Ch 8: Investm Companies Flashcards
(105 cards)
1
Q
investm company
A
corp/trust through which investors may require an interest in large, diversified portfolios of secs by pooling their funds with other investors’ funds and buying shares/units of the fund
2
Q
3 types of investm cos
A
- Mgmt investm cos
- Unit Investm Trust (UITs)
- Face amount certificate cos (FACs)
3
Q
FACs
A
contract between an investor and an issuer in which the issuer guarantees payment of a stated/fixed sum to the investor at some set date in the future
In return for this future payment, the investor agrees to pay the issuer a set amt of money either as lump sum or periodic installments.
JUST KNOW THAT THIS SEC IS 1 OF THE 3 TYPES.
4
Q
UITs
A
an unmanaged investm co. organized under a trust indenture.
UITs:
- DO NOT have board of directors
- DO NOT employ an investm adviser
- DO NOT actively manage their own portfolios (trade secs)
IMPORTANT FEATURES OF UITs:
- UITs are NOT actively managed; no BOD or investm adviser
- UIT shares (or units) must be redeemed by the trust
- UITs are investm companies as defined under the Investm Co. Act
5
Q
UITs: issue or trade?
A
UIT issues only redeemable secs (known as UNITS orr SHARES OF BENEFICIAL INTEREST) each of which reps an undivided interest in the portfolio.
Once the specified total is raised, trustees use investor’s money to purchase secs designed to meet the UIT’s stated obj. The trustees must maintain secondary markets in the units, thus allowing unit holders the ability to redeem their units at NAV.
Without an adviser, the portfolio remains FIXED.
UITs are sold by prospectus.
6
Q
mgmt investm cos
A
actively manages a securities portfolio to achieve a stated investm objective
can be either open or closed
both closed-end and open-end cos sell shares to the public; the difference between them lies in the way they raise capital and how investors buy and sell their shares (in primary and secondary mkts). so basically:
- initial raising capitalization
- how they’re priced + bought/sold
7
Q
NAV
A
(value of all assets - liabilities) / # of sh understanding
NAV per share computation is critical to the buying and selling of open-end cos; has little to do with close-ended funds
8
Q
***definition of “investm company” DOES NOT include…
A
holding companies
9
Q
special term only used for mgmt cos…
A
diversified/undiversified
diversified investm co is one that meets the following 75-5-10 requirement:
- at least 75% of the fund’s total A must be invested in cash and secs issued by cos other than the investm co itself or its affiliates
- 75% must be invested in such a way that…
1) NOR MORE THAN 5% OF THE FUND’S TOTAL A are invested in the secs of any 1 issuer AND
2) no more than 10% of the outstanding voting secs of any 1 issuer is owned (by the 75%)
10
Q
Open-End Investm Companies Initial Capitalization (the way they raise capital from investors)
A
Open endeds/mutual funds DO NOT specify the exact # of shares it intends to issue. It registers an open offering with the SEC
open-end investm co. can raise an unlimited amt of investm capital by continuously issuing new shares. AND bc the shares area ALWAYS A NEW ISSUE, it’s required to deliver a PROSPECTUS PRIORT TO/CONCURRENT WITH THE SALE.
Money invested goes to the issuer (the MF). 1 other point is that open-end cos COMMONLY ISSUE COMMON STOCK!!! Money raised from issuance of common stock is then used by PMs to invest in secs meeting that fund’s obj
11
Q
***so an open-end investm co can by preferred stock and bonds, but…
A
it cannot issue any security other than common stock
12
Q
Closed-End Investm Companies Initial Capitalization (the way they raise capital from investors)
A
close-ended investm companies conduct a common stock offering to raise capital. For the initial offering, the co. registers a FIXED # OF SHARES with the SEC and offers to the public for a limited time through underwriting group (similar to IPO)
fund’s capitalization is FIXED unless additional public offerings made later.
Investors CANNOT REDEEM shares back to the co. Investors close their position by selling them in the 2nd market just like trading stocks. 1 exception to this (details to come)
Close-end funds can also issue bonds and pref stock. Therefore, cap structure of a closed-end co can resemble a corp - common stock , pref stock, and bonds!
