FINA2320_ABC_Tutorial 9
THE UNIVERSITY OF HONG KONG
HKU Business School
FINA2320_ABC_Investments and Portfolio Analysis
1st SEMESTER, 2023-2024
Mutual Funds and Other Investment Companies (covers Lecture 8)
➢
Investment Companies (Chapter 4.1)
✓ Investment companies collect funds from individual investors and do large-scale
investment by invest those funds in a potentially wide range of securities or other
assets. Each investor has a claim to the portfolio established by the investment
company in proportion to the amount invested.
✓
Roles of Investment Companies
- Portfolio management expertise
- Transaction costs reduction
- Activism
- Administrative management
✓
Investors buy shares in investment companies, and ownership is proportional to the
number of shares purchased. The value of each share is
𝐍𝐞𝐭 𝐀𝐬𝐬𝐞𝐭 𝐕𝐚𝐥𝐮𝐞 (𝐍𝐀𝐕) =
➢
𝐌𝐚𝐫𝐤𝐞𝐭 𝐕𝐚𝐥𝐮𝐞 𝐨𝐟 𝐀𝐬𝐬𝐞𝐭𝐬 − 𝐋𝐢𝐚𝐛𝐢𝐥𝐢𝐭𝐢𝐞𝐬
𝐍𝐮𝐦𝐛𝐞𝐫 𝐨𝐟 𝐒𝐡𝐚𝐫𝐞𝐬 𝐎𝐮𝐭𝐬𝐭𝐚𝐧𝐝𝐢𝐧𝐠
Types of Investment Companies (Chapter 4.2)
✓ Unit Investment Trusts
✓
Managed Investment Companies
▪
Open-end Funds
redeem or issue shares at NAV after establishment.
price equals NAV (except when it is sold with a load and commission)
do not traded on exchanges.
▪
Closed-end Funds
no redemption and issuance of shares after establishment.
price may be at premium or discount to NAV
traded continuously on exchanges.
Premium % or Discount % = (Price – NAV)/NAV
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FINA2320_ABC_Tutorial 9
✓
Other Investment Organizations
▪
REITs
▪
Hedge Funds
➢
Mutual Funds (Chapter 4.3)
✓ Types of Mutual Funds
➢
Costs of Investing in Mutual Funds (Chapter 4.4)
✓ Fee Structure
▪
Front-End Load (FEL; Initial Fee)
One-time commission paid when the shares are purchased. Loads effectively
reduce the amount of money invested.
𝐏𝟎 × (𝟏 − 𝐅𝐄𝐋𝟎 ) = 𝐍𝐀𝐕𝟎
✓
▪
Back-End Load (BEL; Redemption Fee)
One-time exit fee incurred when the shares are sold. Typically, funds that
impose back-end loads reduce them by certain percentage for every year the
funds are left invested.
𝐍𝐀𝐕𝐭 × (𝟏 − 𝐁𝐄𝐋𝐭 ) = 𝐏𝐭
▪
Operating Fees
Operating expenses are administrative expenses and advisory fees paid. The
expenses are deducted from the assets of the fund at the beginning of each
period.
▪
Distribution Fees
advertising, promotional literature including annual reports and prospectuses,
and commissions paid to brokers who sell the fund to investors. The
expenses are deducted from the assets of the fund at the beginning of each
period.
Documentation
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FINA2320_ABC_Tutorial 9
✓
Fees and Mutual Fund Returns
Rate of Return =
▪
▪
NAV1 − NAV0 + Income and Capital Gain Distributions
NAV0
It assumes price = NAV. If price ≠ NAV, it does not reflect the true rate of return
to the investor as it ignores any commissions such as front-end loads paid to
purchase the fund.
The rate of return is affected by the fund’s operating fees and distribution fees.
This is because such charges are periodically deducted from the portfolio, which
reduces net asset value.
𝐑𝐚𝐭𝐞 𝐨𝐟 𝐑𝐞𝐭𝐮𝐫𝐧 =
➢
𝐏𝟏 − 𝐏𝟎 + 𝐈𝐧𝐜𝐨𝐦𝐞 𝐚𝐧𝐝 𝐂𝐚𝐩𝐢𝐭𝐚𝐥 𝐆𝐚𝐢𝐧 𝐃𝐢𝐬𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧𝐬
𝐏𝟎
Exchange-Traded Funds (Chapter 4.6)
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FINA2320_ABC_Tutorial 9
IN-CLASS EXERCISE 1 (Fee Structure)
The EGL Fund sells Class A shares with a front-end load of 6% and Class B shares with
distribution fees of 0.5% annually as well as back-end load fees that start at 5% and fall by
1% for each full year the investor holds the portfolio (until the fifth year). Assume the
portfolio rate of return net of operating fees (change in value) is 10% annually. If both
classes of shares can be purchased at beginning for $1,000 and investors plan to sell both
classes of shares after 4 years, are Class A or Class B shares the better choice? What if
investors plan to sell both classes of shares after 15 years?
FINA2320_ABC_Tutorial 9
FINA2320_ABC_Tutorial 9
SELF-STUDY PROBLEM SET 1 (NAV)
The composition of the Guardian closed-end Fund portfolio is as follows:
Stock
Number of Shares
Price
A
200,000
$35
B
300,000
40
C
400,000
20
D
600,000
25
The fund has not borrowed any funds, but its accrued management fee with the portfolio
manager currently totals $30,000. There are 4 million shares outstanding. The share of the
fund is currently traded at $12. What is the net asset value of the fund?
SELF-STUDY PROBLEM SET 2 (Open-End Fund and Closed-End Fund)
A closed-end fund starts the year with a net asset value of $12. By year-end, NAV equals
$12.10. At the beginning of the year, the fund was selling at a 2% premium to NAV. By the
end of the year, the fund is selling at a 7% discount to NAV. The fund paid year-end
distributions of income and capital gains of $1.50.
a. What is the rate of return to an investor in the fund during the year?
b. What would have been the rate of return to an investor who held the same securities in an
open-end fund with a front-end load of 5% and a back-end load of 1.5%?
SELF-STUDY PROBLEM SET 3 (Mutual Fund)
You purchased 1,000 shares of the New Fund at a price of $20.83 per share at the beginning
of the year. You paid a front-end load of 4%. The securities in which the fund invest
increase in value by 12% during the year. The fund’s annual operating fees are 1.2%. What
is your rate of return on the fund if you can sell your shares equals to NAV at the end of the
year?
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