Unit 4: Types of Mutual Funds

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1 Unit 4: Types of Mutual Funds Welcome to Types of Mutual Funds. This unit gives you an overview of the types of mutual funds available. Before providing your client with an investment solution, you need to know what products are available, and what products are most appropriate. This unit takes approximately 1 hour and 30 minutes to complete. You will learn about the following topics: Three Categories of Funds Income Funds Growth Funds Combination Growth and Income Funds Comparing the Funds Series of Mutual Fund Units To start with the first lesson, click Three Categories of Funds on the table of contents. Lesson 1: Three Categories of Funds Welcome to Three Categories of Mutual Funds lesson. In this lesson, you will review the three main categories of mutual funds, and the objectives of each one. Before providing your client with an investment solution, you need to know what products are available, and how they work. This lesson takes 15 minutes to complete. At the end of this lesson, you will be able to do the following: list the three categories of mutual funds describe the investment objectives of each category of fund Three Categories of Funds You can group mutual funds according to investment objectives and investment type. There are two main categories of mutual funds: income and growth. A third category combines income and growth. All three have specific objectives: Type of Fund Objective Income Growth Combined Income and Growth Provide a regular stream of income Provide long-term growth Provide a combination of income and long-term growth Income Funds Income funds are mutual funds that provide a regular stream of income to the investor. Most funds in this category invest in fixed income investments such as mortgages and bonds. However, dividend funds differ from other income funds since they hold primarily preferred shares, but can also hold common shares and income trust units. Income funds are considered the safest type of mutual fund, but they come with their own degree of risk, which is dependent on the kinds of investments that they hold IFSE Institute 1

2 The following funds are classified as income funds: money market funds mortgage funds bond funds dividend funds Growth Funds Growth funds provide long-term growth. These funds tend to be the riskiest category of fund since investments within the fund consist of stocks or other equity-based investments, such as real estate. Growth funds consist of the following funds: equity funds international and global funds specialty funds real estate funds index funds commodity pools Combined Income and Growth Funds Funds that provide a combination of income and growth hold a mix of fixed income and equity investments. These funds are considered moderately risky since they provide the investor with a level of stability along with the potential for capital growth. The following funds would fit into this category: balanced funds asset allocation funds Exercise: Three Categories of Funds Lesson 2: Income Funds Welcome to the Income Funds lesson. In this lesson, you will learn about the different types of income funds available to investors. You will learn which instruments these funds hold, how they work, and for whom they are suitable. This lesson takes 15 minutes to complete. At the end of this lesson, you will be able to do the following: describe how a money market fund works describe how a mortgage fund works describe how a bond fund works describe how a dividend fund works Money Market Funds Money market funds hold money market investments (cash and cash-type investments) that are short-term (less than one year). A money market fund portfolio contains the following investments: IFSE Institute

3 treasury bills (T-bills) bankers' acceptances commercial paper provincial and municipal short-term paper Money market funds have terms to maturity of less than one year. By law they must have a weighted term to maturity of 90 days or less so any monies invested are returned quickly. Although the investments within the fund fluctuate with general interest rate levels, the funds are managed in such a way that the fund price remains constant (although it may fluctuate under rare circumstances), typically $1 or $10. In practice the investor does not experience any loss of invested capital. Money market funds pay interest on a monthly basis. You can reinvest the interest automatically or receive it as income. Returns move in the same direction as general interest rates and are usually better than on a traditional bank account. Money market funds invest in low-risk securities and therefore have the lowest risk and pay lower returns. The goal of money market funds is to provide income for the investor with a low risk to capital. These funds are suitable for investors who want to protect their investments, but also want some return. They are not typically a good investment for long-term goals, but they can be a smart choice for short-term goals, such as a 'saving for a rainy day' fund or parking money while deciding on longterm investments. Mortgage Funds Mortgage funds contain mortgages, which are fixed income investments. Like other fixed income investments, mortgage fund prices rise when interest rates fall, and mortgage fund prices fall when interest rates rise. Returns increase in times of falling interest rates and decrease in times of rising interest rates. Most people are familiar with mortgages as borrowers, but when mortgage fund managers purchase mortgages they are acting as lenders. Most mortgage funds hold NHA insured mortgages. By investing in these mortgages, mutual funds are less exposed to the risk of defaulting borrowers, which can lessen the return on a fund. Cash flow to the mortgage funds comes from both the repayment of mortgage principal and interest payments. The mortgage fund, in turn, distributes only the interest to unitholders on a monthly basis. There may also be capital gains distributions from the funds to unitholders at the end of the year. As with other types of mutual funds, mortgage funds do not pass on any capital losses to the investor. A monthly return of capital and interest stabilizes the price of mortgage fund units. This is achieved by having more capital available to invest in new mortgages at current interest rates IFSE Institute 3