13
Q
Investors cannot redeem shares of a close-end fund, BUT there is an exception! 1 type of close-end funds called…
A
interval funds; key facts:
- it’s a closed-ended investm co, registered under the Act
- unlike other closed-end funds, interval funds do NOT TRADE on 2nd market
- they’re called interval funds bc at certain intervals, which may be anything from monthly to annually, investors are allowed to sell a portion of their shares back to the fund at NAV
- 1 benefit of these funds is that the PM can take certain illiquid positions a MF manager might not take bc there is no need for daily liquidity with an interval fund
- in general, these would be MORE SUITABLE FOR AN INVESTOR WITH A LONGER TERM HORIZON
14
Q
Business Development Company (BDC)
A
type of closed-end investm co regulated under the Act; these are creates by an act by Congress
purpose was to create a new vehicle in the promotion and development of small businesses.
It does not have the flexibility of regular closed-end funds bc at least 70% of its A must be invested “eligible” assets.
ELIGIBLE PORTFOLIO COMPANY includes ANY issuer that does NOT have any class of secs listed on a national securities exchange; The exception is for issuers with a class of secs listed on a national sec exchange if they have an aggregate MV of outstanding voting and non-voting common equity of less than $250M.
15
Q
The most significant difference between a closed-end fund and a BDC?
A
for eligible assets, the BDC must make available significant managerial assistance.
In other words, in addition to being an investm co, a BDC is also an operating company.
16
Q
*****biggest difference between open-end and CEFs…
A
how they’re priced; only the open-end co. whose price is solely dependent upon that calculation of NAV
*** CEFs trade in the 2nd market (exchange or OTC); price based on supply and demand of shares. As a result, their buying + selling price does NOT fully relate to NAV of shares (market price of a closed-end fund is independent of the fund’s NAV)
17
Q
closed-end investm co are commonly known as…
A
publicly traded funds
after stock is distributed, anyone can buy./sells hares in 2nd market (either on exchange or OTC)
supply and demand determine the bid and ask prices
Close-end fund shares usually trade at a premium/discount to the shares’ NAV
18
Q
bid vs ask price
A
bid - price at which an investor can sell
ask - price that an investor can buy
19
Q
pricing open-end investm co shares
A
any person who wants to invest in the co buys shares DIRECTLY FROM THE CO/UNDERWRITERS at the PUBLIC OFFERING PRICE (POP)
20
Q
POP
A
public offering price for mutual funds/open ended funds
MF’s POP is the NAV per share plus any applicable sales charge.
no secondary trading of shares in these
21
Q
open-ended investm co sells…
A
redeemable secs
when investors liquidate their shares, the co. redeems them at their NAV; for each share an investor redeems, the co sends the investor money for the investor’s proportionate share of the co’s net assets.
Therefore, a MF’s capital SHRINKS when investors REDEEM shares.
Each investor’s share in the fund’s performance is based on the # of shares owned. MF shares may be bought in either full/fractional units (unlike stock, which must be bought in full units only). So think of MF shares in terms of DOLLARS rather than # of shares owned.
Since CEFs trade like corporate stock, fractional shares are not available
22
Q
Forward pricing
A
open-end investm cos (MFs) must compute their NAV per share at least once per day as of the close of the mkts.
Price is determined based on forward pricing principle (next computed NAV per share)
23
Q
how often is NAV calculated for CEFs?
A
weekly (not daily) since their price is independent to NAV
24
Q
FINRA prohibits underwriters from assessing sales charges more than…
A
8.5% of POP on the purchase of open-end investm co shares.
historically, MFs change FRONT-END LOADS of up to 8.5% of the money invested (POP); today, few charge that much. Instead, funds may charge a BACK-END LOAD when funds are withdrawn.
Some funds charge ongoing fees under section 12b-1 of the Investm Co Act.
25
*** the term for the expense of buying/selling MF shares is called...
sales charge/sales load/charge/load
26
Costs to purchase MFs
ALL sales commissions and expenses for open-ended funds are contained in the POP/other fees.
Sales expenses include: commissions for managing underwriter/BDs/registered reps, advertising expenses.
MFs use different methods to collect fees for sales of shares and for compensating sales persons on an ongoing basis (trailer commissions):
- front-end loads (POP - NAV) - CLASS A SHARES
- back-end loads (contingent deferred sales loads) - mostly B SHARES
- level loads (asset-based fees; provides trail commissions to the RR servicing the acct) - C SHARERS
27
Class A Share fees
front-end load
charges added to NAV at time an investor buys shares.
most common way of paying for distribution services that a funds underwriter and BDs provide
28
Breakpoints
these are a schedule of quantity purchase discounts a MF offers
MFs that offer breakpoints must disclose their breakpoint schedule in thee prospectus and how an acct is valued for breakpoint purposes.
