asset mgmt mutual funds
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Saunders Learning Group, LLC, Andover, KSSaunders Learning Group, LLC
Introduction toInvestment Companies,
Mutual Funds and Exchange Traded Funds
Financial Services Industry Training
Saunders Learning Group, LLC, Andover, KS
Saunders Learning Group provides a variety of training programs, workshops and seminars targeted to the financial services industry.
Programs are available in a wide range of topics, and we are specialists in developing custom programs that are targeted to your needs.
Contact the founder, Floyd Saunders at 316-680-6482 or at floyd@floydsaunders.com for more information.
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Training from Saunders Learning Group
Saunders Learning Group, LLC, Andover, KS
1. Investment Companies2. Open-End Mutual Funds3. Closed-End Funds 4. Benefits of Investment Companies5. Regulation of Investment Companies6. Fees7. Fund Objectives8. Selecting a Mutual by Investment Objectives9. Management Styles
Slide 3
Topics
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Investment Companies
• The investment company sells shares to the public and invests the proceeds into a diversified portfolio of securities
A Mutual Fund is one type investment company.
• Investors pool their capital and delegate the investment decision to a central authority
• The central authority making the investment decisions earns a fee for their service
Q: What exactly are the services offered by this central authority?
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Difference between Banks and Mutual Funds
Slide 5
Banks Mutual Funds
Leverage Banks have leverage – can borrow funds at a fixed rate of interest
Have no debt in their capital structures – cannot borrow funds
Incentive Investment quality is signaled through the market value of equity. Banks risk (invest) their own capital (borrowed from depositors at a fixed rate) which gives them strong incentives to invest wisely
Managers collect fees and do not own equity; There is no incentive alignment with investors based on performance of the investments. Profits and losses are simply passed through.
Transparency Investments (loan portfolios) are opaque Investments are relatively transparent, with investment advisors required to list their portfolios at certain intervals
Types of investments
Banks cannot invest in equity securities – conflicts of interest may develop
Mutual funds do not negotiate loans. They may purchase loans if securitized
Ownership Managers of the firm can also be owners (stock and/or options) which promotes incentive alignment
Mutual Fund managers cannot invest in their own fund, and since they do not risk their own capital, are not incentive aligned.
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An open-end investment company is commonly called a mutual fund and is the most common investment company.
These funds are open to new investment. New investor proceeds are exchanged for new shares in the fund, and are invested in the portfolio. A mutual fund has no limit on the size of the fund or the number of shares outstanding.
The value of a mutual fund share is called its net asset value. Mutual fund shares are not sold in the traditional sense. Instead, they are redeemed by the fund
management. Investors buy-in at the Net Asset Value (NAV)
NAV = Market value of the portfolio - Liabilities Shares outstanding
The market value is easy to calculate at any point in time if the underlying securities are traded in liquid markets (particularly true for an equity fund),
However, investment companies do not real-time mark to market For most funds and investors, there is a 1:00PM commitment to
purchase shares, but at the 4:30PM NAV (market close) Fund size is determined by:
The change in value of investments Net flow of funds -- buy-ins (+) and redemptions (-). If a fund is performing well, then its growth through Net New Flow
of Funds will likely be bigger than the growth through changes in Investment value (Don’t confuse fund growth with return!!!).
Open-End Investment Companies or Mutual Funds
Stats: • 8,200 firms • < 7,100 stock
and bonds funds.
• Total assets of $5.12 trillion.
• $6.97 trillion if money market mutual funds included
As of XXXX
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Top 10 Mutual Fund Companies1
Rank CompanyTotal net asssets
1 Fidelity Investments $949,043,3262 Vanguard Group 864,809,3323 Capital Research & Management 721,894,8294 Franklin Templeton Investments 258,649,7555 Morgan Stanley 212,703,0426 J.P. Morgan Chase & Co. 197,084,5177 Columbia Management Group 193,563,6428 PIMCO Funds 178,399,5789 TIAA-CREF 173,865,479
10 OppenheimerFunds/MassMutual 168,695,094
(1) As of March 31, 2005. Includes members of Investment Company Institute only.
