1. McGraw-Hill/Irwin Copyright © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Mutual Funds and Other Investment Companies CHAPTER 4

2. 4-2 4.1 INVESTMENT COMPANIES

3. 4-3 Investment Companies Definition: financial intermediaries that collect funds from individual investors and invest those funds in a potentially wide range of securities Administration & record keeping –issue periodic status reports, keeping track of capital gain distributions, dividends, investments, and redemption Diversification & divisibility: diversify portfolios and investors can buy fractional shares of many different securities Professional management: full-time staffs of security analysts and portfolio managers Reduced transaction costs: can achieve substantial savings on brokerage fees and commissions because of large transactions

4. 4-4 Investment Companies: Net Asset Value Net Asset Value –Used as a basis for valuation of investment company shares –Selling new shares –Redeeming existing shares Calculation: Market Value of Assets - Liabilities Shares Outstanding Shares Outstanding

5. 4-5 4.2 TYPES OF INVESTMENT COMPANIES

6. 4-6 Unit Trusts Pools of money from many investors that is invested in a portfolio fixed for the life of the fund Little active management Example: invest in municipal bond, corporate bond

7. 4-7 Managed Investment Companies: Open-End and Closed-End Hire managers to manage portfolio Open-End –stand ready to redeem or issue shares at their net asset value. If investors in open-end funds want to cash out shares, they sell back to the fund at NAV Closed-End –Funds cannot issue or redeem shares. Investors who want to cash out must sell shares to other investors –Sold at premium or discount to NAV –Shares of close-end fund are traded on organized exchanges just like other common stocks.

8. 4-8 Figure 4.1 Closed-End Mutual Funds

9. 4-9 Other Investment Organizations –Commingled funds partnership of investors that pool their funds. Similar to open- end fund. Example: trust or retirement account that have portfolios much larger than those of most individual investors but still too small to warrant managing on a separate basis –REITs: similar to closed-end fund but invest in real estate or loans secured by real estate –Hedge Funds like mutual fund: hedge fund allows private investors to pool assets to be invested by a fund manager Unlike mutual fund: hedge fund are commonly structured as private partnerships and are not subject to many SEC regulations

10. 4-10 4.3 MUTUAL FUNDS

11. 4-11 Investment Policies mutual fund is a common name for open-end investment company. Account for >90% of investment company asset. Described in the prospectus Management companies manage a family of mutual funds. Some examples include: –Fidelity –Vanguard –Putnam –Dreyfus

12. 4-12 Types of Mutual Funds Money Market: invest in money market securities. Equity: invest in stocks –Income fund and growth fund Specialized Sector: sector funds Bond: invest in bond

13. 4-13 Types of Mutual Funds Balanced Funds: hold both equities and fixed income securities in relatively stable proportions to meet needs of individual investors Asset Allocation and Flexible: similar to balance funds but the proportion can change according to managers’ forecasts Indexed: match performance of a broad market index. Example: Vanguard 500 Index Fund International

14. 4-14 Table 4.1 Mutual Funds by Investment Classification

15. 4-15 4.4 COSTS OF INVESTING IN MUTUAL FUNDS

16. 4-16 Fee Structure –Front-end load: commission or sale charge paid when purchasing the shares –Back-end load: redemption or exit fee incurred when you sell shares. Operating expenses 12 b-1 charges distribution costs paid by the fund Alternative to a load Fees and performance

17. 4-17 Example 4.1 From Text

18. 4-18 Fees and Mutual Fund Returns

19. 4-19 Fees and Mutual Fund Returns: An Example Initial NAV = $20 Income distributions of $.15 Capital gain distributions of $.05 Ending NAV = $20.10:

20. 4-20 Table 4.2 Impacts of Costs on Investment Performance

21. 4-21 4.6 EXCHANGE-TRADED FUNDS

22. 4-22 Exchange Traded Funds ETF allow investors to trade index portfolios like shares of stock Examples – SPDRs, Diamonds, and WEBS Potential advantages –Trade continuously –Lower taxes –Lower costs Potential disadvantages

23. 4-23 4.7 MUTUAL FUND INVESTMENT PERFORMANCE: A FIRST LOOK

24. 4-24 Mutual Fund Performance Evidence shows that average mutual fund performance is generally less than broad market performance Evidence suggests that over certain horizons some persistence in positive performance –Evidence is not conclusive –Some inconsistencies

25. 4-25 Figure 4.2 Diversified Equity Funds Versus Wilshire 5000 Index

26. 4-26 Table 4.4 Consistency of Investment Results

27. 4-27 4.8 INFORMATION ON MUTUAL FUNDS

28. 4-28 Sources of Information Wiesenberger’s Investment Companies Morningstar (www.morningstar.com) www.morningstar.com Yahoo (finance.yahoo.com/funds) finance.yahoo.com/funds Investment Company Institute Popular press Investment services