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FINA 4310 Spring 2002

FINA 4310 Spring 2002. Chapter 4: Mutual Funds and Other Investment Companies. Investment Companies. Unit Investment Trusts Managed Investment Companies Open-end funds ( Mutual Funds ) Closed-end funds Real Estate Investment Trusts (REITs) Exchange-Traded Funds (ETFs) Commingled Funds

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FINA 4310 Spring 2002

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  1. FINA 4310Spring 2002 Chapter 4: Mutual Funds and Other Investment Companies

  2. Investment Companies • Unit Investment Trusts • Managed Investment Companies • Open-end funds (Mutual Funds) • Closed-end funds • Real Estate Investment Trusts (REITs) • Exchange-Traded Funds (ETFs) • Commingled Funds • Hedge Funds

  3. Unit Investment Trusts • Portfolio is fixed for the life of the trust • Fixed-Income UIT • Government securities • Corporate bond • Municipal bond • International bond • Equity UIT

  4. Mutual Funds Open-end funds • Invest by sending money directly to the fund • New units are created as new money flows in • Units retired as money flows out • Go in and out at Net Asset Value (NAV) • Management companies – “Families” • Fidelity • VanguardMany Others

  5. Types of Mutual Funds • Equity Funds • Fixed-Income Funds • Money Market Funds • Balanced Funds • Asset Allocation Funds • Index Funds • Specialized Funds

  6. Equity Mutual Funds • Aggressive Growth/Capital Appreciation • Small companies/Narrow market sectors • Growth • Firms with good revenue & earnings potential • Blend (Growth and Income) • Combination of Growth and Value Stocks • Value • Profitable, Dividend-paying stocks • Stocks with low P/E ratios

  7. 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

  8. 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

  9. 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

  10. Specialized Funds • Focus on a particular sector or industry • Real Estate • Technology • Health Care • Utilities • Financial Services

  11. 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 NAV • Above: Premium • Below: Discount

  12. Real Estate Investment Trusts • Like a closed-end fund • Buy it on an exchange • Equity REITS • Buy investment property • Mortgage Trusts • Buy mortgage loans

  13. Exchange-traded Funds • Like closed-end funds, they trade on an exchange • Like index funds, they tend to be passively managed • A variety of legal forms: • Unit Investment Trusts (SPDRs, HOLDRs) • Open-end Mutual funds (iShares) • Traditional mutual fund share class (Vipers)

  14. Commingled Funds • Partnerships of investors that pool their funds • Similar to open-end mutual fund • Typically, small institutional investors • Most commonly pension plans • Larger than typical individual investor • Too small to warrant individual management

  15. Hedge Funds • Limited partnership of investors • Accredited 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

  16. Mutual Fund Fees • Front-end load • Back-end load • 12b-1 charges • Operating Expenses • Broker Commissions

  17. 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

  18. Back-end Load • Also called: • Redemption Fee • Contingent Deferred Sales Charge • This is a fee charged when you exit the fund • Charged in percentage terms • Some funds have no back-end load • If they do, it often drops off gradually to zero the longer you hold the fund • Discourages investors with short horizons

  19. 12b-1 charges • Managers can use up to 1% of the fund’s assets each year to pay for... • Advertising • Annual reports and prospectuses • Commissions paid to brokers • Because these fees come straight from the fund’s assets, they are “hidden” costs to the investor

  20. 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”

  21. 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.

  22. 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 shares • Example: Vanguard “Admiral” Shares

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