Unit 4 - Investment Companies

Packaged investments

portfolios that are made up of other investments, primarily stocks and bonds, most common are mutual funds

Investment Company Act of 1940

defines investment companies in the U.S. by classifying them into three broad classifications (FACs, UITs, and management companies)

Investment company

a corporation or trust that pools investors’ money and invests it in securities on their behalf, each one having a clearly defined objective (growth or income), they raise capital by selling shares to the public

Face-Amount certificates (FACs)

a contract between an investor and issuer where issuer guarantees payment of a stated (face) amount to the investor at a set date in the future either as lump sum or periodically, investment companies defined under the Investment Company Act of 1940

Fully paid FAC

investor pays for the certificate in a lump sum

Unit investment trusts (UITs)

investment company organized under a trust with trustees instead of a BODs, selling redeemable units of shares in the portfolio (portfolio is fixed, not managed) with a fixed end or maturity date

Portfolio turnover

buying and selling of securities within a portfolio

Debt-based UIT

ends when the last bond in the portfolio matures

Equity-based UIT

has an end date in the prospectus when the portfolio is liquidated and the funds distributed to investors

Management investment company

actively manages securities portfolio to achieve a stated investment objective, either closed end or open ended, selling shares to the public in an IPO

Close-ended investment company

aka a publicly traded fund (IPO), raises capital through an initial offering of a limited number of shares and once those shares are sold, the fund is closed to new investors

• May issue common stock, bonds, and preferred stock

• After IPO, investors can buy/sell in secondary market

• Price is determined by supply and demand> CMV + commission

• Shareholder rights include dividends, voting, and preemptive

• EX-dividend date set by exchange or FINRA

Open-ended management company

aka continuous primary offering or mutual fund, continuously offers new shares to the public and is always open to new investors without limiting the number of shares issued, allowing it to raise unlimited capital

• Only issue common stock

• When sold, shares are redeemed directly from investors at current NAV

• Price determined by formula in prospectus > NAV + SC

• Shareholder rights include dividends and voting

• Ex-dividend date set by BOD

Mutual fund

a pool of investor’s money invested in various securities determined by the fund’s objective, investor purchases shares from the fund, an investment company that issued common stock

• Purchase/sale of shares changes shares outstanding so NAV is not affected

• Redeemable securities, marketable, and liquid

• Shareholder has voting rights

Investment advisers or investment managers

professional who manages a funds’ portfolios

MF share classes

Class A, Class B, and Class C share class options, difference among them is how much and in which way investors will pay sales charges

Sales charges (loads)

cover the cost of distribution of shares, a percentage of POP that cannot exceed 8.5%

Class A shares

have front-end sales charges as they are paid at the time the investor buys the shares, sales charge is taken from the total amount invested (best for large investments and long time frames)

Class B shares

have a back-end sales load as they are paid at the time investor redeems shares, sales load is reduced by a percentage each year after purchase aka a declining percentage change (best for small investments and long time frames) but higher expenses

Class C shares

have a 0.25% annual shareholder service fee charged quarterly and never goes away (level load), best for short time frames (at lease 1 ear but no more than 5) as annual charges make them expensive to own if investing for more than four or five years

No-load shares

shares are purchased at NAV without any type of sales charge as companies market their shares directly to the public, eliminating need for underwriters and sales charges used to compensate them, but are permitted to charge other fees (i.e. purchase, account, exchanged, and redemption)

Redemption fees

deducted from redemption proceeds just as in deferred sales load, not considered a sales charge since it is much smaller and a fixed dollar amount instead of a percentage of the redemption

Breakpoints

quantity discounts on mutual fund sales charges only applying to Class A shares with no industry standard, the greater the dollar amount the lower the sales charge %

Letters of intent (LOI)

allows a mutual fund investor to qualify for a reduced sales charge (breakpoint discount) by committing to invest a certain amount in the same fund within 13 months, the lower sales charge means investor receives more shares and they are held in escrow until the commitment is completed

Breakpoint sale

viewed as an effort by representative to make higher sale charges as they are a sale just below a breakpoint, inconsistent with just and equitable principles of trade (a violation)

Rights of accumulation

allows investors to qualify for reduced sales charges (breakpoint discounts) on future mutual fund purchases based on the current value of shares already owned without reducing the sales charge on the initial purchase; it applies to subsequent investments

• to qualify look at higher of total investments made to date and current value of position

Mutual fund sponsor

may offer more than one fund as an investor can receive reduced sales charges by combining investments in two or more funds within the same family to reach a breakpoint (the fund family)

Exchange privileges

allow an investor to redeem an investment in on fund for an equal investment in another fund in the same family without paying additional sales charges avoiding any sales loads on the purchase of the new fund after original fund is redeemed, a taxable event with possible tax consequences (aka conversion privilege)

Net asset value (NAV)

the share price of a mutual fund determined by the value of the fund’s portfolio, must be calculated at lease once per day and one must take place after close of trading ( funds can choose to more often but most don’t) =  total assets – total liabilities / outstanding shares