Reprinted from financialservicesfacts.orgSource: Investment Company Institute.
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Mutual Fund Size by Type of Funds($millions)
Year Equity Hybrid Bond
Taxable Money Market
Tax-exempt Money Market Total
2004 4384.10 519.30 1290.30 1602.80 310.40 8106.902003 3684.20 430.50 1247.80 1763.60 288.40 7414.402002 2662.50 325.50 1130.50 1997.20 274.80 6390.402001 3418.20 346.30 925.10 2013.00 272.40 6975.002000 3961.90 346.30 811.20 1607.30 238.00 6964.701999 4041.90 378.80 812.50 1408.70 204.40 6846.301998 2977.90 365.00 830.60 1163.20 188.50 5525.201995 1249.10 210.30 598.90 630.00 123.00 2811.301990 239.50 36.10 291.30 414.70 83.60 1065.201985 111.30 17.60 122.70 207.50 36.30 495.40
Reprinted from financialservicesfacts.orgSource: Investment Company Institute.
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A closed-end investment company has a fixed number of shares and is closed to new investment.
Investors buy and sell these shares on an exchange just like shares of stock. The pricing of closed-end fund shares is a financial puzzle - they usually sell at a discount
to their net asset value. Number of shares stays constant: An underwriter issues the shares and they remain
constant for the duration of the fund (capitalized only once), or a fund that starts as open-ended closes to new investment.
Liquidity provided for in secondary market: Entering a closed-end fund requires buying shares from existing shareholders. Exiting the fund may also require selling the shares to new investors.
Deviations in valuation: Since shares are traded instead of redeemed, it is possible for their to exist a deviation between the NAV and traded price
• The supply and demand for the fund shares may influence their price (this could not be true in a perfect capital market – violates perfect competition.
• “Trading at a discount” Share price below NAV (most common)• “Trading at a premium” Share price above NAV
Closed-End Investment Companies
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Unit Trusts and Exchange Traded Funds Unit Trust:
A unit trust is similar to a closed-ended fund in that the number of units is fixed
It is different in that the investments do not change over the duration of the fund life. The trust might consist of a portfolio of bonds that are held until maturity.
Exchange Traded Fund: A cross between all three of the prior investment companies Similar to a closed-end fund, there is continuous
trading of shares Similar to an open-end fund, investors can redeem
shares (they receive the underlying securities) Investments are generally passive (do not change),
tracking an index.
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Exchange Traded Funds
ETF characteristics that are similar to other types of investment companies Closed-end fund: Priced at every point in time, trade in secondary market. Open-end fund: Investors can purchase new shares, and share can be redeemed, in addition to
trading on a secondary market. Unit Trust: The investments are passive ETF’s generally track and index.
What are the important features of an ETF that contribute to it explosive growth? Shares are liquid and can be traded at any point in time. This circumvents mutual fund restrictions of
buying in by 1PM at the 4:30PM price If the Stock price deviates from the NAV, then arbitragers can redeem large blocks of stock and take
advantage of the mis-pricing. The result is that ETF shares reflect fairly closely the value of the underlying stock.
Costs are low. Management fees on order of passively managed index funds (18bp) are common. Tax liabs are REDUCED! ETF investors own a fractional share of the underlying stock (these are basket
shares). In other words, an investor’s ownership is directly mapped to shares in the repository, hence, when other investors redeem shares, their tax liabilities are not passed on to you. NO DOUBLE TAXATION.
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Mutual Fund v. ETF
With all of these advantages, why aren’t Mutual Funds gone?
ETF’s trade on an exchange, and investors are charge brokerage fees (ie. $19.95 per trade). If you are a dollar cost average investors (invest a little bit each month), then these fees become significant. Mutual funds will generally let you add investment to your funds without additional transaction feels.
