CHAPTER 4 4.1 INVESTMENT COMPANIES Mutual Funds And

CHAPTER 44.1 INVESTMENT COMPANIESMutual Funds and OtherInvestment CompaniesInvestment CompaniesAdministration & record keepingDiversification & divisibilityProfessional managementReduced transaction costsInvestment Companies:Net Asset ValueNet Asset Value– Used as a basis for valuation of investmentcompany shares– Selling new shares– Redeeming existing sharesCalculation:Market Value of Assets - LiabilitiesShares OutstandingUnit Trusts4.2 TYPES OF INVESTMENT COMPANIESPools of money fixed for the life of the fundLittle active management

Managed Investment Companies:Open-End and Closed-EndFigure 4.1 Closed-End Mutual FundsOpenOpen-End– Sold at Net Asset Value (NAV)– Changes when new shares are sold or oldshares are redeemedClosedClosed-End– Sold at premium or discount to NAV– No change unless new stock is offeredOther Investment Organizations– Commingled funds– REITs– Hedge FundsInvestment PoliciesDescribed in the prospectusManagement companies manage a familyof mutual funds. Some examples include:– Fidelity– Vanguard– Putnam– Dreyfus4.3 MUTUAL FUNDSTypes of Mutual FundsMoney MarketEquitySpecialized SectorBond

Types of Mutual FundsTable 4.1 Mutual Funds by InvestmentClassificationBalanced FundsAsset Allocation and FlexibleIndexedInternationalHow Funds Are SoldDirectly marketedSales force distributedRevenue sharing on sales force distributed4.4 COSTS OF INVESTING INMUTUAL FUNDS– Potential conflicts of interest– It must be disclosed to the investorFinancial supermarketsFee StructureFee Structure– FrontFront-end load– BackBack-end loadOperating expenses12 bb-1 charges– distribution costs paid by the fund– Alternative to a loadFees and performanceExample 4.1 From Text

Fees and Mutual Fund ReturnsRate of return NAV1 NAV0 Income and capital gain distributionsNAV0Fees and Mutual Fund Returns:An ExampleInitial NAV 20Income distributions of .15Capital gain distributions of .05Ending NAV 20.10:Rate of Return Table 4.2 Impacts of Costs onInvestment Performance 20.10 - 20.00 .15 .05 1.5% 20.00Trading Scandal with Mutual FundsLate trading – allowing some investors topurchase or sell after the market closesMarket timing – allowing investors to buyor sell on stale net asset values– InternationalNet effect is to transfer value from othershareholders to privileged traders– Reduction in the rate of return of the mutualfundPotential ReformsStrict 4:00 PM cutoff with late ordersexecuted the following trading dayFair value pricing with net asset valuesbeing adjusted for trading in open marketsImposition of redemption fees4.5 TAXATION OF MUTUALFUND INCOME

Taxation of Mutual Fund IncomeInvestor directed portfolios can bestructured to take advantage of taxeswhile mutual funds cannotHigh turnover leads to tax inefficiencyMore disclosure on taxes was required in20004.6 EXCHANGE-TRADED FUNDSExchange Traded FundsETF allow investors to trade indexportfolios like shares of stockExamples – SPDRs, Diamonds, andWEBSPotential advantages4.7 MUTUAL FUND INVESTMENTPERFORMANCE: A FIRST LOOK– Trade continuously– Lower taxes– Lower costsPotential disadvantagesMutual Fund PerformanceEvidence shows that average mutual fundperformance is generally less than broadmarket performanceEvidence suggests that over certainhorizons some persistence in positiveperformance– Evidence is not conclusive– Some inconsistenciesFigure 4.2 Diversified Equity FundsVersus Wilshire 5000 Index

Table 4.4 Consistency ofInvestment Results4.8 INFORMATION ON MUTUAL FUNDSSources of InformationWiesenberger’Wiesenberger’s Investment CompaniesMorningstar (www.morningstar.com(www.morningstar.com))Yahoo Investment Company InstitutePopular pressInvestment services

Fees and Mutual Fund Returns 1 0 0 NAV NAV Income and capital gain distribut ions Rate of return NAV Fees and Mutual Fund Returns: An Example Initial NAV 20 Income distributions of .15 Capital gain distributions of .05 Ending NAV 20.10: 20.10 - 20.00 .15 .05 Rat