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Chapter 3 Investment Funds. Learning objectives. Distinguish between direct and indirect investing. Define open-end and closed-end investment funds. State the major types of mutual funds and give their features. Define exchange-traded funds (ETFs).

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learning objectives
Learning objectives
  • Distinguish between direct and indirect investing.
  • Define open-end and closed-end investment funds.
  • State the major types of mutual funds and give their features.
  • Define exchange-traded funds (ETFs).

inguish between direct and indirect investing.

  • Define open-end and closed-end investment funds.
  • State the major types of mutual funds and give their features.
  • Define exchange-traded funds (ETFs).
indirect investing
Indirect Investing
  • Refers to buying and selling the shares of intermediaries that hold a portfolio of securities
    • Shares are ownership interest in the underlying portfolio
    • Shareholders are entitled to portfolio income
    • Shareholders also pay expensesefers to buying and selling the shares of intermediaries that hold a portfolio of securities
    • Shares are ownership interest in the underlying portfolio
    • Shareholders are entitled to portfolio income
    • Shareholders also pay expenses
investment fund
Investment Fund
  • Financial company or trust fund that sells shares to the public and uses the proceeds to invest in marketable securities
    • Acts as conduit for distribution of dividends, interest, and realized gains
    • Offers the benefits of diversification
    • Offers professional management

Offers professional management

fund types
Fund Types
  • Unit Investment Trust: an unmanaged, fixed-income security portfolio put together by a sponsor and handled by an independent trustee
    • Passive investments designed to be bought and held with capital preservation as a major objective
    • Currently represent a very small part of total investment company assetsUnit Investment Trust: an unmanaged, fixed-income security portfolio put together by a sponsor and handled by an independent trustee
    • Passive investments designed to be bought and held with capital preservation as a major objective
    • Currently represent a very small part of total investment company assets
slide6
Fund Types
  • Closed-end investment fund: No additional shares sold after initial public offering
    • Share prices determined and traded in a secondary market
    • Price may not equal Net Asset Value of the shares
      • Net Asset Value (NAV): Total market value of the security portfolio divided by total shares
fund types7
Fund Types
  • Open-end investment fund: Shares continue to be sold to the public at NAV after initial sale that capitalizes the company
    • Shares may be sold back (“redeemed”) to the company at NAV
    • Capitalization constantly changes
    • Popularly called mutual funds
types of mutual funds
Types of Mutual Funds
  • Money Market Funds
    • Objectives of income and liquidity
    • Short-term money market instruments
    • Low risk and high liquidity
  • (a) Mortgage Funds
    • Investment terms may be  5 years
    • Riskier than money market (more interest rate risk), but less risky than bond funds (shorter maturities)

(b) Bond Funds

    • Objectives of income and safety
    • Subject to capital gains/losses due to interest rate risk
types of mutual funds9
Types of Mutual Funds
  • (a) Balanced Funds
    • Objectives of safety, income and capital appreciation
    • Min./max. rules apply for percentage invested in each asset class.

(b) Asset Allocation Funds

    • Similar objectives as balanced funds, but typically not restricted by asset class percentage rules
  • Equity/Common Stock Funds
    • Objective of capital gains
    • Bulk of assets are in equity, but other assets held for liquidity, income and diversification purposes
    • May vary greatly in degree of risk and growth objectives
types of mutual funds10
Types of Mutual Funds
  • Growth Funds
    • Tend to invest in small-cap stocks, i.e. small companies with growth potential
    • Riskier than equity funds (small firms pay no dividends)
  • Specialty Funds
    • Objective of superior capital gains (through minimal diversification)
    • Tend to focus on one industry, market, or segment
    • International/Global Funds, for example, invest in foreign securities (and carry the risk of foreign exchange exposure)
types of mutual funds11
Types of Mutual Funds
  • (a) Real Estate Funds
    • Invest in income-generating properties for long-term growth and capital gains
    • Portfolio valuation is based on infrequent external appraisal
    • Less liquid than other funds – investors may need to give advance notice when selling

(b) Ethical Funds

    • Relatively new type of fund
    • Investments are guided by moral criteria (e.g., not investing in tobacco-related firms)
types of mutual funds12
Types of Mutual Funds
  • Index Funds
    • Objective is to mirror the performance of a market index (e.g., S&P/TSX 60)
    • Generally lower management fees than other funds.
  • Dividend Funds
    • Objective of tax reduction through favourable treatment of dividend
    • Inappropriate for RRSPs or RRIFs
    • Price changes are driven by interest rates and market trends
types of mutual funds13
Types of Mutual Funds
  • ranked from lowest risk/return to highest risk/return as follows:
  • Money market
  • Mortgage
  • Bond
  • Balanced
  • Dividend
  • Equity
  • Real estate
  • Specialty

