CHAPTER 4. Mutual Funds and Other Investment Companies INVESTMENTS BODIE, KANE, MARCUS

Transcription

1 CHAPTER 4 Mutual Funds and Other Investment Companies INVESTMENTS BODIE, KANE, MARCUS McGraw-Hill/Irwin Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

2 4-2 Investment Companies Pool funds of individual investors and invest in a wide range of securities or other assets. Services provided: Administration & record keeping Diversification & divisibility Professional management Reduced transaction costs

3 4-3 Net Asset Value - Calculation Net Asset Value (NAV) = Market Value of Assets - Liabilities Number of Shares Outstanding

4 4-4 Types of Investment Companies According to Investment Company Act of 1940: Unit Investment Trusts Managed Investment Companies Closed-end Open-end (aka Mutual Funds)

5 Types of Investment Companies Unit Trusts Fixed portfolio of uniform assets Unmanaged Cash out by selling back to Trustee, which will disinvest or find new buyer Total assets have declined from $105bn in 1990 to $29bn in 2009 (recovered to ~60bn in 2012) Q. When was the first one created? 1868: created to give smaller investors access to the new stock markets of the USA. Also used to bankroll expansion (such as railway lines) in the New World, hence names such as Foreign & Colonial. Many were formed in Scotland, still a centre of investment trusts. INVESTMENTS BODIE, KANE, MARCUS 4-5

6 4-6 Types of Investment Companies Managed Investment Companies Closed-End No change in shares outstanding; old investors cash out by selling to new investors Priced at premium or discount to NAV Open-End (Mutual Funds) Fund issues new shares when investors buy in, and redeems shares when investors cash out Priced at Net Asset Value (NAV) Transactions are executed after market closes and NAV is computed (more about this later)

7 4-7 Types of Investment Companies Other investment organizations Commingled funds: partnership of investors that pool money. Resemble mutual funds (units instead of shares). REITs: similar to closed-end fund. Most are leveraged. Equity and Mortgage trusts. Hedge Funds: pools of assets actively managed. Lock-up periods. Leverage and risk. More later in the textbook.

8 4-8 Mutual Funds types Money Market Equity Sector Bond International Balanced and funds of funds Asset Allocation and Flexible Index

9 Table U.S. Mutual Funds by Investment Table Classification 4.1 (Investm. U.S. Company Mutual Inst. 2009) Funds by Investment Classification 9 INVESTMENTS BODIE, KANE, MARCUS 4-9

10 Table 4.1 U.S. Mutual Funds by Table U.S. Mutual Funds by Investment Classification (Investm. Company Inst. 2012) Investment Classification 10 INVESTMENTS BODIE, KANE, MARCUS

11 Mutual Funds Market (Year-end 2011) Source: INVESTMENTS BODIE, KANE, MARCUS 4-11

12 Mutual Funds Market (Year-end 2013) Source: INVESTMENTS BODIE, KANE, MARCUS 4-12

13 4-13 Mutual Funds Flows ($bn) Source:

14 4-14 How Funds Are Sold Direct-marketed funds (mail, phone, internet) Sales force distributed (about half) Revenue sharing on sales force distributed (you ultimately pay for it) Potential conflicts of interest SEC: Must tell prospective investors Financial Supermarkets No charge, but fee split with MF company Unified reporting

15 4-15 Costs of Investing in Mutual Funds Fee Structure Four types: 1. Operating expenses 2. Front-end load 3. Back-end load (contingent deferred sales fee) b-1 charge (From SEC rule #, includes misc. costs, broker commissions) Fees must be disclosed in the prospectus Share classes with different fee combinations

16 Example 4.2: Fees for Various Classes (Dreyfus Worldwide Growth Fund) INVESTMENTS BODIE, KANE, MARCUS 4-16

17 4-17 Fees and Mutual Fund Returns example Initial NAV = $20 Income distributions of $0.15 Capital gain distributions of $0.05 Ending NAV = $20.10: R N AV N AV Incom e C apital G ain 1 0 N AV 0 $ $ $.15 + $.05 Rate of Return = 1.5% $20.00

18 4-18 Table 4.2 Impacts of Costs on Investment Performance All grow 12% p.a.

19 Late Trading and Market Timing Late trading accepting buy or sell orders after the market closes and NAV is determined Market timing rapid in-and-out trading on stale net asset values Net effect is to transfer value from ordinary shareholders to privileged traders Q. Why should MF managers allow this? Mutual funds penalized for improper trading. New rules to prevent these practices INVESTMENTS BODIE, KANE, MARCUS 4-19

20 4-20 Taxation of Mutual Fund Income Pass-through status under the U.S. tax code Taxes are paid only by the investor (you) Fund investors do not control the timing of the sales of securities from the portfolio Q. What is the tax difference between short and long term capital gain(loss)? Turnover = fraction of portfolio replaced High portfolio turnover (60% on average) leads to tax inefficiency

21 4-21 Exchange Traded Funds (ETFs) Examples: spiders, diamonds and cubes Potential advantages: Trade continuously like stocks Can be sold short or purchased on margin Lower costs Tax efficient Potential disadvantages: Prices can depart by small amounts from NAV Must be purchased from a broker

22 4-22 Total Net Assets, Number of ETFs $bn, year-end Source:

23 ETF assets ($ million) INVESTMENTS BODIE, KANE, MARCUS Fig 4.2 Growth of U.S. ETFs, per type 1,000, , , , , ,000 Bond Commodities Global/int'l equity U.S. equity: sector U.S. equity: broad index 400, , , ,

24 4-24 Mutual Fund Investment Performance: A First Look Performance of actively managed funds: below the return on the Wilshire index in 23 of the 41 years from 1971 to 2011 Evidence for persistent superior performance (due to skill, and not just good luck) is weak, but suggestive Bad performance more likely to persist

25 Rate of Return INVESTMENTS BODIE, KANE, MARCUS Figure 4.4 Diversified Equity Funds versus Wilshire 5000 Index (see here) 40% Active funds Wilshire % 20% 10% 0% -10% -20% -30% -40%

26 4-26 Information on Mutual Funds Fund s prospectus describes: investment objectives Fund investment adviser and portfolio manager Fees and costs Statement of Additional Information (SAI) List of securities, etc. You must ask for it. aka Something Always Ignored Fund s annual report

27 4-27 Information on Mutual Funds Wiesenberger s Investment Companies Morningstar ( Yahoo (biz.yahoo.com/funds) Investment Company Institute ( Directory of Mutual Funds

28 4-28 Table 4.3 ETF Sponsors and Products

29 4-29 Let s move to the next chapter