Popular ETF’s QQQ: Qubes – Nasdaq 100 DIA: Diamonds – Dow Jones Industrial Average WEBS: ishares – World Equity Benchmark (MSCI –
Morgan Stanley Capital International index) SPR: SPDRS – SP500 index
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Benefits of Investment Company
Diversification & Divisibility: A single investment is immediately diversified
through the fund’s holdings Since a share in the fund is a proportion interest in
the securities held, this could represent fractional interest in the underlying security (Example: Would be very difficult to replicate an S&P500 index fund within a personal portfolio)
Liquidity: Underlying fund securities are often illiquid (like
Real Estate or certain non-traded debt) If investors can redeem or trade fund shares, then
these underlying assets become liquid Investing through funds might the only avenue for
investing in otherwise illiquid securities – improves market completeness, and hence efficiency.
Record Keeping: The central agent aggregates holdings, computes gains and taxable income, and sends statements.
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Benefits of Investment Company
Professional Management: Informed money managers may make better
decisions than uninformed investors. But, how much more informed are these
managers? Do they have access to private information?
Reduced transaction costs: Costs are reduced with economies of scale. Direct Costs: Brokerage and exchange fees. Less
costly to buy 500 shares of an S&P500 index fund than one share of each of the underlying firms.
Indirect Costs: Search costs and decision making Taxes: These costs might be higher or lower
depending on certain factors
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Regulation of Investment Companies
One of the most closely regulated among non-depository FIs.
Primary regulator: SEC Emphasis on full disclosure and anti-fraud measures to protect small investors. NASD supervises mutual fund share distributions.
Securities Act 1933, 1934 Investment Advisers Act, 1940. Insider Trading and Securities Fraud Enforcement
Act of 1988. Market Reform Act of 1990
Allows SEC to halt trading and introduce circuit breakers.
National Securities Markets Improvement Act of 1996.
• Exempts mutual fund sellers from state securities regulatory oversight.
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The Investment Company Act of 1940 provides the potential investor with some degree of protection from misleading advertising or incomplete investment information.
The Investment Company Industry: Regulation
Almost all mutual funds choose toorganize as a regulated investment company, so that any tax liability on capital gains and income can be passed on to the accountholders.
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The Investment Company Amendments Act of 1970 serves primarily to clarify legal points. It mandates that the fund manager and the board of directors be held to fiduciary standards in their actions.
Many states have their own version of the Securities and Exchange Commission. Today, these blue sky laws function largely to inform investors of the suitability of certain proposed investments.
The Investment Company Industry: Regulation
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The National Securities Markets Improvement Act of 1996 sought to largely eliminate Federal and state regulatory overlap. The principal effects include lower registration fees, lower broker-dealer margin fees, and ensuring that a fund’s name is consistent with its objective.
The Investment Company Industry: Regulation
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Mutual Fund Costs
Two types of fees: Sales loads
Generally, negative effect on performance outweighs benefits
Fund operating expenses Management fee 12b-1 fees
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Load vs. No-Load Fees Load funds have a salesforce and the
shareholders have to pay a sales charge.
If paid at the time of purchase, the fee is a
front-end load.
If levied when shares are sold, the fee is a
back-end load, or contingent deferred sales
charge.
A no-load fund charges no sales
commission.
In addition, all funds have management and
administrative fees
Some funds have fees for marketing costs
(known as 12-1B charges)
The Investment Company Industry: Fees
Most mutual funds separate their charges into a number of categories, making it difficult to determine the actual cost of investing. Some fees are avoidable, others can be managed.
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Compensation and Fee Structure
Mutual Funds charge fees that are independent of performance. Mangers cannot tie their pay to performance
unless they apply the compensation equally to gains as well as losses.
The magnitude of the downside is too large to make feasible, so instead, their compensation is tied to fund size. This is done in the following way
Loads: Front/back-end fees are charged to investors entering/exiting a fund. Historically these fees were around 2-3% (Charged
as a percent of amount invested), and can be as high as 8.5% per government restrictions
Industry competition has largely eroded these fees. Most funds can now be bought as “no-load”
12b-1 fees: Advertising fees, must be less than 1%, and are charges as a percent of assets under management (fund size)
Management fees: Charged annually as a percent of assets by the investment advisor, and may be as low as 18 basis points or as high as 2%. This is independent of fund performance.