4 For example, every month when a borrower makes a mortgage payment, part of the payment goes towards the principal, and part of it goes towards interest. The interest portion is first sent to the lender, and then the lender flows it to the investor (mutual fund unitholder). This is how a mortgage fund supplies a steady stream of interest income. The principal portion is retained in the fund and used to purchase new mortgages. Mortgage funds are a low-risk investment, although certainly not as low-risk as money market funds. Mortgage funds are less volatile than bond funds because mortgages typically have terms of less than five years. Investors should be aware of the risk of early repayment of principal, which can result in a potential loss of interest payments at higher interest rates. However, this risk is partially offset by the requirement of the borrower to pay a penalty for any unscheduled prepayments. Mortgage funds are suitable for clients who want to protect their capital, require a steady stream of income, and do not have an immediate need for the invested funds. Younger people, who are already earning an adequate income, do not necessarily need income from their investments to support themselves. But income funds (money market, bond, and mortgage) can help them diversify their portfolios. Exercise: Money Market and Mortgage Funds Bond Funds Bond funds invest in bonds. Some bond funds invest exclusively in one type of bond for instance, government bonds while others may hold a combination of bond types. The main objective of bond funds is to produce income in the form of interest, which is usually paid to unitholders on a monthly basis. However, capital gains may also be derived from the trading of bonds in the portfolio. Bond funds can also experience capital losses when bond prices drop. These losses are not distributed but held in the fund to offset capital gains. Since bond funds hold a portfolio of bonds, portfolio managers can minimize some of the risks associated with bonds, such as interest rates and issuers, with diversification. Portfolio managers can adjust the bond maturities to take advantage of different stages in the economic cycle. Longer maturities can be used when interest rates are low or falling and shorter maturities can be used for periods of high or rising rates. If permitted by the investment objectives, portfolio managers can also diversify their portfolio by type of bond issuer. For instance, they may hold bonds from the federal and provincial governments as well as corporate bonds. Bond funds are considered low to moderate risk investments. They tend to be more volatile than mortgage funds because they hold securities with longer maturities, which are often 20 years or more. The longer the maturity of a bond, the more it will be affected by interest rate changes. Longer-term bonds rise in value more when interest rates fall, and drop in value more when interest rates rise IFSE Institute

5 Bond funds that invest in corporations or foreign governments may be riskier than ones that invest in domestic bonds since there may be a higher possibility of default. Bond funds are suitable for investors who want to protect their capital, but also require a stream of income for living. Dividend Funds Dividend funds provide investors with periodic income from dividend-paying investments, as well as the potential to earn capital gains through growth. The majority of the investments are preferred shares of Canadian corporations, and to a lesser extent, the common shares of dividend-paying corporations. These corporations are large, established companies with a history of steady dividend payment on their common shares. These companies are usually referred to as blue chip. These investments enable dividend funds to generate tax-preferred income. Investors in these funds benefit from the dividend tax credit. This credit reduces the amount of tax payable by investors who receive dividends distributed by Canadian corporations. Returns from dividend funds consist of a combination of income and capital appreciation (or depreciation) of shares. Therefore, returns are dependent on both the direction of interest rates which have an inverse relationship to prices of preferred shares and the general direction of stock markets. Although corporations do not have to pay dividends, blue chip corporations generally do issue dividends in order to ensure market and investor confidence. Therefore, dividend funds are less risky than equity funds that often hold equity investments that rarely or never pay dividends. Dividend funds are a moderate risk investment. They are riskier than bond and mortgage funds, because the market value of the preferred and common shares fluctuates as market conditions change. Dividend funds are suitable for investors with a moderate risk profile who would like a steady stream of tax-preferred income, but would also like the opportunity to earn some capital gains through growth of the investments. Investors should be able to tolerate some decline in the value of their investments. Exercise: Income Funds 2010 IFSE Institute 5