Discounts may be the result of a single large investm, series of aggregated investments, or a promise to invest via LOI.
29
***WHO is eligible for breakpoints?
married couples, parents with minor children, corporations.
parents combined with adult children (even if they're legally considered dependents) and investment clubs are NOT eligible.
30
FINRA PROHIBITS RRs from making/seeking higher commissions by...
selling investm co shares in a dollar amt JUST BELOW THE POINT AT WHICH THE SALES CHARGE IS REDUCED.
THIS IS A "BREAKPOINT SALE"
31
Letter of Intent (LOI)
person signs an LOI informing the investm co that he intends to invest the additional funds necessary to reach the breakpoint within 13 months
It's a one-sided contract binding on the fund only. If customer does NOT invest enough money to complete LOI, he's given the choice to either pay the sales charge difference or have the underwriter liquidate enough of the escrowed shares to do.
32
backdating the letter
fund often permits a customer to sign a LOI as late as the 90th day after an initial purchase. LOI may be backdated up to 90 days to include prior purchases but may NOT over more than 13 months in total.
customer who signs the LOI 60 days after purchase has 11 months to complete the letter
33
*KEY POINTS OF LOI
- letters of intent are good for max of 13 months and may be backdated 90 days
- if LOI is NOT completed, the sales charge amt that applies is based on total amt invested
- share appreciation and income paid by the fund do NOT count toward completion of the letter
34
Rights of accumulation vs LOI
Rights of acc (like an LOII) allows investor to reduce sales charged by reaching a breakpoint.
MAJOR DIFFERENCES:
- allow the investor to use prior share appreciation and reinvestm to quality for breakpoints and
- do not impose time limits
35
Combination privilege
MF co frequently offers more than 1 fund and refers to these multiple offerings as its family of funds.
Investor seeks a reduced sales charge by allowing the COMBINATION OF SEPARATE INVESTMENTS IN 2 OR MORE FUNDS within the same family to reach a breakpoint.
36
Class B shares
DO NOT charge a front-end sales charge/sales charge at time of purchase. so 100 cents of the invested dollar are invested.
DO impose a back-end charge for early redemption of shares.
In addition, there is an asset-based 12b-1 fee greater than those for Class A shares.
***Altho not a violation, regulators scrutinize large purchases of Class B shares. A purchase large enough to reach a significant Class A share breakpoint results in a low enough sales charge that, in just a few yrs, the lower operating expenses o the Class A shares will more than make up the difference in front-end cost. In practice, very few firms will accept an order for Class B shares in excess of $100K, particularly if the investor intends to maintain the position for a number of yrs.
37
Class C shares fees
have 1-yr 1% CDSC, a 0.75% 12b-1 fee, and a 0.25% shareholder services fee.
Since these fees are pretty high and never go away, these are known as "level loads".
Class C shares good for ST horizons bc they become quite expensive to own if investing for more than 4 yrs.
38
12b-1 fees (asset-based distribution fees)
used to cover marketing + distributing the fund to investors costs
used to compensated RRs for servicing an acct (trailer commissions) but should NOT be confused with sales charges.
fee is dedicated quarterly as % fo fund's avg total NAV.
MAX 12B-1 FEE IS 0.75% FOR DISTRIBUTION AND PROMOTION. FINRA permits funds to charge an additional 0.25% service fee. SO total of 1%, where only 0.75% of that is the 12b-1 fee.
39
No-load funds
funds that DO NOT charge any type of sales load.
no-load fund is permitted to charge redemption fees. charged if investor is going in and out of the fund too frequently.
combined amt of fund's 12b-1 fees or separate shareholder service fees CANNOT EXCEED 0.25% of the fund's avg annual net assets
40
misusing "no-load" terminology
fund that has a deferred sales charge or 12b-1 fee of more than 0.25% of avg net assets may NOT be described as a "no load fund"
41
***12b-1 fee is expressed as...
annual amt but is charged and reviewed quarterly
42
*** charged covered by 12b-1 fees include...
advertising, sales lit, and prospectuses delivered to potential customers, not fund-mgmt expenses
43
*** in order for a fund to mkt itself to the public as a no-load fund...
fund may not charge more than 0.25% of avg net assets for 12b-1 fees
44
*** max allowable 12b-1 charge under FINRA rules is...
0.75% (so 75 bps)
45
*** FINRA does permit an additional __ charge for shareholder services, but that is treated separate from 12b-1 fee for mkting and promotion
0.25%
46
expense rratio
expenses are NOT considered a cost of purchasing the fund! sales charge is NOT considered an expense when calculating fund's expense ratio.
expense ratio expresses mgmt fees + op expenses as a % of fund's net assets
ALL MFs, load and no-load, have expense ratios
EXPENSE RAATIO = ANNUAL OP EXPENSES / AVG DOLLAR VALUE OF FUND'S AUM
47
cost of entry for MFs
initial investm as low as $1000. For IRAs, the initial $1000 might be as low as $100.
after opening the acct, additional investm may be made with as little as $25.
