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Indirect Investment. Introduction. In Direct Investment, investors have control over the buying and selling of securities. In Indirect Investment, investors handed-over their investment to third party; thus losing their direct control of the securities.
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Introduction • In Direct Investment, investors have control over the buying and selling of securities. • In Indirect Investment, investors handed-over their investment to third party; thus losing their direct control of the securities. • Mutual fund is one of the best alternative of indirect investment. • Difference between direct investment and indirect investment [Jones,....Figure 3.1, p. 51,]
Introduction • Direct Investment: Investor owns portfolio of financial assets and receive dividend or capital gains. • Indirect Investment: Investor owns share in an ‘investment company’ fund’ which invest in portfolio of financial assets and receive dividend and capital gains; out of these inflow, shareholders receive their shares.
Investment Company? • “A company engaged in investing in, and managing, a portfolio of securities”. • There are three types of investment companies. • Closed-End investment companies (Managed Firm) • Exchange-Traded Funds (ETFs) [Un-Managed Firm] • Mutual Funds (Managed Firm)
Managed Vs Unmanaged Firms • Managed Fund (Active Management or Active Investing) – the investment strategy where the managers try to earn beyond the investment benchmark index. • Un-managed Fund (Passive Investing): Investment strategies which do not entail any forcasting in order to minimize investing fees. The objective is not to outperform the benchmark index.
1. Closed-End Investment Companies • An investment company with a fixed capitalisation (the number of fund share outstanding) whose share trade on exchanges. • Investors buy and sell through brokerage houses. • The oldest form of investment company
2. Exchange-Traded Funds (ETFs) • Unmanaged funds • Passive strategy investment • Investment fund traded on the stock exchange like shares. • It posses the features of both closed and open-ended funds. Like closed-end, it is traded on the stock exchange; and like open-end, ETFs shares are created and extinguished in response to demand for them. • The newest form of the three major types.
3. Mutual Funds (Open-Ended Investment Companies) • Investment company selecting and managing a portfolio of securities. • An investment company whose capitalization constantly changes as new share are sold and outstanding shares are redeemed. • Unlike closed-end funds and ETFs, mutual funds do not trade on stock exchanges. • Investors buy mutual funds shares from investment companies and sell their share back to the companies. • Mutual Fund Association of Pakistan (http://www.mufap.com.pk/)
Types of Mutual Funds • There are four types of mutual funds • Money Market mutual funs • Equity (stock) funds • Bond Funds • Hybrid or Balanced Funds (Combination of Bond and Stock) On the basis of risk, it is categorised as:
Money Market Funds (MMFs) • Open-end investment companies whose portfolios consist of money market securities. • Interest is credited on daily basis. • Investors can earn interest alongwith securities diversification and great liquidity. • Not insured
1. Equity Fund • Fund where investments are in the form of equity (Shares). • Having two categories: • Value Fund (Income Fund): Shares having a constant flow of income; may be evaluated on the basis of standard fundamental analysis such as earnings, book value and dividend yield. Usually such investment in the form of large cap. companies • Growth Fund: The companies are expected to show rapid growth in earnings, even if current earnings are poor. Such investment is usually in small cap. firms.
2. Bond Funds • Investment in the form of bonds. • Usually fixed income securities... • There are many categories such as corporate bond, government bonds etc. • Having different maturities bonds...
3. Hybrid Fund • Investment in the form of both shares and bonds. • Also called balanced fund. • Having objective of preserving investment alongwith earning return. • A bit risky than equity investment
4. Index Fund • “Mutual Fund holding a bond or stock portfolio designed to match a particular market index.” • It is unmanaged portfolio investment. • First it was created by John Bogle 1976 in his undergraduate research; he was the CEO of Vanguard Company as well. • It was also known as Vanguard’ 500 Index Fund.
ETF Vs Index Fund • ETFs can be purchased and sold anytime during the trading day at the current price; while mutual funds (index fund) are priced once a day.
The Net Asset Value (NAVs) Per Share • NAV is the per share value of the securities in the fund’s portfolio. • Market value of a fund’ securities = the product of each security’s current market price multiplied by the number of shares of that security owned by the fund. • The NAV Of a fund is calculated each day. • NAV is the price an investor pays to buy a mutual fund on a given day or the price an investor receive when selling shares back to the investment company. • NAV = Market Value of a Fund’ Securities – Liabilities Number of Investor Shares Outstanding
NAV Calculation • A portfolio consists of 10 shares of OGDCL @ 100 each; 5 shares of PTCL @ 50 each; and 1 bond of PTC @ 20 each. The liabilites of the fund is Rs. 70 and number of shares held by the fund is 100. what is NAV • Market Value of the Portfolio = • 10 @ 100 = 1000 • 5 @ 50 = 250 • 1 @ 20 = 20 Sum = 1270 • NAV = 1270 – 70/ 100 = 12 At Rs. 12, a buyer and seller will be ready to purchase (sell) the fund.
The Mechanics of Investing Indirectly Closed-Ended Fund • The price of close-ended funds are determined on the basis of supply and demand of the fund not on its NAVs. • May be sold at discount if market price is less than NAV • May be sold at premium if the market price is more than NAV.
The Mechanics of Investing Indirectly Mutual Fund – mutual fund can be purchased in two ways • Directly, from a fund company.... • Indirectly, from a sales agent including securities firms, banks, life insurance etc. • May take the services of underwriter... • The owners of fund shares can sell them back to the fund company at time at the NAV minus any sales charges (purchase) and redemption fee (for sales) • Service charges may be in the form of fees and expense
Fees Vs. Expense • Mutual fund fees are paid directly by an investor; it includes • Sales charges (load) either front-end (at the time of purchase) or back-end (at the time of sales) • Redemption fee – fee at the time of redemption • Exchange fee – transfer of funds within same fund family • Annual account maintenance fees – may be charged on low balance accounts
Expense • These show the operating expenses and not directly charged to investors. • The expenses are charged form the fund’ income such as dividends, interest and capital gains. • These are indirect expenses; it includes: • Management fees • Distribution fees • Other expnses
Load Funds Vs. No-load Funds • Load Funds • Funds that charge investors a sales fee for costs of selling the fund to the investors is load funds. • NAV + front-end load = selling price of fund • No-Load Funds • No-load funds are purchased at the NAV directly from the fund itself.
Fund Supermarkets • A mechanism through which investors can buy, own, and sell the funds of various mutual fund families through one source (brokerage firm).