6 Lesson 3: Growth Funds Welcome to the Growth Funds lesson. In this lesson, you will learn about the different types of growth funds available to investors. You will learn the financial instruments these funds hold, how they work and for whom they are suitable. This lesson takes 20 minutes to complete. At the end of this lesson, you will be able to do the following: describe how an equity fund works describe how an international and global fund works describe how a specialty fund works describe how a real estate fund works describe how an index fund works describe how a commodity pool works Equity Funds Equity funds invest primarily in the common shares of corporations. There are many types of equity funds, ranging from funds that invest in a variety of shares to funds that invest in shares of a specific economic sector or shares in foreign companies. Some may specialize in more secure, bluechip stocks while others invest in smaller growth companies. Canadian equity funds invest primarily in the shares of Canadian companies. Returns from these funds consist mainly of capital gains through share appreciation. Investors may also receive minimal dividends. Some equity funds concentrate on smaller companies and are known as small capitalization or small-cap funds. Others may concentrate on medium or large companies. Large, well-established companies are often referred to as "blue-chip". U.S. equity funds invest primarily in shares of U.S. companies. As with Canadian equity funds, U.S. equity funds can hold a diversified portfolio of stocks or specialize in a particular sector, geographic area, or market capitalization. Returns from equity funds vary according to a number of factors: the industries in which the fund invests the aggressiveness of investing the proportion of domestic and foreign equities held the skills of the fund managers in selecting stock market investments Generally, equity funds are higher-risk investments. Volatility is high because of the extreme variability of stock prices in general. The tradeoff, however, is the potential of far greater returns. Funds that invest in larger companies are considered lower risk than small-cap funds. Those stocks, especially blue-chip stocks, are larger, more established, and have a longer performance record and history of paying dividends. Their stock price tends to be less volatile, reflecting the market s greater confidence. Equity funds tend to invest in stocks in different industry sectors. This diversification moderates the volatility of the funds in comparison to more specialized funds IFSE Institute

7 Equity funds are suitable for the moderate to high-risk investor who is seeking capital growth over the longer term. The investor would have to be prepared to see his or her investment decline in value in the short term. Equity funds invest primarily in the common shares of corporations. There are many types of equity funds, ranging from funds that invest in a variety of shares to funds that invest in shares of a specific economic sector or shares in foreign companies. Some may specialize in more secure, bluechip stocks while others invest in smaller growth companies. Canadian equity funds invest primarily in the shares of Canadian companies. Returns from these funds consist mainly of capital gains through share appreciation. Investors may also receive minimal dividends. Some equity funds concentrate on smaller companies and are known as small capitalization or small-cap funds. Others may concentrate on medium or large companies. Large, well-established companies are often referred to as "blue-chip". U.S. equity funds invest primarily in shares of U.S. companies. As with Canadian equity funds, U.S. equity funds can hold a diversified portfolio of stocks or specialize in a particular sector, geographic area, or market capitalization. Returns from equity funds vary according to a number of factors: the industries in which the fund invests the aggressiveness of investing the proportion of domestic and foreign equities held the skills of the fund managers in selecting stock market investments Generally, equity funds are higher-risk investments. Volatility is high because of the extreme variability of stock prices in general. The tradeoff, however, is the potential of far greater returns. Funds that invest in larger companies are considered lower risk than small-cap funds. Those stocks, especially blue-chip stocks, are larger, more established, and have a longer performance record and history of paying dividends. Their stock price tends to be less volatile, reflecting the market s greater confidence. Equity funds tend to invest in stocks in different industry sectors. This diversification moderates the volatility of the funds in comparison to more specialized funds. Equity funds are suitable for the moderate to high-risk investor who is seeking capital growth over the longer term. The investor would have to be prepared to see his or her investment decline in value in the short term. International and Global Funds International funds invest almost exclusively in securities outside of Canada and North America, while Global Equity funds may invest in the Americas but must also invest in Asia and Europe IFSE Institute 7