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Certain expenses such as the management fee are associated with operating a mutual fund. These fees are measured by the fund’s expense ratio, which is the fund’s total expenses expressed as a percentage of the fund’s assets.
Note that within the same fund, there may be several classes of shares with different fee combinations. Their relative merits depend on how long the investor anticipates keeping the investment.
Management Fees
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The annual 12b-1 fees permit the fund manager to pass certain advertising costs on to the accountholders.
A trailing commission is an annual fee paid to a broker, sometimes independent of the level of activity in the account or its size.
Other fees include fund transfer charges, custodian fees, low-balance fees, account opening or closing fees etc.
Studies indicate that the lower the expense ratio, the better the fund performance.
Additional Fees
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Compensation and Fee Structure
Soft dollars: These are fees that are not explicitly broken out by
the Fund. For example, in exchange for distributing shares in
one of its funds, a sponsor may pay one of its brokers by directing its trades through them. The broker earns fees off these trades, and to maintain this business, they push the sponsors financial products.
The sponsor might even pay higher than required brokerage fees if other services, like analyst research, is given in return.
Soft dollars are not necessarily inefficient, but they are not transparent.
Expense Ratio: Sum of 2 and 3. Comment how you charge the fee is irrelevant
(12b-1 or management or load). It’s all a fee. Funds generally offer multiple share classes
that allow investors to choose the fee structure most desirable, in the same way that insurance policy holders choose deductibles. For example, Class A shares may be for customers choosing front-end load, B shares for Back-end, C shares for level load, and D shares for no load.
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The Investment Company Industry : Fees
Back End Load21%
No Load35%
Level Load15%
Front End Load29%
Prevalence of Load Charges by Type
Source: Wiesenberger Mutual Funds Update
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Fund Objectives
Fund Objectives: Fund charters will list in the prospectus the strategy of the investment advisor. No matter what Active strategy is chosen, it will be a function of Market Timing and/or Stock Picking.
Consider the following: Size Factors:
Small Cap – small firms Mid Cap Large Cap – large firms (IBM, Microsoft, Intel)
Growth Factors: (high or low beta - can be aggressive or non aggressive)
Value (low growth/ low beta) Blend Growth (high beta stocks)
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Fund Objectives
International: (regional or type of market) Europe Asia South America Latin America Emerging markets Developing markets
Sector Funds: Investors take on the idiosyncratic risk of the industry (stock picking) Semiconductor Pharmaceuticals Energy Financial Services Heath care Agriculture Retail
Note: The size of the fund may limit the investment options available to the investment advisor.
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With a mutual fund, return comes from the change in the net asset value, capital gains distributions, and income distributions.
Selecting A Mutual Fund
before-load(gross) return
change innet asset
valuecapital gainsdistributions
incomedistributions
beginning net asset value
+ +
=
after-load(net) return
change innet asset
valuecapital gainsdistributions
incomedistributions
beginning net asset value
+ + -
=
loadfee
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Money market funds invest in short-term government securities and sometimes in short-term corporate securities. They are used primarily as a temporary cash haven.
Bond funds invest in fixed income securities. They vary widely, and have no common maturity date to simultaneously return the components to their par value.
Stock funds vary widely in their risk and price behavior. They are classified as growth or value, and as large-cap or small-cap.
Selecting A Mutual Fund : Types of Funds
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A balanced fund is a mixture of stocks and fixed income securities. It forces discipline on the fund manager.
An international fund is limited to buying securities registered outside the country where it is sold, while a global fund can invest anywhere in the world.
Fund of funds invest only in other mutual funds. Their diversification is good, but their expense ratios tend to be higher than that of the typical mutual fund.
Selecting A Mutual Fund : Types of Funds
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Sector : Such funds invest in specific market sectors, such as physical commodities or stocks closely tied to natural resources e.g. oil, forest products, and gold.
An index fund may be a stock or bond fund that tries to behave exactly like the market. A stock index fund, for instance, may seek to mirror the performance of the Standard & Poor’s 500 stock index.
Investors should determine their investment objective first, and then choose an appropriate fund or group of funds.
