Series 65 Pooled Investments Study Guide | Economics Terms

What are pooled investments?

packaged products such as mutual funds, exchange-traded funds (ETFs), variable annuities and variable life insurance, and real estate investment trusts (REITs)

represent a pool of funds contributed by a number of investors

What are the 3 categories of investment companies based on the Act of 1940?

management, open end (mutual funds), closed-end

What is an investment company?

a corporation or a trust through which investors may acquire an interest in large, diversified portfolios of securities by pooling their funds with other investors' funds

What are the three types (NOT categories) of investment companies?

face-amount certificate (FAC) companies

management investment companies

unit investment trusts (UITs)

What is a management investment company?

Actively manages a securities portfolio to achieve a stated investment objective.

A management investment company is either closed end or open end. Mutual funds are open-end investment companies. Initially, both closed-end and open-end companies 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 the primary or secondary market.

Mutual funds are ___________ investment companies

open-end

Prohibited actives for open-end investment companies (mutual funds)

- purchase security on margin

- participate in a joint basis on trading accounts

- sell any security short

- acquire more than 3% of the voting securities in another IA

What is NAV?

net asset value

Definition of an investment company (does/does not) include holding companies

Does NOT

(T/F) NAV per share computation is critical to the purchase and sale of open-end companies

True

There can be no more than ____% of interested persons on an investment companies board of directors

60%

*40% noninterested

The Investment Company Act of 1940 prohibits registered open-end investment companies from engaging in any of the following practices except:

A. issuing common stock.

B. selling short or purchasing securities for the company's portfolio on margin.

C. owning more than 3% of the outstanding voting securities of another investment company.

D. opening a joint account with another investment company.

A. issuing common stock

What is the least amount that a public offering of securities from a registered investment company is required to be?

$100,000 net worth

What is required for a fundamental policy change at an investment company?

majority vote of the outstanding voting stock

What are the requirements of a written contract between the investment advisory & their underwriter?

- be approved by the majority vote of shareholders

- describes all compensation

- will be approved at least annually if it is to be renewed after the first two years

- may be terminated at any time

Define an affiliated person:

Any person directly or indirectly owning, controlling, or holding, with power to vote, 5% or more of the outstanding shares of the investment company

Define a control person:

a person owning or controlling more than 25% of outstanding shares

Where is a registered investment company required to keep/house their assets?

With a custodian

*Alternatively, the investment company may use a broker-dealer that is a member firm of a national securities exchange.

ABC is an FINRA member broker-dealer. Among other functions, it serves as the principal underwriter of the XYZ Mutual Fund. Which of the following transactions of ABC would be prohibited?

A. ABC tenders, from its investment account, 500 shares of the XYZ Mutual Fund for redemption.

B. ABC purchases, for its investment account, 500 shares of XYZ Mutual Fund.

C. ABC purchases some securities directly from XYZ's portfolio.

D. All of these.

C. It would be a violation of the Investment Company Act of 1940 for any affiliated person, such as the principal underwriter, to purchase any security from an investment company other than shares of the fund itself. Investing in the fund's shares would be permitted, not prohibited.

What can a shareholder vote on for investment companies?

- changing the nature of business

- changing investment objectives or policies

- changing investment advisors

majority vote of shareholders is required

The price of a closed-end investment company is (dependent on/independent of) the fund's net asset value per share

independent of

An investor is always purchasing newly issued shares of common stock when investing in

A. a closed-end investment company.

B. an open-end investment company (mutual fund).

C. a unit investment trust (UIT).

D. a holding company.

Answer: B. A unique characteristic of mutual funds is that they are capitalized by a continuous offering of new shares. Whenever an investor adds to her portfolio, she is buying new shares of common stock issued by that fund. In a UIT, the investor is purchasing units, not shares.

Because mutual funds are a continuous new offering, the _________________ must be distributed to a prospective investor before or during any solicitation for sale.

prospectus

(T/F) Investors in mutual funds are always purchasing a new issue

True

(T/F) NAV for closed funds is also calculated daily.

False.

We said earlier that closed-end funds also compute NAV; however, because their price is determined by supply and demand and, as a consequence, may be more than, the same as, or less than the NAV, it does not have the relevance that it does with open-end funds. Therefore, instead of daily computation, it is generally only done once per week.

Daniella has a number of investment company products within her retirement portfolio. One of these investments trades on an exchange and may trade at a premium or discount to its net asset value. These features are most likely found in what type of investment?

A. Closed-end investment company

B. Unit investment trust

C. Open-end investment company

D. Face-amount certificate company

Answer: A. A closed-end investment company (closed-end fund, or CEF) is a type of investment company whose shares trade in the secondary market. It is critical to remember for the exam that the price of the shares of a closed-end company is based on supply and demand and, therefore, can sell at, above, or below the fund's net asset value

An investment company's portfolio is elastic meaning...

Money is simultaneously invested into the fund and paid out when shares are redeemed. The investor's account value fluctuates proportionately with the mutual fund portfolio's value.

Which type of investment company can only issue common stock?

OEIC - open end investment companies

What are redeemable securities?