8 These funds may specialize in one type of security, such as stocks, or invest in a variety of securities, such as stocks and bonds. These funds are moderate to high risk. The returns and risks of these funds are dependent on the following factors: location of the investment type of security changes in currency exchange rates type of investment approach taken: conservative or aggressive International and global funds are suitable for investors who have a moderate to high-risk profile, and investors who are looking for international diversification. Specialty Funds Specialty funds invest in the common shares of companies in a particular industrial or economic sector, or a defined geographic area. They are a subset of equity funds but are narrowly focused. Some specialty funds concentrate their investments in a particular sector, like natural resources, science and technology, or health care. Others may invest in securities that correspond to one country, like Japanese equity, or a group of countries, like the Far East or Europe. Specialty funds may invest in stocks, bonds, or other securities. Gold funds, for example, may invest in shares of mining companies in North America and abroad, as well as in gold bullion. Specialty funds are usually high-risk investments. Many of these funds strive to earn high rates of return through capital gains. As a result, returns can be highly volatile. These funds offer the potential for large gains and large losses, and performance can vary widely from year to year. Specialty funds are suitable for investors who have a high-risk profile, and who are looking for longterm growth. Exercise: Equity, International, and Specialty Funds Real Estate Funds Real estate funds invest in real estate, usually in commercial and industrial properties. Some invest in the shares of real estate management companies or development companies. Investor returns are in the form of rental and other income generated by properties in the fund's portfolio, plus capital gains if the properties are sold at a profit IFSE Institute

9 In addition, real property holdings (any type of building) are depreciable for tax purposes. Consequently, they generate tax deductions for investors. These deductions, known as capital cost allowances, are deductible against rental income that is distributed to holders of units in real estate funds. When properties are sold, the fund and ultimately the investors may experience a recapture of capital cost allowance. In this situation, the recaptured amount is distributed amongst unitholders and included as income for tax purposes. This applies only to real estate funds that pass on the capital cost allowance to their investors; otherwise redemption proceeds are treated in the same manner as those for other types of funds. The rate and the conditions of these charges are clearly defined in the fund's prospectus. Real estate funds are valued on a different basis than most funds. Most mutual funds are valued daily to reflect constant changes in the prices of investments that are frequently bought and sold and for which there are defined prices. However, the valuation of real estate funds is based on appraisals of the properties in the fund's portfolio. These appraisals are used to calculate the fund's net asset value, which in turn is used to determine the price of fund units. As a result, unit prices are usually set monthly or quarterly. Because unit prices of real estate funds are set less frequently than other mutual funds, real estate fund units are less liquid. Investors may be able to redeem fund units only at specified times, and may have to give prior notice. It may also take considerable time to receive the proceeds of a redemption request. If the fund does not have enough cash on hand, redemption requests may be only partially filled. Real estate funds are high-risk investments because the fund is concentrated in one industry, the real estate industry. Investors also have less liquidity since the portfolio may hold real properties. Real estate funds are suitable for investors who have a high-risk profile, who are looking for tax advantages, and who have a longer time horizon. Index Funds An index fund matches its portfolio to that of a specific financial market index, such as the Standard & Poor's 500 Index (S&P 500). The value of fund units then fluctuates in tandem with those indexes. Although most popular index funds are growth oriented, they also can be income oriented or oriented towards a combination of income and growth. Index funds are considered passive funds because they do not require any analysis or specific expertise from the portfolio manager. To construct an index fund, the manager purchases all of the stocks in the particular index in exactly the same proportion in which those stocks are represented in the index. Therefore, the return of an index fund should mirror that of the underlying index. For example, if the total returns for the S&P 500 rise by 10% in one year, unit values of a fund based on this index should rise by the same percentage (less management fees). Some of the stocks in the index pay dividends that are passed on to the investor, but the primary income expectation of an index fund is capital gains through investment appreciation IFSE Institute 9

