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CHAPTER 4

CHAPTER 4. Mutual Funds and Other Investment Companies. Services of Investment Companies. Administration & record keeping Diversification & divisibility Professional management Reduced transaction costs. Net Asset Value. Used as a basis for valuation of investment company shares

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CHAPTER 4

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  1. CHAPTER 4 Mutual Funds and Other Investment Companies

  2. Services of Investment Companies • Administration & record keeping • Diversification & divisibility • Professional management • Reduced transaction costs

  3. Net Asset Value • Used as a basis for valuation of investment company shares • Selling new shares • Redeeming existing shares Calculation Market Value of Assets - Liabilities Shares Outstanding

  4. Types of Investment Organizations • Unit Trusts • Managed Investment Companies • Open-End • Closed-End • Other investment organizations • Commingled funds • REITs • Hedge Funds

  5. Open-End and Closed-End Funds: Key Differences Shares Outstanding • Closed-end: no change unless new stock is offered • Open-end: changes when new shares are sold or old shares are redeemed Pricing • Open-end: Net Asset Value(NAV) • Closed-end: Premium or discount to NAV

  6. Figure 4.1 Closed-End Mutual Funds

  7. Figure 4.2 Listing of Mutual Fund Quotations

  8. Investment Policies • Money Market • Equity • Specialized Sector • Bond • Balance & Income • Asset Allocation • Indexed • International

  9. Table 4.1 Classification of U.S. Mutual Funds

  10. How Funds Are Sold • Directly marketed • Sales force distributed • Revenue sharing on sales force distributed • Potential conflicts of interest • Financial supermarkets

  11. Potential Conflicts of Interest - Revenue Sharing • Brokers put investors in funds that may that may not be the most appropriate • Mutual funds could direct trading to higher cost brokers • Revenue sharing is not illegal but it must be disclosed to the investor

  12. Costs of Investing in Mutual Funds • Fee Structure • Front-end load • Back-end load • Operating expenses • 12 b-1 charges • distribution costs paid by the fund • Alternative to a load • Fees and performance

  13. Table 4.2 Impacts of Costs on Investment Performance

  14. Trading Scandal with Mutual Funds • Late trading – allowing some investors to purchase or sell later than other investors • Market timing – allowing investors to buy or sell on stale net asset values • International • Net effect is to transfer wealth from existing owners to the new purchasers or sellers

  15. Potential Reforms • Strict 4:00 PM cutoff with late orders executed the following trading day • Fair value pricing with net asset values being adjusted for trading in open markets • Imposition of redemption fees

  16. Taxes on Mutual Funds • Investor directed portfolios can be structured to take advantage of taxes while mutual funds cannot • High turnover leads to tax inefficiency • More disclosure on taxes was required in 2000

  17. Exchange Traded Funds • ETF allow investors to trade index portfolios like shares of stock • Examples - SPDRs and Webs • Potential advantages • Trade continuously • Lower taxes • Lower costs • Potential disadvantages

  18. First Look at Mutual Fund Performance • Evidence shows that average mutual fund performance is generally less than broad market performance • Evidence suggests that over certain horizons some persistence in positive performance • Evidence is not conclusive • Some inconsistencies

  19. Figure 4.3 Percentage of Funds Below Wilshire 5000

  20. Table 4.4 Consistency of Investment Results

  21. Sources of Information on Mutual Funds • Wiesenberger’s Investment Companies • Morningstar (www.morningstar.com) • Yahoo (biz.yahoo.com/funds) • Investment Company Institute • Popular press • Investment services

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