With a tiny sum, the investor has the diversification of aa portfolio of as many as several hundred different securities. Technically, it's said that the owner of 1 share has an UNDIVIDED INTEREST in the entire portfolio of the fund.
48
*** dollar cost avging
1 method of purchasing MF shares is through dollar cost averaging, where 1 person invested identical amounts of money at regular intervals (regardless of mkt price fluctuation).
If market price of shares are up, fewer shares are bought.
If market price of shares are down, more shares are bought.
Over time, if mkt fluctuates, dollar cost avging will achieve a lower avg cost per share than avg price per share.
REMEMBER THIS EXAMPLE: 401k plan regularly investing in an index MF is an example of dollar cost avging.
49
***dollar cost avging neither __ nor __. it merely __.
neither guarantees profit nor protects from loss. it merely results in a lower cost per share than the avg price per share.
50
Withdrawal plans
systematic withdrawals for MFs; free service
51
Fixed-dollar
for MF, a customer may request the periodic withdrawal of a fixed-dollar amt. Thus, the fund liquidates enough shares each period to send that sum.
52
Fixed-%
or fixed-shared withdrawal plan
either a fixed number of shares or fixed % of acct is liquidated each period
53
fixed-time
another MF withdrawal plan where customers liquidate their holdings over a fixed periodd
54
because withdrawal plans are not guaranteed, the RRs must...
- never promise an investor a guaranteed ROR
- stress to investor that it's possible to exhaust the acct by over-withdrawing
- state that during a down mkt it's possible that the acct will be exhausted if the investor withdraws even a small amt, and
- never use charts or tables unless the SEC specifically clears their use
55
voluntary accumulation plan
MFs have a # of arrangements to implement an investment program; This plan allows a customer to deposit regular periodic investments on a voluntary basis (minimum amts found int he prospectus)
plan is designed to help the customer form regular investm habits while still offering some flexibility; this is an easy way to take adv of dollar cost avging
*** In a voluntary accumulation plan, once the acct has been opened, contribution and frequency are VERY flexible
56
exchanges within a family of funds
many offer exchange/CONVERSION privileges within their families of funds. a MF family (called a COMPLEX) is when a single sponsor/distributor offers more than 1 fund.
Exchange privileges allows an investor to convert an investm in 1 fund for an equal investm in another fund in the same family without incurring additional sales charges.
To have the exchange take place with no-load, these rules apply:
- the purchase may NOT exceed the proceeds generated by there redemption of the other fund
- redemption may not involve a refund of sales charges
- sales personnel and dealers must receive no compensation of any kind from the reinvestment
***EXAM: MUST KNOW THIS IS A TAXABLE EVENT!!! IF TERE IS A GAIN (O LOSS) IT MUST BE REPORTED
57
major fund categories for MFs
- stock funds (invest in stocks)
- bond funds (invest in bonds)
- balanced funds (invest in combo of stocks and bonds)
- mm funds (invest in very ST instruments)
58
stock funds
objective of growth (whether it's a primary or secondary objective)
equity funds have historically outpaced inflation over most 10-yr time horizons
59
growth funds
invest in stocks of cos whose biz are growing rapidly.
growth cos tend to reinvest all/most of their profits for R&D instead of paying out dividends. Growth funds focused on generating capital gains rather than income.
Growth managers may consider stocks that many feel are OVERVALUED bc there may still be upside potential. As such, funds managed for growth tend to have elevated levels of risk.
Blue-chip or conservative growth funds invest in established and more recognized companies to achieve growth with less risk.
- usually large market caps; funds tend to be more stable and less volatile in a turbulent market
Type of investor: investor willing to take moderate risk and is willing to invest for a min of 5-7 yrs may be interested in a blue-chip or large-cap growth fund.
60
aggressive growth funds / performance funds
funds are willing to take GREATER RISK TO MAXIMIZE CAPITAL APPRECIATION.