10 Index funds are of moderate to high risk. Because index funds move directly with the market index, there can be some pronounced movements in the fund value. These funds have more risk than dividend funds because there is not a focus on large, stable, dividend-paying companies. Index funds are suitable for the investor with a moderate to high-risk profile who is not expecting a steady stream of income. The investor should have a relatively long time horizon since market indexes can vary in the short term, although over the long term indexes generally trend upwards. Commodity Pools Commodity pools are mutual funds that are permitted to use or invest in specified derivatives and physical commodities beyond what is permitted by National Instrument These funds are governed by National Instrument In addition, commodity pools must be issued under a long form prospectus rather than the simplified prospectus permitted by National Instrument , and they must issue financial statements on a quarterly basis, rather than semi-annually. Commodity pools are similar to other mutual funds except they are able to employ alternative trading strategies for their portfolios. Commodity pool managers attempt to increase their rate of return by investing in: specified derivatives physical commodities Some of the investments that may be found in a commodity pool are commodity futures and forward contracts for grains, meats, metals, energy products, and coffee. In addition, a commodity pool may invest more than 10% of its net assets with any one counterparty in one or more specified derivatives transactions. However, it is still subject to the 10% rule in relation to any securities of any issuers, for example, common shares of a counterparty or issuer. Commodity pools can be highly speculative and hence, they are high risk investments. The very nature of derivative and commodity trading can lead to substantial losses. As a result, returns can be extremely volatile. You should review the risk factors outlined in the prospectus before recommending these products to a client. These investments are suitable only for sophisticated investors willing to accept the high risk associated with commodity pools. Please be aware that your mutual fund registration does not entitle you to sell these products. Contact your compliance department for information on the necessary licensing requirements. Exercise: Growth Funds IFSE Institute

11 Lesson 4: Combination Growth and Income Funds Welcome to the Combination Growth and Income Funds lesson. In this lesson, you will learn about the different types of combination growth and income funds available to investors. You will learn the financial instruments these funds hold, how they work, and for whom they are suitable. This lesson takes 15 minutes to complete. At the end of this lesson, you will be able to do the following: describe how a balanced fund works describe how an asset allocation fund works describe how a target fund (or life cycle fund) works Balanced Funds Balanced funds invest in a combination of cash, bonds, and stocks. Bonds provide income and offer a measure of stability, while common shares provide growth and some dividend income. The fund manager adjusts the mix of bonds and common shares in a balanced fund's portfolio to reflect the changing conditions of financial markets. Most balanced funds are required to hold minimum percentages of each type of investment, according to objectives set out in the fund's prospectus. Usually, there is a range specifying the minimum and maximum limits for each asset category. For example, a fund may be required to hold no less than 30% of its portfolio in either stocks or bonds at any given time. Returns may be made up of interest, dividends, and capital gains. Balanced funds are moderate risk investments. Returns from balanced funds are generally higher than those for bond funds but lower than those for equity funds. Balanced funds are suitable for investors who match the moderate risk profile, and for investors who want to earn income and realize capital gains. Asset Allocation Funds Unlike other balanced funds, asset allocation funds generally have no restrictions on the asset mix of the portfolio. Therefore, an asset allocation fund could have all of its assets in one type of investment at a particular time or have a mixture of investments. Like balanced funds, managers of asset allocation funds vary the asset mix of the portfolio in response to changing market conditions. However, asset allocation portfolio managers have more freedom to adjust their portfolios. For example, if there is an anticipation that interest rates will decrease in the near future, a manager may decide to invest in equities to take advantage of this trend. A balanced fund manager may only invest in equities up to a maximum, such as 60% of the portfolio. However, an asset allocation 2010 IFSE Institute 11

12 manager does not have this restriction and if desired, he or she can invest more than 60% of the fund's portfolio in equities. The risk to investors in asset allocation funds varies greatly, depending on the fund's mandate and objectives. Most asset allocation funds would be moderate to high-risk. Asset allocation funds are suitable for investors who match the moderate to high-risk profile, and investors who want to earn income and realize capital gains. Target Date Funds Target date funds (also known as life-cycle funds) are a kind of asset allocation fund that focuses on a specific future date, like retirement, and changes the asset mix throughout the life of the fund. As time goes on and the investor approaches retirement, the fund manager adjusts the asset allocation away from equities and towards fixed income, thereby reducing risk exposure. Diane is attracted to the Krueger Target Date Fund Funds in this category 'mature' - tend to become more conservative in their asset allocation. Since the year 2020 is still many years away, the fund will have a relatively aggressive investment strategy. The portfolio will tend to have a relatively higher weighting in stocks and a smaller weighting in bonds. As we get closer to the maturity date, the fund's investment strategy will become progressively more conservative. The stock component will be progressively reduced and the bond component progressively increased. At maturity, most of the portfolio will be invested in bonds and/or money market funds. The exposure to risk of a target date fund changes throughout the life of the fund. However, because the fund will likely be invested heavily in equities in the early years, investors should have a moderate to high risk tolerance, depending on the fund itself. Indeed, two fund companies may offer a target fund with the same maturity date, e.g., 2020, but have very different allocations between equities and fixed income. Target date funds may be appropriate for those investors who are unable or unwilling to make their own asset allocation decisions and are attracted to the simplicity of investing in a diversified portfolio that is rebalanced for them over their life cycle. Exercise: Balanced and Asset Allocation Funds IFSE Institute

