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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
Chapter 8 Investment Co.
  • indirect investment
  • types
  • fees
  • objectives
  • regulation
  • ETFs
i indirect investment
I. Indirect investment
  • investment co.
    • pools investor funds
    • purchases & manages portfolio
    • direct investments
  • investors
    • own shares of portfolio
    • indirect investment
advantages
advantages
  • diversification & asset choice
    • small amount of capital
  • professional management
  • lower transactions costs
    • trading
    • information
disadvantages
disadvantages
  • lack of control over portfolio
    • choice of assets
    • tax consequences of trading
  • lack of voting rights
    • that come w/ common stock
ii types
II. Types

Open-end funds (mutual funds)

sell new shares, redeem existing shares

  • # shares changes over time
slide6

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
growth of mutual funds
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)
closed end funds
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
slide9
share price & NAV
    • price < NAV

-- trading at a discount

    • price > NAV

-- trading at a premium

  • many closed end fund shares trade a a discount
unit trusts
Unit Trusts
  • # shares fixed
  • typically invest in bonds
  • portfolio is fixed: no active trading
  • fixed termination date
iii mutual fund fees
III. Mutual fund fees
  • sale charges
  • operating expenses
sales charges
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

slide13
buy funds directly

-- no sales charge

-- no load funds

  • today many distribution channels
    • fund supermarkets
    • fund families
    • “distribution is king”
operating expenses
Operating Expenses
  • management fee
  • distribution fees
    • 12b-1 fees (SEC rule)
    • 1% max (100 basis pts.)
    • cover marketing costs
  • other
    • trading, records, auditing
all fees
All fees
  • NASD, SEC set some limits on fees
    • most funds charge much less
  • average
    • actively managed funds: 1.44%
    • index funds: .4%
impact of fees
impact of fees
  • $10,000, 10% annual return, 20 yrs.
  • if fees 1.5% annually,
    • $49,725
  • if fees .5% annually,
    • $60,858
iv fund objectives
IV. Fund Objectives
  • funds differ in
    • types of assets
    • investment goals
equity funds
Equity funds
  • income funds
    • stocks w/ high, stable dividends
  • growth funds
    • stock w/ high expected capital gains
  • growth/income funds
slide19
value funds
    • “bargain” stocks

-- low PE ratio

-- high book-to-value ratio

  • sector funds
    • stocks in specific industry
    • health care, biotech, financial, electronics
slide20
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
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
index fund returns slightly below index return
    • operating expenses
    • must hold some cash to redeem shares
why i like indexing
why I like indexing
  • 1990-99
    • S&P 500 index outperformed 76% of all actively managed stock funds
bond funds
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
money market
Money Market
  • share price = $1, check-writing
  • general taxable
  • U.S. Government
  • tax-exempt
stocks bonds
Stocks & Bonds
  • balanced funds
  • hybrid funds
  • asset allocation funds
    • 529 plans for college
fund families
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
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
v regulation
V. Regulation
  • SEC is main regulator
    • disclosure rules
    • fees
    • insider trading
    • “truth in advertising”

-- returns & risks

-- name and objective of fund

slide30
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
taxation trap
  • as share holders redeem shares
    • funds sells assets to raise cash
    • remaining share holders face tax liability
vi exchange traded funds etfs
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
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