Some of these funds invest in newer cos with relatively small market caps and are called SMALL CAP FUNSD.
Mid cap funds (somewhat less aggressive - $2-$10B market caps)
Large-cap funds ( >$10B); lower the market cap, greater the volatility
Type of investor: An investor who's seeking high potential returns with the understanding that there can ALSO BE SIGNIFICANT LOSSES and is WILLING TO INVEST FOR 10-15 YRS may be interested in an aggressive growth fund that focuses on small/mid cap cos.
61
Value funds
value managers focus on cos whose stocks are currently. undervalued (earnings potential is not reflected in stock price); undervalued cos are expected to perform better than reports indicate (so opp for profit!)
value stocks typically have DIVIDEND YEILDS HIGHER THAN GROWTH STOCKS. Funds managed for value are considered more conservative than funds managed for growth.
Type of investor: willing to take MODERATE RISK when investing to purchase a vacation home in 7-10 yrs may be interested in a fund that's VALUE-ORIENTED.
62
Equity income funds
mostly made of stock in this portfolio; STRESSES CURRENT INCOME OVER GROWTH.
Fund's obj may be accomplished by INVESTING IN THE STOCK OF COMPANIES WITH LONG HISTORIES OF DIVIDEND PAYMENTS (ie utility companies, blue-chip stocks, preferred stocks); managed for INCOME, NOT GROWTH.
Type of investor: Willing to take low to moderate risk and seeks income from equity investm in the form of dividends with some capital appreciation; they may invest in equity income funds, utility funds, or preferred stock fund.
63
option income funds
invest in securities on which call options can be sold (known as covered calls); they earn premium income from writing/selling the options.
may also earn capital gains from trading options at a profit.
These funds SEEK TO INCREASE TOTAL RETURN BY ADDING INCOME GENERATED BY OPTIONS TO APPRECIATION ON THE SEC HELD IN THE PORTFOLIO. GREATER RISK THAN INCOME FUNDS.
64
Growth and income fund
combo
attempts to combine obj of GROWTH AND CURRENT INCOME by diversifying stock portfolio among cos showing LT growth potential and cos paying high dividends.
Type of investor: Seeking dividends and capital appreciation with moderate risk may be interested in this.
65
Specialized/Sector Funds
specialize in particular economic sectors/geographic areas
speculative in nature
Ex: gold, tech, pharma, biotech, geographic
Type of investor: WILLING TO SPECULATE on investment in a particular sector they're interested in
66
Special Situation Funds
Cos that may benefit from a change within cos or in the economy.
Takeover candidates and turnaround situations are common investments!!!
Type of investor: SPECULATIVE (HIGH RISK); Investors believing banking is going thru M&A or those willing to take on more risk growth stocks. Both growth and vale mgmt styles are used. Purpose is to allow investors to DIVERSIFY THEIR INVESTMENT via mgmt and securities in a single fund.
Value funds are considered more conservative than growth or blend/core funds.
67
index fnds
mirrors market index
turnover of sec in these portfolio is minimal bc the only trades that take place are triggered by a change in the index (ie 1 company replacing another).
As a result, these funds usually have lower mgmt costs than other types of funds.
Type of investor: Investor does NOT believe in paying for the professional stock selection of a managed fund. Aka believes it's difficult to outperform the market.
68
International Funds vs Global Funds
International funds have entire portfolio invested in sec issued OUTSIDE OF THE US.
Primary obj: LT capital appreciation; altho some funds that seek current income
Global funds - have portfolio invested around the global, INCLUDING US SECURITIES.
risks: currency risk, political risk
international and global stock funds are often purchased to diversify an investor's portfolio.
69
balanced funds/hybrid funds
invest in stocks for appreciation and bonds for income.
In a balanced fund, different types of securities are purchased according to a formula the manager may adjust to reflect market conditions.
Type of investor: one who seeks a conservative balance between stocks and bonds
70
asset allocation funds
split investm between stocks for growth, bonds for income, and money mkt instruments or cash for stability.
fund advisers switch weightings according ot performance. can also hold hard Assets (ie precious metals like gold and real estate)
Type of investor: target funds that target a specific goal (retirement, in a 5, 10, 15 or 20 yr period); AS TARGET YR GETS CLOSER, THE MIX OF INVESTMENTS BECOMES MORE CONSERVATIVE. INVESTORS SEEK THIS AND LOOK FORR ONE THAT PERFORM WELL UNDER MOST MARKET CONDITIONS NAD IS DIVERSIFIED BY PURCHASING MULTIPLE TYPES OF SECURITIES.
