Mutual Funds and Other Investment Companies

Investments
CHAPTER 4
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Mutual Funds and

Other Investment
Companies
McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved
4- 2
Investment Companies
 An investment company invests a pool

of funds belonging to many individuals
in a portfolio of individual investments
such as stocks and bonds.
 The firm raises funds from investors by
selling shares in itself.
 Portfolio management is handled by an
investment management company.
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4- 3
Services of Investment Companies
 Administration & record keeping


 Professional management

 Check-writing privilege
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4- 4
Net Asset Value
 Used as a basis for valuation of

investment company shares.
–
–
 Calculation: Net Asset Value (NAV)
Market Value of Assets - Liabilities
Shares Outstanding
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4- 5
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4- 6
Types of Investment Organizations
 Unit Trusts
 Managed Investment Companies
–
–
 Other investment organizations
–
• A Partnership of large investors
• Portfolio managed by a bank or other FI
–
–
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Open-end vs Closed-end
Shares Outstanding
 Closed-end: no change unless new shares are
offered.
 Closed-end shares traded on secondary
market.
 Open-end: changes when new shares are sold
or old shares are redeemed.
Pricing
 Open-end:
 Closed-end: Premium or discount to NAV
– Price determined by demand and supply
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4- 8
Closed-End Mutual Funds
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4- 9
Listing of Mutual Fund Quotations
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Investment Policies 4- 10
 Money Market

 Specialized Sector

 Balance & Income
 Asset Allocation

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 International
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4- 11
Investment Style
 Aggressive Growth (or Max Capital Gain)


 Growth-Income

 Balanced

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Style and Beta Risk
Beta Risk and Investment Style

1.6
1.4
1.2
1
Be ta
0.8
0.6
0.4
0.2
0
Aggre s s ive Growth Growth Growth-Income Income -Growth Ba la nce d Income
S tyle
1
Style and Volatility
Volatility and Investment Style

10
8
Vo la tility
0
S tyle
1
Style and Average Returns
Average Excess Returns and Investment Style
1.5
1
Exc e s s Re turns
0.5
(0.5)
S tyle
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4- 15
Costs of Investing in Mutual Funds
 Fee Structure
–
–
 Operating expenses
 12 b-1 charges (Annual)
– distribution costs paid by the fund
–
 Fees and performance
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4- 16
Hedge Funds
 An actively managed, pooled investment vehicle that
is open to only a limited group of investors.
 Private investment vehicles where the manager has a
significant personal stake in the fund and enjoys high
level of flexibility to employ a broad spectrum of
strategies involving use of derivatives, short selling
and leverage in order to enhance returns and better
manage risk.
 Can take both long and short positions, use arbitrage,
trade mispriced securities, trade options or bonds,
and invest in almost any opportunity in any market
where it foresees impressive gains at reduced risk.
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Hedge Funds
 Unlike mutual funds, hedge funds are unregulated and

therefore unrestricted. Hedge funds are structured to
take advantage of exemptions in regulations. However,
an informal restriction is generally imposed on hedge
fund managers by professional investors who
understand different strategies.
 Hedge funds are almost always organized as LPs or
LLCs to provide pass-through tax treatment. Hedge
funds do not pay tax, only investors pay.
 Pension funds, endowments, insurance companies,
private banks and high net worth individuals and families
invest in hedge funds to minimize overall portfolio
volatility and enhance returns.
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Hedge Funds
 The Investment Company Act of 1940 exempts

(hedge) funds with fewer than 100 investors. In 1996,
it was amended so that more investors could
participate, so long as each “qualified purchaser” was
either an individual with at least $5 million in assets or
an institutional investor with at least $25 million.
 Mutual funds generally reward managers based on a
percent of assets under management. Hedge funds
always reward managers with performance-related
incentive fees as well as a fixed fee.
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4- 19
Exchange Traded Funds (ETFs)

 ETFs bundle together the securities that are in an
index.
 A fund that tracks an index, but can be traded like a
stock.
 Because ETFs are traded on exchanges, they can be
traded at any time during the day (unlike mutual funds).
 Their price will fluctuate from moment to moment, just
like any other stock's price.
 ETFs are more tax-efficient than normal mutual funds,
and since they track indexes they have very low
operating and transaction costs associated with them.
 Examples include DIAMONDS Trust Series I (DIA),
Nasdaq-100 Index Tracking Stock (QQQ), and SPDR
Trust Series I (SPY).
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4- 20
ETF Sponsors and Products
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4- 21
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
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4- 22
Sources of Information on Mutual Funds
 Wiesenberger’s Investment Companies

 Morningstar (www.morningstar.com)
 Yahoo (biz.yahoo.com / funds)
 Investment Company Institute
(www.ici.org)
 Popular press
 Investment services
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Investments

Mutual Funds and

 An investment company invests a pool

Services of Investment Companies

 Administration & record keeping

Net Asset Value

 Used as a basis for valuation of

Types of Investment Organizations

Closed-End Mutual Funds

Listing of Mutual Fund Quotations

 Aggressive Growth (or Max Capital Gain)

Beta Risk and Investment Style

Volatility and Investment Style

Average Excess Returns and Investment Style

 Unlike mutual funds, hedge funds are unregulated and

 The Investment Company Act of 1940 exempts

Exchange Traded Funds (ETFs)

ETF Sponsors and Products

First Look at Mutual Fund Performance

 Evidence shows that average mutual

Sources of Information on Mutual Funds

 Wiesenberger’s Investment Companies

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