Selecting A Mutual Fund : Types of Funds
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Organizational Structure
Investment Advisor: Manages the fund in accordance with the prospectus outlined by the board. If the investment advisor is not also the fund sponsor (example – Vanguard, Janus, Fidelity), then it is referred to as a sub advisor.
Distributor: Principal underwriter of the fund who sells shares to the public, either directly, or through brokerages. The distributor may also be the Investment advisor and fund sponsor, but not necessarily.
Custodian: Holds the fund’s assets, maintaining them separate from the distributor and investment advisor to protect shareholder interests. They are the repository (vault) for title to invested securities.
Transfer Agent: Processes the buy and sell orders
Independent Public Accountant: Certifies financial statements in the same manner firms have their financial statements certified.
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Management Styles
Passively managed funds: The investment advisor tracks an index and rebalances holdings only when an index changes composition NASDAQ 100 S&P500 Wilshire 2000 Dow Jones Industrial
Expenses are generally lower since there is reduced overhead. There is no investment decision making, no information collecting, and no attempt to “beat the market”.
Are index funds really passively managed? No! An index fund manager delegates the decision making to the institutional organization that has created and manages the composition of the benchmark index– Dow Jones, Standard and Poors, NASDAQ,
Willshire…
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Management Styles
Actively managed funds: An investment advisor actively trades securities in an attempt to beat the market.
There are two management styles that describe all actively managed funds! Market timing
• The manager choose the level of risk (Beta) by moving into and out of stocks at the right time
• This is not the same as stock picking. Rather, the investment advisor might move between a diversified portfolio of stocks, bonds or even cash.
Stock picking • Managers choose idiosyncratic (firm-specific) risk by selecting stocks that will “beat
the market”• Managers try to find stocks that are under-valued (buy these) or over-valued
(sell/short these). They take advantage of “mispricing”
What is the value of having and active fund manager? Less than 10% of actively managed funds beat their index on an average year.
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Turnover within funds
The following is a chart of turnover of investments within funds. 100% indicates that the average investment in the fund is bought and sold within one year.
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Resources
For details of regulation of securities firms and investment banks, visit:SEC: www.sec.govNASD: www.nasd.com
For investor information, visit:Morningstar www.morningstar.com
Several periodicals like Forbes, Fortune and Business Week provide excellent coverage of the investment company industry.
Some organizations like the Investment Company Institute publish some educational material for the public.
Most public libraries carry somereference material, such as the Morningstar Mutual Funds and the
Weisenberger Investment Company Survey.
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Questions
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Post Workshop Action Plan
Complete the Post Workshop Action Plan
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Module Summary
Monday morning you will have XX new financial management techniques that you can use immediately on your project
Don’t wait for a new project, verify financials controls on your current project
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Thank You !
Saunders Learning Group, LLC, Andover, KS
About the Author/Presenter
Floyd Saunders has worked on Wall Street with both Bank of America and JPMorgan, where is was a vice president in global financial systems. He has worked across the industry in retail, commercial, and investment banking.
He has taught courses in Money and Banking and extensively for the American Institute of Banking and various colleges.
As a consultant, he developed and taught a wide range of banking and investing courses.
He authored three programs for the American Bankers Association: Banking on Mutual Funds and Annuities, Introduction to Securities Markets and Investing in Securities.
He is the author of “Figuring Out Wall Street” and his next book is “Family Financial Freedom” a book on personal money management.
Saunders Learning Group, LLC, Andover, KS
Reference Material
Book summary: Figuring Out Wall Street, is the concise guide to help everyone understand how what to do now to restore our financial systems. Written in an easy to understand manner, even the most complex financial concepts are easy to digest. This book provides help to monitor investments with a review of investment products, financial regulators and economic indicators. Learn how the stock market exchanges work and the world of investment banking, hedge funds, venture capital and private equity. Every chapter includes action plans for investing.
Figuring Out Wall Street Consumer’s Guide To Financial Markets By Floyd Saunders Publisher: Saunders Learning Group
ISBN: 978-0-9824019-0-3
Available from Amazon: http://www.amazon.com/Figuring-Out-Wall-Street-Consumers/dp/0982401906and many other online book stores.
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