Mutual Funds and Other Investment Companies

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Shawn May
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1 Mutual Funds and Other Investment Companies

2 Investment Companies Pool funds of individual investors and invest in a wide range of securities or other assets. pooling of assets Provide several functions to investors: Administration & record keeping Status reports, keep track of dividend, gains etc.. Diversification & divisibility can Act as large investors even if any individual can not Professional management can hire professional analysts, fund managers. Reduced transaction costs substantial brokerage and commissions.

3 NAV : Net asset value Investment companies need to divide claims to the pooled assets among investors Investor buy shares in investment companies, the value of each share are expressed as net asset value.

Investor buy shares in investment companies, the

4 NAV : Net asset value Example : Assets $ Liabilities $270.3 #Shares The net asset value (NAV) of the portfolio : = ( ) / = $27.97 per share

5 Types of Investment Companies Unit Investment Trusts (Unit Trust) Fixed portfolio : brokerage buys a portfolio of securities and sell to investors. Unmanaged : fixed portfolio composition Sponsors profits generated from buy low sell high Lost market share to mutual fund : Total assets have declined from $105 billion in 1990 to $29 billion in 2009

Unmanaged : fixed portfolio composition Sponsors profits generated from buy low sell

6 Types of Investment Companies Managed Investment Companies Open-End (commonly known as mutual funds) Number of shares changes daily : Fund stand ready to issues new shares when investors buy in and redeems shares when investors cash out Priced at Net Asset Value (NAV) investors buy and liquidate via investment company : mutual fund do not traded on organized exchanges

investors buy in and redeems shares when investors cash out Priced at Net Asset Value (NAV)

7 Types of Investment Companies Managed Investment Companies Closed-End no change in numbers of shares outstanding; old investors cash out by selling to new investors Priced at premium or discount to NAV Traded on organized exchange, just like other common stock

investors cash out by selling to new investors Priced at premium

8 Types of Investment Companies Other investment organizations Commingled funds (pooled fund) economies of scale REITs Invest in real estate or loan backed by real estate Equity trust : invest directly in real estate Mortgage trust : invest in mortgage loan Hedge Funds Lightly regulated : not subject to SEC regulations usually have lock ups initial investment can not first years thus, allow hedge fund to invest in illiquid assets withdrawn for the

trust : invest in mortgage loan Hedge Funds Lightly regulated : not subject to SEC regulations usually have lock

9 Mutual Funds: Open-End Investment Companies Many fund types Money Market Equity Sector Bond Balanced (bond & equity) Asset Allocation and Flexible (high risk) Index International

10 How Funds Are Sold Direct-marketed funds - Mail, Newspaper or Internet Sales force distributed Revenue sharing on sales force distributed Potential conflicts of interest : brokerage tend to recommend funds that pay them

sharing on sales force distributed Potential conflicts

11 Costs of Investing in Mutual Funds Apart from past performance and fund policy, investors should take a look at costs. Fee Structure: Four types 1. Operating expenses % of assets usually 1-2% 2. Front-end load sales charge for broker 3. Back-end load exit fee 4. 12b-1 charges deductable from net assets if <= 1% Fees must be disclosed in the prospectus Share classes with different fee combinations

Front-end load sales charge for broker 3. Back-end load exit fee 4.

12 Mutual Fund Returns Mutual Fund Returns are measures as the changes on NAV plus income distributions, expressed as a fraction of NAV at the beginning of investment period Example : Mutual fund returns

$distributions, expressed as a fraction of NAV at$

13 Mutual Fund Returns : Example The equity fund sell share in Class A : front-end load 4% Class B : 12b-1 0.5% annually & back-end load start at 5% and reduce by 1% each year (until fifth year) Assume 10% rate of returns net of operating expense annually. What will be the value of investment in class A and Class B shares after 1) 4 years 2) 10 years? Which asset class provide higher net proceeds at the end of each horizon? Sol. 4 year : Class A : front end load 4%, Class B: x% 12b-1 fee + 1% back end load : Class A : 10% annual return, Class B : = 9.5% net Hence ; Net Proceed A : = (0.96*10000)*(1+0.1) 4 = 14, Net Proceed B : = 10000*0.99*( ) 4 = 14,232.84

What will be the value of investment in class A and Class B shares after 1) 4 years 2) 10 years? Which asset class provide higher net proceeds at the end of each horizon?

14 Mutual Fund Returns : Solutions 4 years : Class A : front end load 4%, Class B: x% 12b-1 fee + 1% back end load : Class A : 10% annual return, Class B : = 9.5% net Hence ; Net Proceed A : = (0.96*10000)*(1+0.1) 4 = 14, Net Proceed B : = 10000*(1-0.01)*( ) 4 = 14, years : Class A : front end load 4%, Class B: 12b-1 fee 0% back end load : Class A : 10% annual return, Class B : = 9.5% net Hence ; Net Proceed A : = (0.96*10000)*(1+0.1) 10 = 24, Net Proceed B : = 10000*( ) 10 = 24,782.28

15 Exchange Traded Funds (ETF) Textbook Examples: spiders S&P Depository Receipt, diamonds DowJoans industry ticker DIA and cubes NASDAQ 100 ticker QQQ Thai Market Examples : TDEX (SET50 ETF), GLD (Gold track ETF), TH100 (SET100 ETF) 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

ETF) Potential advantages: Trade continuously like stocks Can be sold short or purchased on margin Lower costs

16 Hedge Funds

17 Similarities : Mutual Funds and Hedge Funds Similarities Both are pooled investments Both represent investor s stake in the portfolio as NAV But Many differences..

22 Hedge Fund Styles

23 Hedge fund Strategies: Example Clarify each of the following strategies as directional or non-directional 1) The fund buys shares in India Investment Fund, a closed-end fund that is selling at a discount to NAV, and sells the MSCI India index swap 2) The fund buys shares in Petrie stores and sell toy r us, which is a major component of Petrie s Balance sheet 3) The fund buys shares in Generic Pharmaceuticals, betting that it will be acquired by Pfizer.

24 Hedge fund Strategies: Solutions Clarify each of the following strategies as directional or non-directional 1) Non-directional, long in India investment, short in India index constitute a hedged position. 2) Non-directional, both positions are driven by the performance of Toy R us. Hence, long petries stores and short Toy R us constitute a hedged position. 3) Directional. The trading strategy is an outright bet that the price of generic pharmaceuticals will receive favorable effect from the takeover bid by Pfizer.

Investment Companies

Mutual Funds Mutual Funds Investment companies Financial intermediaries that collect funds form individual investors and invest those funds in a potentially wide rande of securities or other asstes Polling