Lesson 4: Investment Companies

Investment companies

pool money from investors and deploy it based on specific investment goals

Management companies

• type of investment company that includes open-end funds (mutual funds) and closed-end funds

• actively manage portfolios to achieve stated investment objectives

Open-end fund (mutual fund)

• number of shares: unlimited

• capitalization: continuous offering

• secondary market: purchased and redeemed with fund

• pricing: buy at public offer price (POP) and sell at net asset value (NAV)

• investors buy common stock of mutual funds which invest in diverse asset classes

Public offer price

NAV + sales charge

Closed-End Fund

• number of shares: fixed

• capitalization: one time IPO

• secondary market: exchanges or OTC

• pricing: supply & demand, bid-ask spread

Purchasing mutual funds

• purchase from fund family (Vanguard, Fidelity T. Rowe, etc.)

• all shares are new shares

• sales price may include a sales charge

Ways to reduce sales charge (SC)

1. Breakpoints

2. Letters of intent

3. Rights of accumulation

Breakpoint

• reduced sales charge for large investments

• as more is invested, NAV stays the same but POP gets smaller

Letters of intent

• a breakpoint discount based on a commitment to invest a specified amount over a period of time (13 months)

• is not legally binding for the client

Rights of accumulation

• A reduced sales charge based on share appreciation and aggregated holdings (total investments) in related accounts

• can aggregate w/ immediate family members (spouse/children)

• aggregate holdings in different accounts owned by the investor

Net asset value (NAV)

• is updated by mutual funds on a daily basis

• portfolio value - fund liabilities

• per share = NAV / shares outstanding

No load fund

a mutual fund without a sales charge

Forward pricing

• describes how mutual fund orders are filled at a price based on the next calculation NAV plus a sales charge if applicable

• mutual fund orders can be placed throughout the day but are executed at 4:00 pm ET (next NAV)

mutual fund expense ratio

• the annual fee to run a fund

• includes management fees → pay the fund’s portfolio manager and typically the largest expense

• 12b-1 fees → pays for marketing and shareholder services

• other expenses → misc. costs outside 12b-1 fees

• equals the operating expenses / average value of fund assets

Class A shares

• have an upfront sales charge and offer breakpoints

• cheaper way for long term ownership of mutual funds

• has the lowest 12b-1 fees

Class B shares

have a back-end sales charge (paid on redemption) and do not offer breakpoints

Class C shares

have a level load (assessed each year) and do not offer breakpoints

Unit Investment Trusts (UITs)

• a type of investment company that holds a fixed portfolio

• sell redeemable shares or “units” to investors typically in a one-time public offering (no secondary market)

• passively managed/supervised

• distributes portfolio income to investors (no reinvestment in the UTI)

• on the trust’s maturity dates any remaining securities in the portfolio are liquidated and distributed to investors

Exchange-Traded Funds (ETFs)

• a type of UIT that tracks an underlying index

• trade intra-day in the market

• track an index, sector, or commodity

• more liquid than mutual funds and typically have lower fees for investors

Reconstitution

the process of updating an ETF portfolio as companies are added or subtracted from the underlying index

investment company cost basis

• investors who reinvest their dividends into an investment company must adjust their basis upward by the amount reinvested

• investors pay taxes on reinvested dividends

• investors do not pay a sales charge on reinvested dividends

summary prospectus

• includes highlights and pertinent information from the full prospectus

• if provided must be delivered to investors by the time of sales

• if provided the full prospectus must still be made available

• only mutual funds must provide them to investors

mutual fund custodian

responsible for holding and safekeeping a mutual fund’s cash and securities

Face-Amount Certificates (FAC)

a type of investment company that issues debt securities that guarantee the payment of a stated face value sum to the investor on a specific future date