When an investor sells, the company buys back that share at NAV

What is IPO and which type of investment company does this?

Initial public offering, closed end

What is public offering price?

POP = NAV + any sales charges

*applies only to open end investment company

(T/F) Closed end companies can issue bonds, preferred stock, & common stock

True

NAV per share is found....

Net assets / # of outstanding shares

*Net assets = a fund's liabilities - a fund's assets

What is this an example of?

An order received prior to 4pm EST uses the same day's NAV. Any order received after 4pm EST uses the next day's NAV for pricing.

Forward Pricing

Mutual funds NAV is calculated how often?

At least once per day

(T/F) An open end fund can NEVER have a POP below the NAV

True

The actual schedule of sales charges for a fund is specified in the ___________________

prospectus

An expense ratio of 1.72% means that the fund spends $1.72 per year for every $100 of invested assets.

True *The expense ratio is calculated by dividing annual operating expenses by the average dollar value of the fund's assets under management

Define front-end loads

difference between POP and net NAV

Define back-end loads

contingent deferred sales loads

Define 12b-1 fees

asset-based fees—technically not a sales charge, but may be referred to as an asset-based sales charge on the exam.

A 12b-1 fee is used for:

Marketing and distribution purposes only.

None of that money is used to pay the for the fund's portfolio management.

What is a CDSC?

contingent deferred sales charge or load

(back-end load)

Which class of shares usually has a lower sales charge as well as operating expense?

Class A

Which other classes could possibly be referenced on the exam?

1. Class I shares, which would be sold only to institutional investors (hence the letter I), and usually have lower fees and expenses.

2. Class R shares, which would be sold only to participants in retirement plans, such as a 401(k), and have no front-end or back-end load, but may have a 12b-1 fee that is lower than Class B and Class C shares, but higher than Class A shares.

A person who plans to invest more money with the same mutual fund company may decrease overall sales charges by signing a

letter of intent (LOI)

How do rights of accumulation differ from a LOI (letter of intent)?

- are available for subsequent investments (the reduced sales charges will not apply to initial transactions);

- do not require making a specific commitment for future investment;

- allow the investor to use prior share appreciation to qualify for breakpoints

- do not impose time limits.

When discussing investment companies, the term sales load most commonly refers to:

A. the fund's sales charge, expressed as a percentage of the NAV.

B. the fund's sales charge, expressed as a percentage of the public offering price.

C. the commission earned by the broker-dealer making the sale.

D. the 12b-1 fee.

B

12b-1 fees are a maximum of 0.75% & are charged

against the fund's NAV

*A 12b-1 fee is a yearly marketing or distribution fee that mutual funds charge investors

FINRA prohibits a sales charge in excess of

8.5% of the POP

A fund can use the term "no-load" only if...

the 12b-1 fee is less than 0.25%

What are two ways to get a reduction of sales charges for funds?

breakpoints & rights of accumulation

Define breakpoint:

a sale of declining sales charges based on the amount invested.

Who are breakpoints available to?

Any person. For a breakpoint qualification, the term any person includes married couples, parents and their minor children, and corporations. Investment clubs or associations formed for the purpose of investing do not qualify for breakpoints.

What are some general characteristics of the class shares?

- Class A shares (front-end load): investors pay the charge at the time of purchase.

- Class B shares (back-end load): declines over time so investors pay the charge at redemption.

- Class C shares (level load): no sales charge to purchase; generally a 1% CDSC for one year, with a continuous 12b-1 charge.

What is a breakpoint sale?

Sale of investment company shares in dollar amounts slightly below the point at which the sales charge is reduced on quantity transactions to make higher commission. In other words... this is a violation of conduct rules because you allow the client to buy shares in an amount immediately below the amount that would qualify them for a discounted sales charge without informing them about it

Which type of investment is meant for investors to hold long term?

(hedge funds/private funds)

Private funds

What are the two categories of private funds?

Direct investments & portfolio investments

Define private liquidity fund:

any private fund that seeks to generate income by investing in a portfolio of short-term obligations in order to maintain a stable net asset value (NAV) per unit or minimize principal volatility for investors

*sounds like a money market fund

Which type of investment looks to invest in businesses that aren't yet operational?

venture capital funds

What is carried interest?

Compensation to the fund manager. Typically, the annual management fee is 2% of committed capital plus 20% of the profits when the business is sold

What is the primary aim of most hedge funds?

to reduce volatility and risk while attempting to preserve capital and deliver positive returns under all market conditions

Define a lock-up provision

during a certain initial period, an investor may not make a withdrawal from the fund

What is "generally" the minimum to invest in a hedge fund?

$500,000 - $1,000,000

Why does the phrase "skin in the game" apply to portfolio managers of hedge funds?

Most hedge funds are organized as limited partnerships with the portfolio managers investing along with the investors. As they say in the industry, they have "skin in the game," so they have a greater motivation to succeed. The partnership is the issuer of the ownership units

Which type of investment company is most often organized as a limited partnership?

A. Face-amount certificate company

B. Exchange-traded fund

C. Hedge fund

D. Unit investment trust

B

What is FOF?