13 Lesson 5: Comparing the Funds Welcome to the Comparing the Funds lesson. In this lesson, you will learn about the relationship between volatility, risk, and return. Before providing your client with an investment solution, you need to know how this relationship works so you can match investments to risk comfort levels and return expectations. This lesson takes 10 minutes to complete. At the end of this lesson, you will be able to do the following: define and describe risk and volatility as they relate to returns define and describe risk and volatility as they relate to each other Fund Categories So far, you have learned about the different types of income, growth, and combined income and growth funds. Mutual fund companies offer a wide variety of mutual funds that fall into one of these categories. To avoid confusion and allow investors to know exactly in what type of mutual fund they are investing, the Canadian Investment Funds Standards Committee (CIFSC) has created a set of requirements to standardize the mutual funds sold in Canada. The following table summarizes these categories. Fund Category Canadian Money Market U.S. Money Market Canadian Short-term Fixed Income Canadian Fixed Income Canadian Long-term Fixed Income Canadian Inflation Protection Fixed Income Global Fixed Income High Yield Fixed Income Canadian Equity Balanced Canadian Neutral Balanced Canadian Fixed Income Balanced Global Equity Balanced Global Neutral Balanced Global Fixed Income Balanced Tactical Balanced 2010 Target Date Portfolio 2015 Target Date Portfolio 2020 Target Date Portfolio Target Date Portfolio Canadian Dividend & Income Equity Canadian Equity Canadian Small/Mid Cap Equity Canadian Focused Equity Canadian Focused Small/Mid Cap Equity Canadian Income Trust Equity U.S. Equity U.S. Small/Mid Cap Equity 2010 IFSE Institute 13

14 Fund Category North American Equity Asia Pacific Equity Asia Pacific ex-japan Equity Greater China Equity Japanese Equity European Equity Emerging Markets Equity Global Equity Global Small/Mid Cap Equity International Equity Health Care Equity Financial Services Equity Precious Metals Equity Natural Resources Equity Science & Technology Equity Real Estate Equity Retail Venture Capital Miscellaneous Alternative Strategies For more information, click here to visit the CIFSC Web site. Volatility, Risk, and Return To understand how mutual funds are categorized and how individual funds fit within those categories, it is important to understand how the concepts of risk and volatility apply to mutual funds. To investors, risk is the chance that they are going to lose some or all of their investment. Volatility is the degree to which the price of an investment fluctuates, or increases and decreases over a period of time. Volatility indicates the amount of risk. The higher the volatility, the higher the risk, and the lower the volatility, the lower the risk. For example, if a fund drops 50% in value, it would have to increase by 100% before it returns to its starting point. These are some of the factors that cause investment prices to fluctuate: changes in interest rates political upheaval shifts in market expectations changes in the credit rating of borrowers time horizon Return is the amount of money you earn on investments IFSE Institute

15 Asset Allocation In the context of this course, asset allocation refers to the mix between growth and fixed income funds within a portfolio. Research has found that in a given year, up to 90% of a portfolio s return depends on its asset allocation. Asset allocation will also affect risk and volatility. If a greater percentage of a portfolio is fixed income funds or income balanced funds, then the portfolio will likely have less risk and volatility. Conversely, if a portfolio is concentrated in equity funds, specialty funds, or even growth balanced funds, then the portfolio will exhibit more volatility and more short-term risk. Hans has a portfolio of five mutual funds consisting of a Canadian Equity Fund, a U.S. Index Fund, a Global Bond Fund, a Canadian Bond Fund, and a Canadian Money Market Fund in equal proportions. Hans allocation is approximately 40% growth funds and 60% income funds. Piyotr has a portfolio of five mutual funds equally split among a U.S. Equity Fund, an Emerging Markets Fund, a Canadian Index Fund, a Global Equity Fund, and a Canadian Bond Fund. Piyotr s asset allocation is approximately 80% growth funds and 20% income funds. Piyotr s portfolio will likely have more volatility and risk in the short term based on his asset allocation. Know your client The suitable allocation between growth and income funds within your client s portfolio is directly related to his or her investment objectives, time horizon, risk tolerance, and any other material information discovered during the KYC process. Table: How the Funds Compare So far, you have reviewed the most common types of mutual funds, the types of products they hold, their characteristics, and their level of risk. This job aid provides a comparison of the most common funds. It will help you as you continue this lesson, as well as on the job. Rate by Risk The following is a generalization of the types of funds and their associated risks. The risk level of a particular fund will be dependent upon the fund manager and the assets within the fund itself. Exercise: Influencing Factors 2010 IFSE Institute 15