71
Target0date fund
"lifecycle fund"
designed to help manage investment risk by selecting a fund with a target date closest to the yr an investor anticipates needing the money.
KNOW THAT THESE DDO NOT PROVIDE GUARANTEED INCOME!
72
***bond funds
main investm obj: bond funds
* **REMEMBER
- bonds pay interest; bond FUNDS pay dividends if declared by fund's BOD
- dividends are typically paid on a QUARTER OR SEMIANNUAL BASIS; but there are income funds (both equity and debt-oriented) that pay monthly dividends
- when interest rates rise, the prices of bonds, and therefore bond funds, fall (vice versa)
73
Corporate Bond funds
have higher credit risk than gov issues
high yield funds - higher yields with greater credit risk; considered speculative instruments
74
tax-free (tax-exempt) bond funds and ITs
muni bond funds and UITs invest in munis or notes that produce income (dividends) exempt from federal income tax.
Type of investor: These funds are appropriate for investors in a HIGH MARGINAL TAX BRACKET SEEKING INCOME.
75
US gov funds
purchase sec issued by the US Treasury or US gov agency; agency sec funds are not considered as "safe" from default risk as US gov funds; therefore, the yields on agency security funds will be higher than US gov fund yields
Type of investor: seek current income and max safety
76
GSE
government-sponsored enterprises
type of bonds (bonds issued or guaranteed by US fed gov agencies); corporations created by Congress to foster a public purpose.
Bonds issued by most GSEs, such as the FNMA and the FHLMC, are not backed by the same guarantee as fed gov agencies.
Type of investor: investor is risk averse and seeks income, but the US gov bond fund yields are too low!
77
principal-protected mutual funds
offers investors a guarantee of principle, adj for fund dividends and distributions, on a set future date (maturity) while providing opps for higher returns through investm in high risk and higher expected return asset classes such in equities.
Investor's return will NEVER be less than original investment, less any sales load.
Usefulness and attractiveness of these principal-protected MFs is limited by 3 factors:
1) guarantee principle
2) lockup period
3) holding a mix of bonds and stocks
Type of investor: investor is risk averse but wishes to invest without possibility of losing the principle of the investm.
78
money market funds
no-load, open-end investm cos (MFs) that serve as temporary holding accts for investors' money; MM MFs are MOST SUITABLE FOR INVESTORS WHOSE FINANCIAL GOALS REQUIRE LIQUIDITY ABOVE ALL.
The interest these funds earn and distribute as dividends is computed daily and credited to customer accts monthly. In general, mm MFs offer check-writing privileges, making for extraordinary liquidity.
NAV of mm funds is usually fixed at $1/share. They are NOT guaranteed nor are they protected by FDIC insurance.
Retail mm funds are allowed to keep a NAV of $1/share. Institutional have a floating NAV, meaning price can change day to date depending on mkt conditions.
only other MMFs with a stable NA are institutional mm funds, which are 99.5% gov securities.
79
ETF
similar to index MF, they invest in a specific index. the DIFFERENCE is that ETFs trade like stock on an exchange/NASDAQ, which is similar to closed-ended investm co. So the investor can take adv of price changes due to the market, NOT JUST underlying value of stocks in portfolio.
Difference between ETFs and mutual funds is ETFs can be purchased on margin and sold short
Expenses tend to be lower than those of MFs as well, bc all the adviser has to do is match specified index, so fees are minimal. There can be tax advantages to owning ETFs.
Most ETFs are open-end companies, but they cannot e referred to as MFs bc shares are not redeemable by issuer.
80
USES OF INDEX ETFs:
- asset allocation
- following industry trends
- balancing portfolio
- speculative trading
- hedging
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Leveraged ETFs
risk associated with leverage is that that volatility can be magnified
82
Inverse/Reverse Funds
attempts to deliver returns that are the opposite fo the benchmark index they're tracking. If benchmark is down 2%, fund's goal is up by 2%.
FINRA warns investors that most leveraged and inverse ETFs reset daily, meaning that they are designed to achieve their stated obj on a daily basis.
Type of investor: NOT suitable investm for buy-and-hold investors or those with other very ST horizons.
BOTH leveraged and inverse index funds can be traded on an exchange. They're known as ETFs!
83
BENEFITS OF INCLUDING INVESTM CO SECS. IN CLIENT PORTFOLIOS?
