Income > $200KIncome > $200K

Annual fees are typically 2% of assets plus Annual fees are typically 2% of assets plus 20% of profit20% of profit

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4-9

Types of Investment Companies

ETFs are closed-end funds ETFs are closed-end funds

Examples - SPDRs and WebsExamples - SPDRs and Webs

Potential advantagesPotential advantages– Trade continuously Trade continuously – Lower taxes Lower taxes – Lower feesLower fees

Potential disadvantagesPotential disadvantages– Must pay brokerage commission Must pay brokerage commission – Price can differ from NAVPrice can differ from NAV

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Types of Mutual Funds

Money Market Money Market

EquityEquity

Specialized SectorSpecialized Sector

BondBond

BalancedBalanced

IndexIndex

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Mutual Fund Fee Structure

Loads:Loads:– Front-end loadFront-end load– Back-end loadBack-end load

Management fees range from < 0.1% to > Management fees range from < 0.1% to > 2% of assets annually2% of assets annually

12 b-1 charges12 b-1 charges– Distribution costs paid by the fundDistribution costs paid by the fund– Alternative to a loadAlternative to a load

Fees and performanceFees and performance

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Trading Scandal with Mutual Funds

Late trading – allowing some investors to Late trading – allowing some investors to purchase or sell after the market closespurchase or sell after the market closesMarket timing – allowing investors to buy Market timing – allowing investors to buy or sell on stale net asset valuesor sell on stale net asset valuesNet effect is to transfer value from other Net effect is to transfer value from other shareholders to privileged tradersshareholders to privileged traders– Reduction in the rate of return of the mutual Reduction in the rate of return of the mutual

fundfund

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Potential Reforms

Strict 4:00 PM cutoff with late orders Strict 4:00 PM cutoff with late orders executed the following trading dayexecuted the following trading day

Fair value pricing with net asset values Fair value pricing with net asset values being adjusted for trading in open marketsbeing adjusted for trading in open markets

Imposition of redemption feesImposition of redemption fees

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4-14

Mutual Fund Performance

Evidence shows that average mutual fund Evidence shows that average mutual fund performance is generally less than broad performance is generally less than broad market performancemarket performance

Evidence suggests that over certain Evidence suggests that over certain horizons some persistence in positive horizons some persistence in positive performanceperformance– Evidence is not conclusiveEvidence is not conclusive– Some inconsistenciesSome inconsistencies

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Figure 4.2 Diversified Equity Funds Versus Wilshire 5000 Index

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Table 4.4 Consistency of Investment Results

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Sources of Information

Wiesenberger’s Investment CompaniesWiesenberger’s Investment Companies

Morningstar (Morningstar (www.morningstar.com))

Yahoo (Yahoo (finance.yahoo.com/funds))

Investment Company InstituteInvestment Company Institute

Popular pressPopular press

Investment services (Value Line)Investment services (Value Line)

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How to Pick a Mutual Fund

In comparing mutual funds, look for: In comparing mutual funds, look for: ________________________________________________________________Low ________________ (including 12b-1)Low ________________ (including 12b-1)Matches your investment _____________ Matches your investment _____________

& __________________ tolerance& __________________ toleranceTax efficiency (unless IRA or 401k)Tax efficiency (unless IRA or 401k)Good recent performance (several yrs)Good recent performance (several yrs)Same portfolio managerSame portfolio manager


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