16 Lesson 6: Series of Mutual Fund Units Welcome to Series of Mutual Fund Units. In this lesson you will learn about the different types of mutual fund units. This lesson takes approximately 15 minutes to complete. At the end of this lesson, you will be able to: explain which series is suitable for which type of investor. Multiple Series So far, we have talked about mutual fund units as if they were a homogeneous quantity. In practice, many mutual funds issue units in multiple series. Each series is aimed at a particular type of investor and has particular characteristics. The more common series are: Series A Series F Series I Series T Series A Series A is the most basic or standard series of mutual funds. It is usually held in commission-based accounts. The typical commission and trailer rates mentioned in Lesson 2 relate to Series A units. The Series A units of the MNO Mutual Fund may be purchased with a sales charge or a deferred sales charge at the option of the investor. Under the sales charge option, the dealer's commission is negotiated between the investor and the dealer. Under the deferred sales charge option, the fund manager pays a fixed commission of 5% to the dealer. The annual management fee is 2% of assets under management in both cases. The manager pays an annual trailer fee of 1% of assets to the dealer under the sales charge option and 0.5% of assets under the deferred sales charge option. Series F Series F units are designed for investors with fee-based accounts. Recall that these investors pay to their dealers an annual fee of around 1% of the assets in the account. The fund manager does not pay a trailer fee on Series F units. This ensures that the investor does not pay twice for service - once directly to the dealer and again indirectly through the trailer fee. Because there is no trailer fee, the management fee which the manager charges on Series F units is usually one percentage point lower than on Series A units. The saving on the management fee is compensated by the dealer's fee and the investor ends up paying the same amount overall. Mr. Jojo has a fee-based account with his mutual fund dealer and pays the dealer an annual fee of 1% of assets. Mr. Jojo may purchase Series F units of the MNO Mutual Fund without commission. The annual management fee on Series F units is 1% of assets and the manager does not pay a trailer fee to the dealer IFSE Institute

17 Series I Series I units are intended for institutional and other investors which invest large amounts. The size of the management fee is negotiated between the investor and the fund manager. The investor pays the management fee directly to the fund manager. The latter does not charge a management fee to the fund in respect of Series I units. The Transmogrifiers Pension Fund invests $10 million in Series I units of the MNO Mutual Fund. The Pension Fund pays an annual management fee of 0.5% directly to the manager of the MNO Mutual Fund. The manager does not charge a management fee to the MNO Mutual Fund in respect of Series I units. Series T Series T units are intended for investors who require a regular cash flow. These units pay a regular distribution which consists, in part, of return of capital. Returns of capital allow the investor to benefit from tax deferral. Series T units are an alternative to systematic withdrawal plans (SWPs). Series T units and SWPs are discussed in detail in Unit 6. Miss Maisie is retired and wishes to enjoy a regular cash flow. She uses her savings to buy Series T units of the PQR Mutual Fund. The fund pays regular distributions at the annual rate of 4% of assets. The distributions supplement Miss Maisie's Old Age Security, her Canada Pension Plan payments and her retirement pension from her former employer. Exercise: Multiple Series Review Let's look at the concepts covered in this unit: Three Categories of Funds Income Funds Growth Funds Combination Growth and Income Funds Comparing the Funds Series of Mutual Fund Units You now have a good understanding of the types of mutual funds offered, their characteristics, and their level of risk. At this point in the course, you should be able to start to identify the best type of mutual fund to suit your client's objectives and attitude to risk. Click Assessment on the table of contents to test your understanding. Assessment 2010 IFSE Institute 17

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