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Principles of Investing FIN 330

Principles of Investing FIN 330. Chapter 4 Investment Companies . Student Learning Objectives. What are mutual funds, ETF’s? Open-ended vs. Closed-end funds, Load vs. No Load funds Net Asset Values (NAV) Evaluating mutual fund performance Managing Mutual Fund Investments. Mutual Funds.

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Principles of Investing FIN 330

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  1. Principles of InvestingFIN 330 Chapter 4 Investment Companies

  2. Student Learning Objectives • What are mutual funds, ETF’s? • Open-ended vs. Closed-end funds, Load vs. No Load funds • Net Asset Values (NAV) • Evaluating mutual fund performance • Managing Mutual Fund Investments

  3. Mutual Funds • Mutual funds pool funds from many investors to buy securities • Mutual funds have grown in importance • Open-end vs. Closed-End Funds • Open-ended mutual funds continually issue and redeem shares at NAV • Closed-end funds issue shares once. Investors must then sell (or buy) in secondary markets • Net asset value (NAV) of a fund is the market value of the fund’s assets less any liabilities, divided by the number of shares outstanding at that time

  4. Mutual Funds • Advantages of mutual funds • Diversification • Smaller minimum investments to access large diversified portfolio • Professional management • Disadvantages of mutual funds • Most funds underperform relative to the S&P 500 Index • Fund expenses reduce returns • Too many to choose from – adverse selection problem • Many funds have minimum holding periods (to avoid trading fees / penalties) • Exchange Traded Funds (ETF’s) • Diversified portfolios of securities traded like ordinary stocks: they are continuously market-to-market. • Portfolio objective similar to regular mutual funds: indexed, growth, income, sector or country, international, emerging markets, etc.

  5. Types of Funds • Overall investment objectives • Growth, Income, Growth & Income, etc…. • Types of securities purchased • Equity funds, money market funds, bonds • Load funds versus no-load funds • Load charges are assessed when shares are purchased (front-end) or sold (back-end)

  6. Services Offered by Mutual Fund Companies • Automatic reinvestment of distributions • Automatic investment plans • Check writing (money market funds) • Exchange privileges within fund families • Periodic statements

  7. Selecting and Evaluating Mutual Fund Performance • Thousands of funds to select from • Set investment goals • Income, capital appreciation, safety, • International/emerging markets • Assess fund risk metrics and historic returns before selecting • Evaluate services offered by the fund

  8. Selecting and Evaluating Mutual Fund Performance • Load charges • Contingent deferred sales charge (CDSC) is a back-end load that declines over time • Back-end loads discourage trading by investors • Front-end loads compensate the broker • No-load funds dominate • Operating expenses • Measured as percent of NAV • Management or advisory fees and other operating expenses • Paid out of investment income • 12b -1 fees cover distribution costs

  9. Unit Investment Trusts (UIT) • Most are pools of bonds: Corporates, Governments, Municipals • Investors looking for secure/known income (interest or dividends) • Fixed life of UIT minimizes interest rate risk

  10. Evaluating Historical Performance • Performance is important criteria • Consider risk and return using standard deviation and beta to measure risk • Relative performance to a benchmark such as S&P 500 or average return of mutual fund group • Consistency of performance over time

  11. Evaluating Historical Performance E. Assessing future performance • Past performance is a poor predictor since funds do not over the long term post better risk-adjusted performance than the broad market averages • Others feel that past performance is a reasonable, though imperfect, predictor because past performance reflects more than mere luck F. Performance and taxes • Mutual funds are not taxed directly on income or capital gains as these are passed on to the shareholders • Returns can be broken down into distributions and change in NAV • Portfolio turnover relates to higher capital gains distributions and unrealized capital gains • Don’t purchase just before a distribution

  12. Managing Mutual Fund Investments • Passive versus active • Funds discourage market timing by imposing fees for frequent trading • Mutual funds are designed to be fairly long term investment vehicles • Investment objectives change through time • Dollar-cost averaging is investing equal dollar amounts at regular intervals and can be beneficial when prices fluctuate but if prices continually rise, buying more earlier is better • Rebalancing means adjusting a portfolio return to its target asset allocation

  13. Homework • Discussion Questions: 1, 3, 4, 5, 8, 12, 13, 15 (first part only) • Problems: 1, 5 (a, b, c), 8, 12 (a, b, c)

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