Chapter 3
Charles P. Jones, Investments: Analysis and Management,
12th Edition, John Wiley & Sons
31

Alternative to direct investment in or
ownership of securities
◦ Accomplishes essentially the same thing as direct
investing

Refers to buying and selling the shares of
intermediaries that hold securities in portfolio
◦ Shares are ownership interest in portfolio entitled
to portfolio income
◦ Shareholders also pay expenses and management
fee
32

Firm that sells shares to the public and uses
the proceeds to invest in marketable
securities
◦ Acts as conduit for distribution of dividends,
interest, and realized gains
◦ Offers professional management
◦ Regulated but not insured or guaranteed by any
federal agency
◦ Shareholders pay taxes as if they directly owned
securities
33

Unit Investment Trust (UIT)
◦ Typically holds an unmanaged, fixed-income
portfolio
◦ Relatively small share of market

Closed-End Investment Company
◦ Actively managed portfolio
◦ Fixed number of shares
◦ Trade on stock exchanges like other stocks
34

Exchange Traded Funds
◦ Portfolio of assets that tracks a sector, region, or
market
◦ Trade like individual equities on exchange
◦ Management fees low
 Typically unmanaged portfolios
◦ Tax efficiency
 Investor has greater control over realization of capital
gains/losses than with a mutual fund
35

Mutual Funds (Open-end Investment
Companies)
◦ Investors buy fund shares from investment
companies, sell shares back to those companies
 Mutual funds not sold on exchanges
◦ Number of shares outstanding constantly changing
(unlike closed-end funds)
◦ Offer diversification, professional management,
other services
◦ Popular with investors, especially in retirement
plans
36

Money Market Funds (MMFs)
◦ Invest in portfolio of money market securities
◦ Taxable or tax-exempt
◦ Investors pay a management fee but not a sales or
redemption charge (load)
◦ Not insured by the federal government
◦ Attempt to keep price at $1/share
◦ Offer investors broad diversification, great liquidity
and a way to earn going money market rate
37

Equity, bond, and hybrid mutual funds
◦ Equity funds hold primarily stocks, bond funds
primarily hold bonds and hybrid funds hold a
combination
◦ All invest in portfolio of securities consistent with
the objectives of the fund
◦ Company’s board sets objects, must specify them
in investment policy
◦ Objectives can be achieved in various ways, so
investment style can also be important
38

Most equity funds are either:
◦ Value funds, which invest in stocks that are cheap
according to standard financial analysis methods
◦ Growth funds, which invest in stocks of firms
expected to show future rapid earnings growth


These fund types tend to perform well at
different times, appeal to investors with
different objectives
Best strategy is probably to hold both fund
types
39
Index Funds


Mutual Funds designed to match a market
index
Unmanaged portfolio, typically with low
expense ratio
◦ Expenses vary widely, though, so investors need to
be sure expenses are reasonable

Often outperform actively managed mutual
funds
310
Net Asset Value Per Share (NAV)




NAV is per share value of securities in a fund
Is the total market value of securities, minus
any liabilities, divided by number of shares
outstanding
Changes daily and is calculated daily after
markets close at 4 p.m.
If no sales charges, NAV is price investors pay
to buy mutual fund or price paid to investors
selling fund
311
The Details of Indirect Investing

Closed-end funds
◦ Market prices often differ from NAV
◦ Market price may be less than NAV (discount) or
more than NAV (premium)
◦ Portfolio’s return calculated based on NAVs
◦ Shareholder’s return calculated based on closing
prices

Individual investors should avoid purchasing
newly offered shares of closed-end funds
312
The Details of Indirect Investing

Mutual Funds
Investors can purchase directly or indirectly
Usually only require a small minimum investment
Investors can redeem shares anytime
Investors purchase/redeem at NAV plus or minus
sales charges
◦ Fund’s prospectus discloses fees and expenses
◦
◦
◦
◦
 Load funds charge a sales fee
 No-load funds do not charge a sales fee
313
The Details of Indirect Investing

Mutual Fund Share Classes
◦ Way to give investors choice over fees
◦ Each class has same claim on portfolio, same NAV

No-load funds
◦ Purchased at NAV directly from the investment
company
◦ No sales force expense to cover
◦ Investors must seek out funds
◦ Annual operating expenses paid out of fund income

All funds charge shareholders an expense
ratio
314
The Details of Indirect Investing

Exchange-Traded Funds
◦ Can be bought or sold anytime during the trading
day
◦ Can be bought on margin or sold short
◦ Have much lower expenses than actively managed
funds
◦ Can weight indexes differently, which can affect
return
315


Reported on a regular basis in the popular
press
Price performance not the same as total
return
◦ Total return measures both price changes and
income (from dividends) over a specified time
period
◦ Average annual return is a hypothetical measure


Costs and taxes should also be considered
Expenses may be the best indicator of a
fund’s performance
316

Some mutual funds specialize in international
securities
◦ Can have higher costs
◦ International funds or global funds emphasize
international stocks
◦ Single-country funds concentrate on one country
◦ Some ETFs match foreign indexes
 Not hedged against currency risk
317
The Future of Indirect Investing

Mutual fund “supermarkets”
◦ Investors can buy/sell funds from various mutual
fund families through a single source
◦ Offer fee and no-fee “aisles”

Hedge Funds
◦ Largely unregulated investment companies
available to private investors
 May use leverage, derivatives, other strategies not
available to mutual fund managers
 Require substantial initial investment, charge
substantial fees
318
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