Mutual Funds and Other Investment Companies Investment Companies

Mutual Funds and Other Investment Companies

Investment Companies § A corporation or trust engaged in the business of investing the pooled capital of investors in financial securities. This is most often done either through a closed-end fund or an open-end fund (also referred to as a mutual fund). § Financial intermediaries that collect money from individual investors and invest these funds in a wide range of securities or other assets § Perform important functions for individual investors including: 1) Diversification and Divisibility 2) Lower Transaction Fees 3) Record Keeping and Administration 4) Professional Management

Investment Companies § Value of each share is called the Net Asset Value or NAV (equals assets minus liabilities expressed on a per-share basis):

Types of Investment Companies § Open-end Investment Companies - This means that managers have to plan and manage the fund to be able to meet the demands for investors who may want their money back at any time. Open-ended funds are often restricted to investing in liquid assets, in other words investments that can be sold at short notice. Commonly known as Mutual Funds - Stands ready to redeem or issue shares at NAV - May have “front-load” or “rear-end” sales charges (capped at 8. 5% by NASD) - Number of shares constantly changes

Types of Investment Companies § Closed-end Funds - Number of shares is fixed - Does not redeem or issue shares - Typically, newly issued shares sell for a premium over the NAV - Shortly after being issued, many shares sell at a discount from NAV - A puzzle that much recent financial research has focused on - Usually traded on organized exchanges

Types of Investment Companies § Unit Investment Trusts - Pools of money invested in a portfolio that is fixed for the life of the fund - Units (also called redeemable trust certificates) sold by a sponsor (brokerage firm) to individual investors - Most unit trusts hold fixed-income securities (bonds, etc. ) and expire at their maturity - Most unit investment trusts are invested in tax-exempt securities (municipal bonds) - Individuals may sell units back to trustee at NAV

Types of Investment Companies § Commingled Funds - Used by trust departments among others - Partnership of investors that pool their funds with a management firm (e. g. , bank) - Similar to open-end funds except units are traded rather than shares

Types of Investment Companies § Real Estate Investment Trusts (REITs) - Similar to a closed-end fund - Invest in real estate or loans secured by real estate - Exempt from taxes as long as at least 95% of their taxable income is distributed to shareholders; however, these distributions (dividends) are taxable as personal income

Mutual Funds Types § Money Market Funds § Equity Funds: 1) Maximum Capital Gain 2) Growth 3) Growth and Income 4) Income 5) Income and Security

Mutual Funds Types § Fixed-Income Funds § Balanced and Income Funds § Asset Allocation Funds § Index Funds § Special Sector Funds § International Funds

Mutual Fund Returns

Taxation of Mutual Fund Income § Granted “pass-through status” (i. e. , taxes paid by investor in the fund, but not by the fund itself) if the fund meets certain requirements including: 1) At least 90% of all income is distributed to shareholders (in order to avoid “excise tax”, fund must distribute 98% of income in the calendar year in which it was earned) 2) Fund receives less than 30% of its gross income from sale of securities held for less than three months 3) Fund must meet diversification criteria

Mutual Fund Performance Benchmark § Benchmark for the performance of equity fund managers is the rate of return on the Wilshire 5000 Index (a value-weighted index of about 7000 stocks that trade on the NYSE and Amex stock exchanges, and the Nasdaq stock market § Useful benchmark to evaluate professional fund managers because it corresponds to a simple passive investment strategy; however, an imperfect comparison due to: 1) Risk Differential: the risk of the Wilshire 5000 Index may differ significantly from the risk of a specific fund 2) Expenses: a specific fund will incur expenses (e. g. , transaction costs, etc. ) that the Wilshire 5000 Index is not exposed to