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Chapter 8 Investment Co. indirect investment types fees objectives regulation ETFs. I. Indirect investment. investment co. pools investor funds purchases & manages portfolio direct investments investors own shares of portfolio indirect investment. advantages.

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Chapter 8 investment co l.jpg
Chapter 8 Investment Co.

  • indirect investment

  • types

  • fees

  • objectives

  • regulation

  • ETFs


I indirect investment l.jpg
I. Indirect investment

  • investment co.

    • pools investor funds

    • purchases & manages portfolio

    • direct investments

  • investors

    • own shares of portfolio

    • indirect investment


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advantages

  • diversification & asset choice

    • small amount of capital

  • professional management

  • lower transactions costs

    • trading

    • information


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disadvantages

  • lack of control over portfolio

    • choice of assets

    • tax consequences of trading

  • lack of voting rights

    • that come w/ common stock


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II. Types

Open-end funds (mutual funds)

sell new shares, redeem existing shares

  • # shares changes over time


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portfolio value - liabilities

NAV =

  • share price based on NAV

# shares outstanding

  • NAV computed at close of day

  • NAV changes with price of assets in portfolio


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growth of mutual funds

  • less than 600 1980

  • over 8000 today ($6.2 trillion)

    • assets concentrated with largest funds

  • why?

    • growth of 401(k)s, IRAs

    • demographics (baby boomers)


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Closed-end funds

  • < 500 funds ($130 billion)

  • fixed # shares initially issued

    • no later sales or redemptions

    • # of shares is fixed

  • shares bought and sold in secondary market

    • price depends on supply & demand


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  • share price & NAV

    • price < NAV

      -- trading at a discount

    • price > NAV

      -- trading at a premium

  • many closed end fund shares trade a a discount


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Unit Trusts

  • # shares fixed

  • typically invest in bonds

  • portfolio is fixed: no active trading

  • fixed termination date


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III. Mutual fund fees

  • sale charges

  • operating expenses


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Sales charges

  • funds originally sold 2 ways:

    • sales force, w/ commission

      -- front-end load (8.5% max)

      -- pay when purchase shares

      -- back-end load (8.5% max)

      -- pay when redeem shares

      -- level loads (.75% max)

      -- annual fee


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  • today many distribution channels

    • fund supermarkets

    • fund families

    • “distribution is king”


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    Operating Expenses

    • management fee

    • distribution fees

      • 12b-1 fees (SEC rule)

      • 1% max (100 basis pts.)

      • cover marketing costs

    • other

      • trading, records, auditing


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    All fees

    • NASD, SEC set some limits on fees

      • most funds charge much less

    • average

      • actively managed funds: 1.44%

      • index funds: .4%


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    impact of fees

    • $10,000, 10% annual return, 20 yrs.

    • if fees 1.5% annually,

      • $49,725

    • if fees .5% annually,

      • $60,858


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    IV. Fund Objectives

    • funds differ in

      • types of assets

      • investment goals


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    Equity funds

    • income funds

      • stocks w/ high, stable dividends

    • growth funds

      • stock w/ high expected capital gains

    • growth/income funds


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    • value funds

      • “bargain” stocks

        -- low PE ratio

        -- high book-to-value ratio

    • sector funds

      • stocks in specific industry

      • health care, biotech, financial, electronics


    Slide20 l.jpg

    • market capitalization

      • small/mid/large cap funds

      • stocks based on size of company

        -- value of total shares outstanding

    • international/global

      • international stock portfolio or

      • stock in particular region


    Slide21 l.jpg

    • index funds

      • match performance of stock index

        -- S&P 500, Wilshire 5000

      • hold portfolio the matches index

      • passive strategy

        -- match, not beat, the market’s average return

      • lower expenses


    Slide22 l.jpg


    Why i like indexing l.jpg
    why I like indexing

    • 1990-99

      • S&P 500 index outperformed 76% of all actively managed stock funds


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    Bond funds

    • U.S. Government

    • Investment grade corporate

      • bond ratings BBB or above

    • High yield corporate

      • junk bonds (rated below BBB)

    • Municipal bonds

      • tax exempt interest


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    Money Market

    • share price = $1, check-writing

    • general taxable

    • U.S. Government

    • tax-exempt


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    Stocks & Bonds

    • balanced funds

    • hybrid funds

    • asset allocation funds

      • 529 plans for college


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    Fund Families

    • one investment company

    • many different funds

    • Fidelity, Vanguard, Strong, Janus

    • 400 families

      • top ten hold over 40% of assets


    Look at some top funds l.jpg
    look at some top funds

    • http://quicktake.morningstar.com/Fund/Snapshot.asp?Country=USA&Symbol=FGRIX

    • http://quicktake.morningstar.com/Fund/Snapshot.asp?Country=USA&Symbol=VWLTX

    • http://quicktake.morningstar.com/Fund/Snapshot.asp?Country=USA&Symbol=VFINX

    • http://quicktake.morningstar.com/Fund/Snapshot.asp?Country=USA&Symbol=FSPHX


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    V. Regulation

    • SEC is main regulator

      • disclosure rules

      • fees

      • insider trading

      • “truth in advertising”

        -- returns & risks

        -- name and objective of fund


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    • NASD is industry self-regulator

      • sales practices

      • commissions, fees

    • taxation

      • investment co. distributes 90% of income annually

      • fund shareholders taxed on gains

        -- even if gains are reinvested

        -- dividends no longer taxable


    Taxation trap l.jpg
    taxation trap

    • as share holders redeem shares

      • funds sells assets to raise cash

      • remaining share holders face tax liability


    Vi exchange traded funds etfs l.jpg
    VI. Exchange-traded funds (ETFs)

    • like index funds & closed-end fund

    • shares traded on exchange

    • trade continually, not just at closing NAV

    • swap large blocks of stock for ETF shares

      • price is always close to NAV


    Etf tax advantage l.jpg
    ETF tax advantage

    • mutual funds

      • other investors sell shares,

        -- trigger tax liability for remaining share holders

    • ETFs

      • tax liability only for seller

      • swap shares for underlying portfolio


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