CH4.

INVESTMENT
COMPANIES
Part 1 of FINA 460
Securities (Ch.1 & 2)
Markets (Ch.3)
Investment
Companies (Ch.4)

Mutual Funds, Closed-end

Funds, ETFs, Hedge Funds,
NAVs, Fees

Ch4.1-2. Types of Investment

Companies
Why do many people invest in funds, not directly in securities?
Administration and Record Keeping
Keeps track of all of your distributions both capital gains and dividends.
Will allow you to easily reinvest any distributions
Easy diversification
Difficult for small investors to do when buying securities on there own.
Allows small investor to hold a fraction of a share in a company.
Professional management
Fund managers generally have plenty of experience trading securities.
Economies of scale allow for reduced transaction costs.
3-2

Organizational Forms

Unit Investment Trusts (UITs): unmanaged, fixed portfolio

Managed Investment Companies
Open-end fund (Mutual Fund)
shares are bought from the fund and redeemed by the fund
Closed-end fund
shares are bought and sold among investors in the
marketplace (NASDAQ or an exchange) and the fund itself is
not involved.
Exchange Traded Funds (ETFs)
Real Estate Investment Trusts (REITs)
Similar to closed-end fund. Invest in real estate and real estate loans.
Highly leveraged.
Hedge Funds
Similar to mutual funds, but not registered and not subject to SEC
regulations.
Available to institutional and high net worth investors
Can pursue investment strategies that are not allowed for mutual funds.
4-3

Ch4.3-5. Mutual Funds

Do you know what these terms mean?
Growth funds vs. Income funds
Balanced funds vs. Asset allocation
funds

Read p.88-95
Check a Fund W
ebsite
3-4

Net Asset Value (NAV)

Used as a basis for valuation of
investment company shares

Selling new shares

Redeeming existing shares

Calculation
Market Value of Fund Assets Fund Liabilitie s
NAV
Fund shares outstandin g

4-5

Open-end vs. Closed-End

Most funds are open-end:
About 90% of investment company
assets are held in mutual funds.
Advantages of the open-end
funds
Liquidity for the investor
Funds ability to grow
Disadvantages of the open-end
funds
The need to keep a cash reserve

4-6

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: Fund share price = Net Asset

Value (NAV)
Closed-end: Fund share price may trade
at a premium or discount to NAV

4-7

NAV calculation
ABC Fund ($Millions except NAV)
Market Value Securities
+ Cash & Receivables$550.0
0
- Current Liabilities
75.00
NAV Total
(20.00)
# Fund Shares
$605.0
NAV
0

20.00
$

Most Mutual
Funds have little
or no Long Term
Debt

P14-8

How Funds Are Sold

Directly marketed
You find them
May avoid front end load
Front end load: up front cost (fee) to purchase mutual
fund shares

Sales force distributed

Recommended by a broker or planner
Usually will have a front end load
May be revenue sharing on sales force distributed
Potential conflict of interest
4-9

Table 4.1 U.S. Mutual Funds by Investment

Classification
Assets ($
billion)

Percent of Total
Assets

Number of Funds

Capital appreciation focus

2,912

24.2%

3,037

World/international

1,660

13.8%

968

Total return

1,950

16.2%

762

6,522

54.2%

4,767

Corporate

301

2.5%

293

High yield

157

1.3%

206

84

0.7%

122

Government

203

1.7%

301

Strategic income

560

4.7%

370

Single-state municipal

156

1.3%

451

National municipal

218

1.8%

224

Total bond funds

1,679

14.0%

1,967

Equity Funds

Total equity funds

Bond Funds

World

Costs of Investing in Mutual

Funds
Fee Structure
Front-end load
Back-end load: redemption fee
Operating expenses
o

Administrative expenses and advisory

fees for the managers

12 b-1 charges

Marketing costs paid by investors

o Alternative to a load, but assessed
annually
o Maximum is 1% of assets
All costs and charges must be revealed in the
o

4-11

Taxation of Mutual Fund

Income

The fund itself is not taxed as long as

Fund meets certain diversification

requirements
Fund distributes virtually all income
earned (less fees and expenses) to
fund shareholders

The investor is taxed on capital gain

and dividend distributions at the
investors appropriate tax rate.
Distribution requirements imply that

4-12

Sources of Information on Mutual

Funds

Wiesenbergers Investment Companies

Morningstar (www.morningstar.com)
Fund prospectus (a must read)
Yahoo
Wall Street Journal
Investment Company Institute (
www.ici.org)

4-13

Ch4.6. Exchange Traded Funds (ETFs)

ETFs allow investors to trade index portfolios

like shares of stock
Examples: SPDRs, Diamonds, Cubes, WEBS
Advantages
o Trade continuously throughout the day
o Can be sold short or purchased on margin
o Large investors can exchange their ETF
shares for shares in the underlying portfolio
o Lower costs (No marketing; lower fund
expenses)
WSJ: Carl Icahns Conference Speech on Bond ETFs
(07/16/15)
4-14

ETF Sponsors and Products

4-15

Figure 4.2 Assets in ETFs

Figure 4.3 Investment Company Assets under

Management, 2010 ($ Billion)

Review Problems for Ch.4

Solve the following End-of-the-chapter

Practice Problems
1, 2, 3, 8, 10, 11, 13, 14, 16, 17, 19, and 22
Compare your answers with the solution
posted on Blackboard

18

For more practice, use the additional

practice problems posted on
Blackboard