Fund of funds

What are some characteristics of private funds?

- not registered with SEC or states

- fund manager registered if not exempt

- high risk, low liquidity

- high compensation to manager

- private equity funds look for "going concerns"

- venture capital funds look for earliest stages

What are some characteristics of hedge funds?

- not regulated (does not fall under the Investment Company Act of 1940)

- uses aggressive investment techniques (short selling, margins, derivatives, currency & commodity speculation)

- can use arbitrage (legal)

- suitable for sophisticated investors only

- high fees & expenses, manager performance bonuses

- lack of transparency compared to mutual funds

- limited liquidity, lock-up period (6mo - 2 years)

- does not trade on NASDAQ

- partnership interest

Define a qualified purchaser?

Individuals with at least $5 million in investments, or business entities with at least $25 million in investments

Louis owns an investment that is an unmanaged portfolio in which the money manager initially selects the securities to be included in the portfolio, and then holds those securities until they mature or the investment portfolio terminates. This statement best describes which type of investment?

A. Closed-end investment company

B. Face-amount certificate company

C. Open-end investment company

D. Unit investment trust

D. Unit Investment Trust

What are some of the key features of UITs?

Unit investment trusts

- not actively managed; there is no board of directors (BOD) or investment adviser.

- units are redeemable at NAV

- portfolio of equity or debt fixed at inception

- UITs are investment companies as defined under the Investment Company Act of 1940.

Which of the following is not touted as an advantage to purchasing ETFs instead of index mutual funds?

A. Intra-day trading

B. Typically lower expense ratios

C. Performance is generally better than the underlying index

D. Can be purchased on margin

C

What is an ETF?

Exchange traded fund

ETFs must register with the SEC as what?

A OEIC or UIT

open ended investment company or unit investment trust

*ETFs cannot be called a mutual fund*

Any class of assets that has a published index around it and is liquid can be made into an...

ETF

What is a Real Estate Investment Trust (REIT)?

a company that manages a portfolio of real estate investments to earn profits and/or income for its shareholders

There are three numbers relating to REITs that might be tested. The REIT must:

- Invest at least 75% of its total assets in real estate assets and cash;

- Derive at least 75% of its gross income from real estate related sources, including rents from real property and interest on mortgages financing real property; and

- Distribute at least 90% of its taxable income to shareholders annually in the form of dividends.

What are the four important points to remember about REITs?

- an owner of REITs holds an undivided interest in a pool of real estate investments.

- REITs are liquid because they trade on exchanges and over the counter.

- REITs are not investment companies (mutual funds).

- REITs offer dividends and gains to investors but do not flow through losses like limited partnerships, and therefore are not considered direct participation programs

What are some characteristics of ETFs?

- continuous pricing (trade on secondary markets)

- marginable securities

- generally no tax consequences until shares are sold

- low expense & operating costs

- commissionable transactions

Non-traded REITs

Real estate investment trusts that are not listed on public securities exchanges, offering investors a way to invest in real estate portfolios without the liquidity of traded REITs.

should have an increased suitability requirement

What are some of the benefits of pooled investments?

- low minimum initial investment

- diversification

- liquidity

- professional management

What are some of the risks of pooled investments?

- market & interest rate

- fees & expenses

- manager's timing

Any exchange of funds is considered a _______ for tax purposes. Any gains or losses are fully reportable at the time of the exchange.

sale

It is generally agreed that the number one advantage to investing in mutual funds is...

diversification

One of your clients wishes to invest in a hedge fund. You should explain which of the following points?

A. Shares of these funds are easy to redeem.

B. The fund can be expected to generate a profit whether the markets trend up or trend down.

C. These funds purchase a large amount of preferred stock.

D. Expenses for these funds tend to be higher than those for traditional mutual funds.

D.

In order for a REIT to avoid being taxed like a corporation, it must distribute at least

A. 75% of its taxable income.

B. 90% of its taxable income.

C. 95% of its taxable income.

D. 100% of its taxable income.

B.

An investor has been comparing several different mutual funds with the same objectives. When making the decision as to which fund to purchase, which of the following factors would be the most important?

A. The date of the annual shareholder's meeting

B. The exchange on which the fund is listed

C. The net assets value per share

D. The fund manager's tenure

D.

The fund manager's tenure (the number of years that manager has been managing that fund's portfolio) is important because, although past performance is no guarantee of the future, in general, investors prefer someone who has performed well over the years instead of a manager with only a year or two at the helm. Because investors in mutual funds invariably purchase in a dollar amount rather than by the number of shares, the NAV per share is not a factor. That is, if you invest $10,000, what difference does it really make if the NAV per share is $10 or $100? No mutual funds are traded on the listed exchanges, and why would someone buy a fund based on the date of the annual meeting?

Open-end investment companies are prohibited from engaging in several activities. Mutual funds may not:

- purchase any security on margin;

- participate on a joint basis in any trading account in securities (i.e., an investment company cannot have a joint account with someone else);

- sell any security short; or

- acquire more than 3% of the outstanding voting securities of another investment company.

Because mutual funds are a continuous new issue, they _________ be purchased on margin

cannot