Mutual Funds and

Other Investment
Companies
Session 5
Chapter 4
Chapter 4 Learning Objectives
Describe an Investment Company

Differences between Investment companies

Net Asset Value, Rate of Return

Investment Styles

Fund Expenses and Performance

Outlines
Investment Companies 01
02 Mutual Funds

ETFs 03
04 Costs in Mutual Funds

Fund Performance 05
1. Investment Companies
Financial intermediary
 Pooling funds from individuals
 Investing in range of stocks, assets
Features
 Record keeping / administration
 Diversification w/ many securities
 Professional management
 Lower transaction fees
Net Asset Value
 Value of each share
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Net Asset Value

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Net Asset Value

Determines mutual fund prices

 Buying new shares
 Redeeming existing shares

How to calculate NAV?

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Ex) ABC Fund Share Price
 Asset under management = $2,905.1 million
 Current Liability = $36.1 mil
 79.6 mil outstanding shares
Calculate share price

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Types of Investment Companies

A. Unit Investment Trusts (UITs):

 unmanaged, fixed portfolios
B. Managed Investment Companies
 Open-end vs. Closed-end funds
C. Commingled funds
 Partnerships of investors
D. REITs
 Real estate / real estate loans
E. Hedge Funds
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B. Open-end Funds vs Closed-end Funds

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B. Open-end vs Closed-end Fund
1. Open-end fund
 A fund that issues or redeems its shares at NAV
 # of outstanding shares changes when new shares are
sold or old shares are redeemed
2. Closed-end fund
 Do not issues new shares
 Buy and sell from other investors
 Price can differ from NAV

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D. REITs

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E. Hedge Funds

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 E. Hedge Funds
Speculative/Risky Trading
 Leverage: Borrow money to amplify return
 Short selling, Futures/options, Currency
 Not subject to SEC Regulation
 “Two and Twenty” Fee
• 2% management fee + 20% cut from gains
10k+ funds, $3.2 trillion (2015)
Chapter 20 (FIN3130)
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2. Mutual Funds

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Mutual Funds
 Open-end Investment Company
 Regulated by SEC
 Specific investment policy
Dominant type
 9,260 U.S. funds, $15 trillion
 $15 trillion (non-U.S. funds)
 Account for 88% of assets

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7 Investment Policies

1. Money Market Funds

 short- term money market securities
2. Equity Funds
 stocks
 Examples
• Income funds: high dividend yield stocks
• Growth funds: high risk, low dividend

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Investment Policies (cont.)
3. Sector Funds
 particular industry
4. Bond Funds
 Fixed income securities
5. International Funds
6. Balanced Funds
 Mixture of stocks and bonds
 Targeted-maturity funds

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Investment Policies (cont.)
7. Index Funds
 Match performance of market
index
• Mimic stock, bond real estate index
• Diversification
• Low cost
• Ex) Vanguard 500 Index Fund
replicates S&P500 basket
 20% of equity funds (2014)
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Index Fund

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Indexing Strategy

For who?
 believe in the efficient market
 prefer to diversify to lower risk
Modern Portfolio Theory (Chp 6,7)
 Market portfolio has the highest
return for a given risk
 Apple higher return (?), but 2-3
times more risk than mkt

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3. Exchange Traded Funds (ETF)

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Exchange Traded Funds (ETF)
Offshoots of index mutual funds
 Diversification
Advantages over mutual funds
 Trade continuously throughout day
 Can be short or purchased on margin
 No minimum requirement
Disadvantage
 Price can deviate from NAV slightly
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ETF.com
Examples of ETFs
 SPY: S&P500
 DIA: Dow Jones
 QQQ: Nasdaq
 VTI: Total stock market
 EFA: MSCI EAFE (developed
countries)
 VWO: FTSE emerging markets
http://www.etf.com/etfanalytics/etf-finder

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ETF.com
Examples of ETFs
 SPY: S&P500
 DIA: Dow Jones
 QQQ: Nasdaq
 VTI: Total stock market
 EFA: MSCI EAFE (developed
countries)
 VWO: FTSE emerging markets
http://www.etf.com/etfanalytics/etf-finder

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Figure 4.2 Assets in ETFs

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4 Reasons To Invest In ETFs
Sample Quiz

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4. Costs of Investing in Mutual Funds
Operating Expense
 Management fee
 Expense Ratio (0.05%-2%)
 periodically deducted from NAV
Load Fee
 Front-end: sales commission
 Back-end: redemption fee
12b-1 Charges
 Marketing / Distribution cost
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Expense Ratios

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 Ex 4.2 Expenses and Rates of Return
XYZ fund
 10 mil outstanding shares
 $100 mil in assets
 10% value increase
 expense ratio = 1%
Is rate of return = 10% - 1%?

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Sample Quiz

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5. Mutual Fund Performance

3 key questions
Q1: Do mutual funds outperform
market?
Q2: Do good managers consistently
outperform market?
Q3: Do funds with higher expense
perform better?

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Q1. Outperform Market?
On average, does a mutual fund
outperform market?
Complete answer:
 How to measure risk-adjusted return?
 Textbook Chapters 5, 8, 18
Simple answer:
No. Evidence shows that average mutual
fund performance is generally less than
broad market performance
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2016 SPIVA (Index vs Active) U.S. Scorecard

http://us.spindices.com/search/?ContentType=SPIVA
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Q2. Do Stars Consistently Outperform?

Do good managers
consistently outperform?

No!
 Does Past Performance Matter?
The Persistence Scorecard

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Q3. Higher Fee = Higher performance?

load funds vs no-load funds

 Performances the same
 Avoid funds that charges sales commissions
High expense funds: poorer performers
 Low cost funds: Not poor performers
 Avoid high expense ratio (ER) funds

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 Advantages of S&P500, TSM index funds
1. Diversification
2. Consistency
 Beats 70% of active funds
3. Low cost (ER ~ 0.05%)
4. Low tax
5. Simplicity
6. Modern Portfolio Theory
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Sample Quiz

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Summary

Investment Company

Mutual Funds

ETFs

Costs in Mutual Funds

Performance

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