Forward pricing

occurs when the investor’s request to purchase or redeem shares is processed, most funds calculate NAV once per day following the close of trading thus most mutual fund transactions are processed once a day following that calculation

Manager's fee

cost of the investment adviser that makes the day-to-day investment decisions for the fund's portfolio

Administrative costs

includes trading costs, legal and accounting costs, transfer agent costs, and other administrative expenses

Board of director's costs

board members are paid for their time, plus meeting costs, report preparation, and costs associated with the support of the board

12b-1 fees

fees are used to pay for certain costs of distribution, often used for advertising and paying trailing commissions to broker-dealers

Expense ratio

expresses the fund’s annual cost of expenses without including sales charges or loads, = fund’s expenses for a year/average net asset for the same year

Public offering price (POP)

price an investor pays for a share, = NAV + a sales charge (SC).

• Load fund > exceeds NAV

• No load fund > equals NAV

• If NAV is higher than it is a closed-end fund

MF dividend dates

mutual funds are purchased and redeemed directly with the fund, so ownership changes immediately, investor who buys mutual fund shares becomes the owner of record the same day and may receive the dividend that day (declaration date>record date/payable date>ex-dividend date DRE)

• All dates are set by BOD

Prospectus

disclosure documents associated with mutual funds (full prospectus, summary prospectus, statement of additional information, and omitting prospectus)

Full (statutory) prospectus

disclosure document that provides investors with the material information needed to make an informed investment decision disclosing 1-, 5-, and 10-year performance histories or performance over the life of the fund (whichever is shorter),

Summary prospectus (Rule 498)

standardized summary of key information taken from the fund’s full prospectus that may be delivered electronically, may be used for a solicitation but investor can request the full prospectus

Legend

statement on the cover page that refers to the summary nature of the prospectus and the availability of the fund's full (statutory) prospectus

Statement of additional information (SAI)

document providing more detailed information about a mutual fund than the prospectus (i.e. fund's financial condition, history, policies, and holdings), available upon request and must be provided within 3 business days though not required to make an investment decision

Omitting prospectus (Rule 482)

another term for a fund advertisement (aka a tombstone ad), which does not contain enough information to qualify as a full disclosure and thus is not sufficient to solicit a trade

Conduit theory

a special set of rules that applies to dividends from investment companies to avoid taxes on the dividend it pays shareholders if they meet certain criteria (aka pipeline theory), can also apply to securities other than investment companies

Net investment income (NII)

= Dividends + Interest – Expenses

Triple taxation

occurs when the same dollar of income is taxed three times

• Corporation pays taxes on its profits

• Mutual fund pays taxes on dividends received from the corporation

• Shareholder pays taxes on dividends received from the mutual fund       

Annuity

a contract with no limit on investment made with a life insurance company that is designed to provide retirement income, a stream of payments guaranteed for some period of time typically the life of the insure person (annuitant)

Accumulation phase

investor puts money into an annuity where it grows tax deferred (aka growth phase)

Tax deferred

investor doesn’t pay taxes until money is withdrawn

Annuity phase

period which the investor receives payment

Fixed annuities

contract has a set interest rate during the growth phase while the rate may fluctuate from year to year it is never less than zero, income is fixed based on a formula and the payment does not change

Investment risk

insurance company must pay the guaranteed return even if investment return does not cover cost

Inflation (or purchasing power risk)

rate of return and fixed payment may not keep up with inflation, investor takes it on

Variable annuities

product is considered a security as investor takes on the investment risk, gives investors opportunity to keep pace with inflation where premiums are placed into separate accounting to be invested and funds are directed into one or more subaccounts (supplement to retirement income)

Subaccounts

type of investment company and are classified as UITs or open-ended management companies under the Investment Company Act of 1940, are considered securities and operate much like mutual funds (may lose value due to market fluctuations)

Variable annuity fees

all fees must be disclosed, these include administrative fees, investment advisor fees, custodial fees, and surrender charges.

Annuitization

a one-time, irreversible election to give up ownership of the assets of the annuity in return for a lifetime income guaranteed by the insurance company, when the annuitant chooses to begin payments either monthly, quarterly or annually (SAAPI)

SAAPI

five criteria used for formula for initial annuity payment (Sex, Age, Amount, Payout, and assumed Interest rate)

Taxing annuitization

based on the balance of the account and what portion of the balance is growth versus principal, each payment will be part return of principal and part taxable income

• Part of your original investment (principal) → not taxed

• Part investment earnings (growth) → taxable

Exclusion ratio

percentage that is excluded from taxation

Lump-sum withdrawal

investor takes everything out and closes the annuity, growth becomes taxable and the rest is return in principal

Taxing partial withdrawal

also called a random withdrawal, happens when the investor takes out a portion of the investment in a VA where the withdrawal will be from the growth first

1035 Exchange

funds in an annuity may be transferred directly to another annuity, not considered a withdrawal and not subject to taxes but surrender fees imposed by the insurance company may apply