Investment Companies

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Investment Companies

Some nomenclature

Types (management companies)

–Open-end (mutual fund): continuously sells and redeems (all transactions with issuer)

–Closed-end: fixed number of shares issued (all post-issue transactions on market)

Mutual fund structure

–Fund adviser, distributor, directors

–Family of funds (nature of ownership - mutual or for-profit)

Competition

–Insurance “special accounts” - variable annuities

–Bank “agency accounts”

How does mutual fund operate?

Services

Investment (diversification)

• Voting

• Marketing/advertising

Management

Fees and expenses

• Marketing/advertising fees

• Advisory and investment expenses

Management expenses

QUESTIONS:

• How are mutual funds regulated? Why must mutual funds register?

• Why are mutual funds diversified? What does this mean? (75% of portfolio - not more than 5% in any one issuer, not more than 10% of stock of any one issuer)

• Reason for extensive federal regulation? Focus - disclosure, structure, ex ante prohibitions, ex post enforcement?

Types of portfolios

Equity (more US mutual funds than US publicly-traded operating companies)

• Growth

• Large-cap

• Small-cap

• Index

• Sector

• International/global

Debt

• Long-term

• Short-term

• Money market (priced daily so # shares = # dollars)

• Government

• Tax-free municipal

• Junk bonds

QUESTIONS

• What drives investor choice of funds?

• How do MF investors allocate their investments?

• How do MF investors re-allocate their investments?

• Do mutual funds outperform the market (consider fees, expenses, taxes)?

The mutual fund “gorilla”

Size (equity and debt)

• 2003 - $7,000 billion

• 1999 - $5,500 billion

• 1989 - $900 billion

Percentage (US public equity market)

• 2003 - 25.0%*

• 2000 - 21.4%

• 1995 - 14.6%

• 1990 - 6.9%

• 1985 - 5.3%

• Under management – 33%

How is mutual fund managed?

Mutual fund adviser does it all

• sets up fund (organized as corporation or business trust)

• chooses investment style

• puts in initial board of directors

Directors (or trustees) are ostensible watchdogs

• approves advisory contract

• approves fees

• supervises conflicts of interest

Computation of value

Rule 22c-1: NAV at least once daily

• industry practice: 4:00pm EST

QUESTIONS:

• Compare mutual fund to an operating corporation?

• Do (should) MF directors function like corporate directors?

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