http://finance.yahoo.com/funds

mutual fund categories
Mutual Fund Categories
  • Money market mutual funds invest in a portfolio of money market securities
    • Treasury bills
    • Commercial paper
    • Short-term government bonds
    • Low risk
    • Not insured by the federal government
mutual fund categories15
Mutual Fund Categories
  • Equity, bond, and income funds invest in portfolios of securities consistent with the objectives of the particular fund
    • Objectives set by the fund’s board
    • Disclosure of objectives to investors through a prospectus
equity funds
Equity Funds
  • Most mutual fund assets are in equity funds rather than bond or income funds
  • Most equity funds are either:
    • Value funds, which invest in undervalued stocks as determined by fundamental financial analysis
    • Growth funds, which invest in stocks of firms expected to show future rapid earnings growth
equity funds17
Equity Funds
  • Closed-End Funds
    • NAV > market price, selling at a discount
    • NAV < market price, selling at a premium
    • If the value of the portfolio remains unchanged, an investor can gain or lose if the discount narrows or widens over time
    • Trade at premiums and discounts across time, and variance is great
exchange traded funds etfs
Exchange-Traded Funds (ETFs)
  • Units of these trusts hold shares of firms in market indices in proportion to their weights in the index
  • Differences from traditional mutual funds: http://finance.yahoo.com/etf
    • Traded throughout the day on exchanges
    • Lower management fees (e.g., 0.08% to 0.25% versus 2.5% average for active equity funds versus 0.75% average for Index funds)
    • Lower portfolio turnover – reduces capital gains income and taxes payable
    • Permit short-selling
    • May be purchased on margin
canadian based etfs
Canadian-Based ETFs
  • I-60s
    • Represent units in the S&P/TSX 60 Index
    • Trade on the TSX (ticker: XIU).; units are valued at 1/10th the value of the S&P/TSX 60 Index; for example, if index is valued at 450, each unit is valued at $45
    • Dividends are paid every quarter; MER is 0.17%
  • DJ40s
    • Represent units in the Dow Jones Canada Index Participation Fund, which hold stocks that mimic those of the Dow 40 Index; MER is 0.08%
canadian based etfs20
Canadian-Based ETFs
  • TD S&P/TSX Index Fund
    • The S&P/TSX Composite Index is the underlying index; MER is 0.25%
    • There are now a growing number of small-cap, mid-cap, industry-based, style-based, and bond ETFs available
  • There are now a growing number of small-cap, mid-cap, industry-based, style-based, and bond ETFs available
differences between etfs and mutual funds
Differences between ETFs and Mutual Funds
  • ETFs
    • Trade all day on exchanges, can be bought on margin, and can be shorted
    • Currently passive in nature
    • Can be traded at discount or premiums.
    • Offer an important advantage over funds with regard to flexibility on taxes
  • Mutual Funds
    • Bought and sold at the end of the trading day when the NAV is calculated
    • Most are actively managed
    • Trade at NAV
    • Mutual fund mangers may have to sell shares to pay those who want to leave the fund, thereby generating capital gains
other funds
Other Funds
  • Segregated funds
    • Provide death benefits
    • Must guarantee a minimum percentage (75% is required, 100% is usually offered) of investor’s payments will be returned at fund maturity (or at death of owner)
    • Structured to prevent fund assets from being seized by creditors if investor declares bankruptcy
    • Upon owner’s death, assets may be transferred to beneficiaries without being subject to probate fees
other funds23
Other Funds
  • Labour Sponsored Venture Capital Corporations (LSVCCs)
    • No 10% maximum ownership restriction
    • Restrictions on transferability and redemption
    • Valuation may not be based exclusively on market prices
    • Tax advantages – federal & provincial tax credits offered
performance
Performance
  • Reported on a regular basis (usually daily) in the popular press
  • Measured over a given time period as a percentage of initial investment
    • Total returns include reinvested dividends and capital gains
    • Average annual return reflects the mean compound growth rate of investment over a given time period
performance25
Performance
  • Investors relate the performance to some benchmark to judge relative performance
  • An important issue is expenses: funds with low MERs provide better returns in the long run
  • Mutual fund ratings: best known rating system is provided by Morningstar
international funds
International Funds
  • Some mutual funds specialize in international securities
    • Canadian investors can participate in emerging market economies
    • International diversification
    • International funds or global funds emphasize international stocks
    • Single-country funds concentrate assets
      • Actively or passively managed
new directions in funds
New Directions in Funds
  • Mutual fund “supermarkets”
    • Various mutual fund families can be purchased through a single source
    • Brokerage account may provide access
    • “Supermarket” managers earn fee
  • On-line investment services
    • Internet used to provide mutual fund information and to make transactions
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