Chapter 17: Mutual Funds: Structure and Regulation

what are the tax implications of a mutual fund trust for the issuer?

the trust structure enables the funds itself to avoid tax.

the most common structure for mutual funds i an open-end trust. A mutual fund trust does not pay tax itself; instead, it distributes all earned income to the unitholders, and the unitholders pay tax on their share of earnings.

How is the NAVPS calculated?

NAVPS = (Total assets of fund - Total liabilities of fund)/ Number of units outstanding

How is a mutual fund’s MER calculated?

Management expense ratio (MER) = Annual total of fees and expenses/ average net asset value

what is a “trailer fee”?

It is a fee charged to the unitholders and paid to the salesperson for the ongoing advice he or she provides

*once you sell an investor a fund, your job is not done - you must meet with the investor regularly to ensure that his or her needs have not changed! A trailer fee is sometimes referred to as a “service fee”. This fee is usually paid out of the management fee.

What is SEDAR +?

System for Electronic Document Analysis and Retrieval +

Mutual funds are subject to regulatory disclosure requirements including Annual Information Forms and financial statements, which are available through the system from Electronic Document Analysis and Retrieval + (SEDAR +) website.

What function does a fund’s transfer agent serve?

a transfer agent maintains records of who owns units

what is an early redemption fee designed to discourage?

short-term trading of mutual funds.

some funds will charge an early redemption fee. With the exception of money market funds, mutual funds are primarily meant to be longer-term investments; therefore, these fees are designed to discourage an investor from using them as short-term investment vehicles.

Are front-end load fees negotiable?

Yes, front-end load fees are negotiable

Front-end load fees ARE negotiable because they are set by the distributor (The distributor can reduce it’s own fee.)

With mutual funds, who receives the trailer fee payment?

the mutual fund sales representative

a “trailer fee” is a service fee that the fund manager pays annually (For as long as the client holds the fund) to the mutual fund sales representative who sold the fund.

Jack has authorized his investment firm to purchase $100 every month into units of XYZ Fund. What is the name of this plan?

a pre-authorized contribution (PAC) plan

a PAC plan allows an investor to authorize regular (monthly, quarterly, etc.) small investments in their accounts.

What is the minimum frequency with which a new mutual fund must calculate its NAVPS?

Weekly

National Instrument 81-102 states that all new funds must calculate NAVPS at least once per week. One exception to this rule is real estate funds, which must calculate the NAVPS at least once per year. This exception is granted becuase it can be very expensive and time-consuming to value a portfolio of real estate.

Will a fund that is actively managed typically have a higher or lower management cost than a fund that is passively managed?

a higher management cost

many fund managers need to make a lot of decisions, such as when to buy or sell a particular security, how much of a security to hold in a fund, and even how much cash to keep on hand to cover any client redemption requests. For this reason, funds that are actively managed will have higher management costs than funds that are passively managed.

what is a pool of investor’s capital used to purchase investments according to a specific mandate known as?

a managed product

mutual funds, exchange-traded funds (ETFs), and segregated funds are examples of managed products.

Is an index fund actively or passively managed?

passively managed

managed products such as mutual funds can be either actively or passively managed. An index fund simply mirrors the market by compiling a portfolio that mimics an overall stock index. Therefore, an index fund is passively managed and as such charges a lower management fee than an actively managed fund.

For example, a fund that mimics, or “indexes”, itself to the S&P/TSX Composite Index would have a very similar return to the index itself. It is not an actively managed fund because all the manager does it buy the same stocks listed in the index.

Under what circumstances would the offering price and NAVPU be the same?

when the fund does not charge a front-end load.

let’s calculate the offering price of a mutual fund that has a NAVPU of $10 and does not charge a front-end loan. In other words, the front-end load is 0%

how is a mutual fund’s offering price calculated?

offering price = NAVPU / (100% - Front-end load fee)

with mutual funds, who pays the trailer fee?

the fund manager/fund company

when does a front-end loan fund charge a commission?

a commission is charged upon purchase

a front-end load is generally a fixed percentage, such as 5%

what is an “unsolicited order”?

An order that was NOT recommended by the advisor and instead was specifically requested by the client

when an unsolicited order is deemed unsuitable for the client, the following must occur:

• proof should be maintained that it was an unsolicited order; the client signs an acknowledgement to that effect

• a suitability review is performed

• the client is advised that the transaction is deemed unsuitable

what is the role of the “custodian” of a mutual fund?

the “custodian” is responsible for carrying out all financial transactions of the fund.

the custodian collects money received from the fund’s buyers and from portfolio income, and arranges for cash distributions for dividend payments, portfolio purchases, and redemptions. The custodian may also serve as the fund’s registrar/transfer agent, who maintains records of who owns units. this process may be complicated by dividend reinvestment plans and purchase of fractional units.

If an investor receives a T3 or T5, would that imply that his or her mutual fund units were held inside a tax-sheltered plan or outside a tax-sheltered plan?

outside of a tax-sheltered plan (non-registered plan)

when units are held outside of a tax-sheltered plan (non-registered plan), the fund assist with income-tax reporting by providing the investor with a T3 form (for mutual fund trusts that issue units) or a T5 form (for mutual fund corporations that issue shares).