2 most important characteristics:
1) diversification - pooling many different assets + opps to own an interest in a far greater # and range of secs than available to almost any individual investor
2) prof mgmt - someone with expertise (we hope) is "minding the store"
84
benefits to owning MFs
can be growth to high aggressiveness to conservatism.
ALL have the goal of growing the investment. Same with income funds where the goal is to generate current income with varying degrees of risk from gov bonds to high yield bonds.
If obj is capital preservation, mm funds fit he bill and then specialized funds (sector funds) which concentrate at least 25% of their portfolio in specific industries or geographic areas.
Convenience! buying and liquidating easily
Liquidity
Minimal Initial Investment - doesn't take a great deal of wealth to get started investing in funds and once you're a shareholder, most funds permit additional investm of $100 or even less.
85
Convenient Tax Info
tax return is simplified; each yr the fund distributes a FORM 1099 explaining the taxability of distributions. The investor is told how much comes from each source and instructs the investor where to put each number on the tax return!
86
Combo privilege
MF that offers more than 1 fund and refers to these multiple offerings are FAIMLY OF FUNDS. An investor seeking a reduced sales change may be allowed to combine separate investments in 2 or more funds with the same family to reach a breakpoint.
87
Exchanged within Family of Funds
exchange/conversion privilege within their families fo funds.
Exchange privileges allow an investor to convert an investm in 1 fund for an equal investm in another fund int he same family at NAV, without incurrent additional sales charge.
By staying in the same family of funds, all changes must be made free of sales loads.
***any exchange of funds is considered a SALE FOR EX PURPOSES. Any gains/losses are fully reportable at this time of the exchange
88
UITs and benefits
1. INCOME - made of debt securities; will provide higher income than a MF with similar portfolio bc there is NO MGMT FEE! 2nd benefit is the stability of the income - bc portfolio is fixed, the income does NOT fluctuate; This is particularly beneficial to those who live on the fixed income generated by their portfolios.
2. LIQUIDITY - trustees obligated to redeem units tendered by investors
3. ROLLING OVER PROCEEDS - there's a date when trust terminates a debt/equity UIT. In most cases, investors have option of investing the proceeds into a new trust, without charge.
89
ETF Benefits and CEF Benefits
1. taxation - investors only realize a capital gain/loss upon sale. Contrast that with a MF where cap gains distributions are paid ANNUALLY AND TAXED.
2. expense ratio - mgmt fee is low
3. portfolio specificity - large and ever growing # of ETFs contain options for almost ANY niche area
4. exchange traded! only 1 significant difference to CEFs - CEFs can price well above/below NAVs, but ETFs rarely stray far from NAV.
5. leveraged and inverse ETFs
CEF BENEFITS - have all of the diversification and mgmt benefits of open-end companies. Here are some benefits CEFs have that MFs don't have
1. Exchange-Traded - a # of benefits that come along with being traded in 2nd markets; Among theme is the ability to buy shares on margin and sell shares short. There is intraday trading.
note: proceeds from sale of a CEF are available 2 biz days after the trade
2. PRICING - CEFs priced based on Supply/Demand
3. LEVERAGE - CEFs can issue debt securities; that borrowed money creates fin leverage which can multiply gains
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***INDEX ETF IS DIFFERENT FROM AN INDEX MF...
1. Intraday trading - investors do NOT have to wait until end of a trading ay to buy.sell shares for index ETFs. ETF shares trade and are priced continuously through the day, making it easier for investors to react to mkt changes.
2. Market eligibility - index ETF shares are purchased on margin, subj to the same terms that apply to common stock.
3. Short selling - Index ETFs can be sold short ANY TIME during trading hours.
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MF risks
- market risk - equity funds
- interest rate risk - when int rates rise, bond prices fall; bond funds don't have a maturity date; the only MF that generally does not fluctuate in price is the mm fund, but that's a lack of growth and low income there
- net redemptions - unique to MFs; esp during declining markets, there's an excess of shareholder redemptions over new share purchases; A fund suffering with net redemptions is probably not going to deliver client the performance they're seeking
- expense risk - fund may temporarily reduce a fee; one must carefully analyze all of the costs involved, including sales charges/12b1 fees/redemption fees, mgmt fees (probably largest expense on an ongoing basis), and tax efficiency (investor has no control over manager's timing of buys and sells)
- tenure risk - contract of fund manager has to be renewed every yr; replacement might not have the same skills
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UIT risks
1. market risk if it's an equity UIT; unique tho where there is no mgmt and portfolio is fixed! meaning there's no way for the trust to get off a sinking ship when it's obvious some stocks are losing money
2. interest rate risk - difficult position fro investors when interest rates are rising; in a bond MF, the continuous inflow of new money allows fund managers to purchase new higher yield bonds
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CEF risks
1. pricing risk - price of closed-end shares is determined by supply/demand
2. leverage risk - CEF's can issue bonds; losses magnified if any
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ETF risks
1. index risk - if 1 or more sec in the index underperforms, could mess up entire ETF
2. tracking risk - impossible to have performance equal (and never better than) the index. You probably want to rec the ETF with the highest tracking reliability.
