Chapter 4 Mutual Funds And Other Investment Companies PDF

Because learning changes everything.® Chapter 4 Mutual Funds and Other Investment Companies INVESTMENTS BODIE, KANE, MARCUS © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Cha...

Because learning changes everything.® Chapter 4 Mutual Funds and Other Investment Companies INVESTMENTS BODIE, KANE, MARCUS © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.  Chapter Overview Investment companies Mutual funds Mutual funds. Functions. Unit investment trusts. Investment styles and Hedge funds. policies. Closed-end funds. Costs of investing. Performance. Sources of information. © McGraw Hill 2  Investment Companies An investment company pools and invests the funds of individual investors in securities or other assets. Record keeping and administration. Diversification and divisibility. Professional management. Lower transaction costs. © McGraw Hill 3  Net Asset Value (NAV) Investment companies pool assets of individual investors, but also need to divide claims to those assets among investors. Calculation of NAV Market Value of Assets − Liabilities NAV = Shares Outstanding © McGraw Hill 4  Investment Companies: Unit Investment Trusts Unit investment trusts are pools of money invested in a portfolio that is fixed for the life of the fund. Unmanaged Declined from $105 billion (1990) to $85 billion (2017). Access the text alternative for these images © McGraw Hill 5  Investment Companies: Managed Investment Companies Open-End Stand ready to redeem or issue shares at the NAV. Priced at Net Asset Value (NAV). Closed-End Do not redeem or issue shares. Shares outstanding constant; investors cash out by selling to new investors. Priced at premium or discount to NAV. Access the text alternative for slide images. © McGraw Hill 6  Investment Companies: Other Investment Organizations Commingled funds: Partnerships of investors that pool funds. REIT: Similar to a closed-end fund but with mortgage trusts. Hedge funds: Vehicles that allow private investors to pool assets to be invested by a fund manager. Access the text alternative for these images © McGraw Hill 7  Mutual Funds Common name for open-end investment companies. Dominant investment company today. Accounts for 80% of investment company assets Assets under management (2021) U.S.—$23.9 trillion. Non-U.S.—$40 trillion. © McGraw Hill 8  Mutual Funds: Investment Policies 1 Money market Invest in money market securities such as commercial paper, repurchase agreements, or CDs. Equity Invest primarily in stock. Sector Concentrate on a particular industry or country. Bond Specialize in the fixed-income sector. © McGraw Hill 9  Mutual Funds: Investment Policies 2 International Global, international, regional, and emerging market. Balanced Designed to be candidates for an individual’s entire investment portfolio. Hold both equities and fixed-income securities in relatively stable proportions. Many are funds of funds. © McGraw Hill 10  Mutual Funds: Investment Policies 3 Asset allocation and flexible funds Hold both stocks and bonds. Engaged in market timing. Not designed to be low-risk index. Tries to match the performance of a broad market index. © McGraw Hill 11  Table 4.1 U.S. Mutual Funds by Investment Classification 1 Assets ($ % of Total Number of billion) Assets Funds Equity Funds Capital appreciation focus 3,021 12.6% 1,234 World/international 3,205 13.4% 1,459 Total return 6,603 27.2% 1,763 Total equity funds 12,728 53.3% 4,456 Bond Funds Investment grade 2,518 10.5% 579 High yield 355 1.5% 250 World 541 2.3% 329 Government 394 1.6% 188 Multi sector 530 2.2% 221 Single-state municipal 191 0.8% 279 National municipal 686 2.9% 271 Total bond funds 5,214 21.8% 2,117 © McGraw Hill 12  Table 4.1 U.S. Mutual Funds by Investment Classification 2 Assets ($ % of Total Number of billion) Assets Funds Hybrid (bond/stock) funds 1,620 6.8% 723 Money market funds Taxable 4,228 17.7% 265 Tax-exempt 105 0.4% 75 Total money market funds 4,333 18.1% 340 Total 23,896 100.0% 7,636 Note: Column sums subject to rounding error. Source: 2021 Investment Company Fact Book, Investment Company Institute. © McGraw Hill 13  Mutual Funds: How Funds Are Sold How Funds Are Sold Directly by the fund underwriter (direct-marketed funds). Sold through the mail, various offices of the fund, over the phone, or over the Internet. Indirectly through brokers acting on behalf of the underwriter (sales-force distributed). Broker or financial advisers receive a commission for selling shares. Potential conflict of interest. Financial supermarkets. Sell shares in funds of many complexes. Broker splits management fees with the mutual fund company. © McGraw Hill 14  Costs of Investing in Mutual Funds Fee structure 1. Operating expenses. 