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Twenty-Three Investment Companies

Investment companies are financial intermediaries that pool funds from investors to purchase securities. There are several types of investment companies, including unit investment trusts (which hold a fixed portfolio for a set time period), managed companies (organized as corporations with boards and hired managers), closed-end funds (whose shares trade on an exchange), and open-ended funds or mutual funds (which continuously offer new shares). Mutual funds are evaluated based on their returns compared to benchmark indexes and peer funds, though services like Morningstar have limitations in their analyses.

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Mahendra Singh
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163 views

Twenty-Three Investment Companies

Investment companies are financial intermediaries that pool funds from investors to purchase securities. There are several types of investment companies, including unit investment trusts (which hold a fixed portfolio for a set time period), managed companies (organized as corporations with boards and hired managers), closed-end funds (whose shares trade on an exchange), and open-ended funds or mutual funds (which continuously offer new shares). Mutual funds are evaluated based on their returns compared to benchmark indexes and peer funds, though services like Morningstar have limitations in their analyses.

Uploaded by

Mahendra Singh
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPT, PDF, TXT or read online on Scribd
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CHAPTER

TWENTY-THREE

INVESTMENT COMPANIES

1
INVESTMENT COMPANIES

• INVESTMENT COMPANIES
DEFINITION: a type of financial
intermediary who obtain funds from
investing to use in purchase of financial
assets
– investors receive certain rights in exchange

2
INVESTMENT COMPANIES

• INVESTMENT COMPANIES
– Advantages to the Individual Investor
• economies of scale
– higher volume purchases, lower commission rate
– provides diversification
• professional management
– manager is a professional seeking mispriced securities full
time

3
NET ASSET VALUE

• KEY CONCEPT FOR INVESTMENT


COMPANIES
– Net Asset Value (NAV)
NAVt = (MVAt - LIABt )/NSOt
where NAVt is the firm’s net asset value
MVAt is the market value of firm’s assets
LIABt is the dollar value of firm’s liabilities
NSOt is the number of shares outstanding
4
MAJOR TYPES OF INVESTMENT
COMPANIES
• UNIT INVESTMENT TRUST
– DEFINITION: an investment company that owns a
fixed set of securities for the life of the company
– FORMATION
• sponsor purchases a specific set of securities
• the securities are deposited with trustee
• firm sells redeemable trust certificates to the public
• all income received by trustee paid out to certificate holders

5
MAJOR TYPES OF INVESTMENT
COMPANIES
• UNIT INVESTMENT TRUST
– LIFE SPANS
• from 6 months to 20 years
– SECONDARY MARKET
• investor may sell the shares back to the trust
• a secondary market may be maintained by the
sponsor of the trust

6
MAJOR TYPES OF INVESTMENT
COMPANIES
• MANAGED COMPANIES
– WHAT ARE THEY?
• organized as corporations with a board of directors
• management company is hired
• annual management fees vary from .5 to 1% of the
average market value of the company’s total assets

7
MAJOR TYPES OF INVESTMENT
COMPANIES
• CLOSED-END INVESTMENT COMPANY
– FEATURES
• shares are traded on an exchange
• unlimited life
• dividends received paid out to shareholders
• can issue shares to raise additional funds
– quotations
• market prices published daily
• NAV published weekly

8
MAJOR TYPES OF INVESTMENT
COMPANIES
• OPEN-ENDED INVESTMENT
COMPANIES
– most known as mutual funds
– continuously offer new shares to the public
– capitalization is open

9
MUTUAL FUNDS

• MUTUAL FUND TAXATION


– re. the investment company:
• no corporate income tax liability if
– it pays at least 90% of its net income to shareholder
– Two kinds of payments to investors:
» one for income
» another for net capital gains realized

10
MUTUAL FUNDS

• MUTUAL FUND PERFORMANCE


– CALCULATING RETURNS:
• Formula:
rt = {(NAVt- NAVt-1) +It + Gt}/ NAVt-1
where rt = return at time t
It = income
Gt = capital gain distribution at
time t

11
MUTUAL FUNDS

• AVERAGE RETURN
– Benchmark portfolio used tom compare the
performance of the investment company
– Composition of the benchmark portfolio
• a market index is chosen (e.g. S&P500)
• a risk-free asset chosen (e.g. T-bills)
• an index to account for the difference in
performance is chosen
– allows for high to low book-to-market price stocks

12
MUTUAL FUNDS

• AVERAGE RETURN
– Style Analysis
• used to derive appropriate benchmark
– Ex Post Alpha Derived
• formula:
parp - arbp
where ar p = the average return on portfolio p

arbp = average return on the benchmark

13
MUTUAL FUNDS

parp - arbp

If p > 0, the portfolio has performed well

14
EVALUATING MUTUAL FUNDS

• PROFESSIONAL SERVICES
– MORNINGSTAR
• is the most often used service
– CAVEATS RE. MORNINGSTAR:
• performance comparisons using S&P500 for all
equity and bond funds
– may not be appropriate for certain types of funds
– e.g. a fund mostly invested in NASDAQ stocks does not
compare

15
EVALUATING MUTUAL FUNDS

• PROFESSIONAL SERVICES
– MORNINGSTAR
• is the most often used service
– CAVEATS RE. MORNINGSTAR:
• their approach to the quest for abnormal returns is
not clearly revealed
• use of peer group comparisons has several serious
shortcomings
– some funds may be restricted by their stated objectives as
to what they can purchase

16
EVALUATING MUTUAL FUNDS

• PROFESSIONAL SERVICES
– MORNINGSTAR
• is the most often used service
– CAVEATS RE. MORNINGSTAR:
• survivorship bias
– the tendency for poorly performing funds to go out of
business and leave the peer group

17

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