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Board of DIrectors
mgmt investm cos (open and closed end) cannot have a BOD that consists of more than 60% of persons who meet def of interested persons of investment company.
Aka at least 40% must be noninterested aka "outside" directors; these are individuals who have no connection to the fund other than a position on the board (maybe owning some shares of the fund like any investor)
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prohibited activities for open ended investm cos/MFs
- purchase of sec on margin
- joint basis in trading acct
- shorting any security
- acquiring more than 3% of outstanding voting sec of another investm co
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changes in investm policy
in order for an investm co's board to make fundamental investm policy changes, a majority vote of the outstanding voting stock is required!!! Ex of fundamental changes would include:
- change in subclassification (such as from an open-end to a closed-end co or from a diversified to nondiversified co)
- deviation from any fundamental policy in its registration statement, including a change in investm objective, AND
- changing nature of its biz where they stop to be an investm co.
any of these changes REQUIRES VOTE OF MAJORITY OF SHAREHOLDERS.
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No registered investm co is permitted to make public offering unless it has net worth of at least...
$100K
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***investment advisory and underwriter contracts
majority vote of shareholders must approve the contract between investm co and its investm adviser and the contract with its principal underwriter.
These contracts must be in writing and provide that the contract:
- precisely describes all compensation to be paid
- will be approved at least ANNUALLY by BOD or by majority vote of shareh if it is to be renewed after first 2 yrs, and
0 provides that it may be terminated at any time, without penalty, by BOD or by majority vote of shareholders on not more than 60 days' written notice to the investment advisor.
It's unlawful for a registered investm co to enter into/renew any contract with an IA or principal underwriter UNLESS TERMS HAVE BEEN APPROVED BY MAJORITY VOTE OF DIRECTORS WHO ARE NOT PARTIES TO SUCH CONTRACT AS AFFILIATED PERSONS. BASICALLY, NO ADVISORY CONTRACT (WHETHER INITIAL OR RENEWAL) MAY TAKE PLACE WITHOUT APPROVAL OF NONINTERESTED MEMBERS OF THE BOARD.
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ohw often are shareholders supposed to send fin info?
semiannually for BS and IS reports.
all investm cos must file annual fin reports with the SEC.
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Selling dividends
prohibited practice of encouraging customers to buy MF shares by implying that an upcoming distribution will benefit them. BUT the NAV of the fund will drop by the amount of the dividend!!!
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Sales agreement
For a member firm and its reps to be able to sell a particular investm co security, the firm must have a written sales agreem with the investm co.
Co says that no member firm may purchase MF shares from a client as price LOWER than NAV next quoted fo the shares. That would be an UNFAIR BIZ PRACTICE bc client can redeem at NAV directly from the fund.
Another part of agreement is designed to keep BDs from receiving compensation on sale of shares that are quickly redeemed. If any fund shares are sent in for redemption to issuer within 7 biz days after initial transaction, member will refund to the underwriter the full concession allowed to the firm on the original sale.
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Anti-Reciprocal Rule
Investm co's choice of a BD to handle portfolio transactions AND investm must be based on the BD's capabilities. Any transaction must be justified on the basis of the value and quality of the brokerage services offered (not basis of the dollar amt of investm company shares by that BD)
Funds should NOT be selected on basis of additional brokerage.
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noncash compensation
Gifts of material value not to exceed $100/person may be given, as well as occasional meals/tickets to sporting events or to educational meetings.
Sales incentives and rewards mutt NOT favor sale of 1 fund over another based on amt of compensation received by member.
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Gifts Rule
prohibits value of $100 per yr to any person where such payment is in relation to the biz of the recipient's employer. There's no limit on the gifts/compensation that may be given to employees, as long as it sin't designed to reward/influence sale of specific products.