2. Front-end load. 3. Back-end load. 4. 12b-1 charges. Fees must be disclosed in the prospectus. Share classes with different fee combinations © McGraw Hill 15  Example 4.2 Fees for Various Classes The table below lists fees for different classes of the Dreyfus High-Yield Fund in 2021. Notice the trade-off between the front-end loads versus 12b-1 charges in the choice between Class A and Class C shares. Class I shares are sold only to institutional investors and carry lower fees. Class A Class B Class I Front-end load 0–4.5%a 0 0 Back-end load 0 0–1%b 0% 12b-1 feesc 0.25% 1.0% 0% Expense ratio 0.7% 0.7% 0.7% a Dependingon size of investment. Starts at 4.5% for investments less than $50,000 and tapers to zero for investments more than $1 million. b Depending on years until holdings are sold. Exit fee is 1% for shares redeemed within one year of purchase. c Including annual service fee. © McGraw Hill 16  Fees and Mutual Fund Returns NAV1 − NAV0 + Income and capital gain distributions Rate of return = NAV0 Example Initial NAV = $20.00 Income distributions of $0.15 Capital gain distributions of $0.05 Ending NAV = $20.10 $20.10 − $20.00 + $.15 + $.05 Rate of return =.015,or1.5% $20.00 © McGraw Hill 17  Table 4.2 Impacts of Costs on Investment Performance Cumulative Proceeds (All dividends Reinvested) Fund A Fund B Fund C Initial investment* $10,000 $10,000 $ 9,400 5 years 15,923 15,211 14,596 10 years 25,354 23,136 22,665 15 years 40,371 35,192 35,194 20 years 64,282 53,529 54,649 *After front-end load. If any. Notes: 1. Fund A is no-load with.25% expense ratio. 2. Fund B is no-load with 1.25% expense ratio. 3. Fund C has a 6% load on purchases and a.8% expense ratio. 4. Gross return on all funds Is 10% per year before expenses. © McGraw Hill 18  Taxation of Mutual Fund Income “Pass-through status” under the U.S. tax code Taxes are paid only by the investor, not by the fund itself. Disadvantage is that fund investors do not control the timing of the sales of securities from the portfolio, reducing their ability to engage in tax management. High portfolio turnover rate can be particularly “tax inefficient”. Average turnover dropped to 32% in 2020. © McGraw Hill 19  Exchange Traded Funds (ETFs) ETFs are offshoots of mutual funds that allow investors to trade index portfolios just as they do shares of stock. Examples: “spiders,” “diamonds,” “cubes,” and “WEBS.” Potential advantages Trade continuously like stocks. Can be sold short or purchased on margin. Cheaper than mutual funds. Tax efficient. Potential disadvantages Prices can depart from NAV. Must be purchased from a broker (for a fee). © McGraw Hill 20  Figure 4.2 Growth of U.S. ETFs Over Time Access the text alternative for these images © McGraw Hill 21  Figure 4.3 Investment Company Assets Under Management, 2021 ($ billion) 1 Access the text alternative for these images © McGraw Hill 22  Figure 4.3 Investment Company Assets Under Management, 2021 ($ billion) 2 Access the text alternative for these images © McGraw Hill 23  Mutual Fund Investment Performance Performance of actively managed funds. Wilshire 5000 index used as a benchmark for the performance of equity fund managers. Wilshire 5000 average return was 12.49%, which was 0.96% greater than the average mutual fund from 1971 to 2020. © McGraw Hill 24  Figure 4.4 Actively Managed Equity Funds Versus Wilshire 5000 Index Access the text alternative for these images © McGraw Hill 25  Information on Mutual Funds 1 Prospectus Statement of Investment Objectives: Describes investment objectives and policies. Description of fund’s investment adviser and portfolio manager. Presents fees and costs. Statement of Additional Information (SAI) Fund’s annual report © McGraw Hill 26  Information on Mutual Funds 2 “Encyclopedias” of mutual fund information. www.morningstar.com. www.finance.yahoo.com/funds. www.ici.org. Directory of Mutual Funds. © McGraw Hill 27