MODULE 1– BASICS OF MUTUAL FUND 1

MODULE 1 – BASICS OF MUTUAL FUND

“An investment in Knowledge Pays the Best Interest” – Benjamin Franklin

INTRODUCTION

Most of the people put their money in the bank. It is their sole strategy of weathering
emergencies and meeting their future needs. Savings in bank may not be enough to
buy the so called “financial security”. To put it simply, financial security means having
enough money to fund your lifestyle, as well as work toward your financial goals. Those
financial goals may include retirement, education, income protection, and important life
milestones. Fortunately, there are other ways to make money grow aside from saving.
And one of the best solutions is to invest in mutual funds.
Investing in mutual funds provides an easy way to participate in the stock market and
other investment markets. Anyone with a stable income or extra cash can start doing it.
But before you start investing in mutual funds, you should know first the basics of
mutual fund investment.

LEARNING OUTCOMES:

After reading this module, the learner should be able to:

1. Describe what an investment company is
2. Compare and contrast open-end and closed end companies
3. Define mutual funds and explain how they work
4. Describe a professional fund manager and explain his role in mutual fund
investment
5. Determine where and how the funds are invested
6. Analyze the factors that affect mutual fund share prices
7. Explain how mutual funds are regulated

TIME:

The time allotted for this module is nine (9) hours.

LEARNER DESCRIPTION

The participants in this module are 3rd year BSBA students

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MODULE CONTENTS:

Lesson 1.1: INVESTMENT COMPANY

What is an Investment Company?

It is any issuer which is or holds itself out as being engaged primarily or proposes
to engage primarily in the business of INVESTING, REINVESTING or TRADING in
Securities.

It may therefore be defined also as a stock corporation that pools money from
numerous investors by issuing its shares and investing the pooled funds in
accordance with its objectives and policies.

CLASSIFICATIONS OF INVESTMENT COMPANIES

1. Open End Company or Mutual Fund

It is an investment company that continuously issues its redeemable shares and
stands ready to redeem them back at net asset value per share (NAVPS) should
investors decide to pull out their investments

2. Closed end companies

It is an investment company that issues a limited number of non-redeemable
shares so that they are listed in the stock exchange to provide liquidity to its
shareholders.

Remember:

In the Philippines, ALL mutual fund companies are open-ended investment

companies

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Open End Companies Closed End Companies

Number of shares offered UNLIMITED LIMITED

for sale
Outstanding number of VARIABLE FIXED
shares
Listing in the stock NOT LISTED LISTED
exchange
Purchase price on the part At NAVPS plus fee At initial public offering
of investors (IPO)thereafter, at market
price plus commission
Sales price on the part of AT net asset value per At market price less
investor share minus back-end commission and tax
sales load or commission
and vat

Lesson 1.2: THE MUTUAL FUNDS AND HOW THEY WORK

What is a Mutual Fund?

A mutual fund is a POOL OF FUNDS of many individual and institutional investors

and invested in diversified portfolio of investments. These are pooling of investors’
money by a stock corporation that issues redeemable shares of stock

Mutual fund companies collect money from investors and add them to investment
funds. The fund is used to investment in different types of securities. The underlying
assets of the fund (stocks, bonds, etc) determine its potential risk and growth.

A mutual fund is a pool of money from the public that is invested with an expectation
of a profit. If the investment fund grows, the investors’ money also grows. If the fund
loses money, the investors’ portfolio also decreases in value. Because of the way it
invites people to invest, it is also called pooled or managed fund.

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How it Works

 Individual investors, companies, and other organizations will pool their money and
will entrust that fund to a PROFESSIONAL FUND MANAGER under a mutual fund
company
 The FUND MANAGER will invest the money to different investment securities
 These securities will then generate returns
 And the returns that will be earned will then pass back to the investors

Remember:

Investing in mutual funds does not always guarantee positive returns. Returns may rise
or fall, thus investments may gain or lose in worth when redeemed.

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- In the Philippines, mutual funds are usually run insurance companies, and other
types of financial institutions. These companies have representatives who face the
investors and explain to them how the process works.

- If the investors are interested they can open an account with the mutual fund
company. The mutual fund company assesses the risk profile of the investors.

- If the investor decides to put his money in the mutual fund, he gives the amount he
is willing to invest.

- After investing the money, the investor does not need to do anything else.

- The mutual fund works for his money through the professional fund managers.
They only need to decide when to withdraw the money or redeem his investment.

Example:

Let us say investors Jay-Ar and Airene were both convinced to invest in mutual
funds. Jay-Ar started by investing P 50,000.00 while Anna invested P100, 000.00.
They both invested in the same fund at the same time.

They money will be added to the pool and invested by the fund manager. A year
later, the mutual fund performed well. The return equals 8% after taxes and fees are
deducted. At this point, Jay-Ar’s investment should be equal to P54,000.00 if he
decided to withdraw his funds. Airene’s investment on the other hand, should be
equal to P108, 000.00

Both investment funds grew by 8%. However, just because Airene invested double
the amount of money, she gets double the returns.

When a person invests in mutual funds, he or she buys shares of the mutual fund
company. The mutual fund company invests the pooled funds to various securities of
top companies. In the Philippines, these companies may include country’s biggest
corporations such as SM, PLDT, BDO, Ayala, Jollibee, and others.

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The number of shares he gets depends on the amount he invests and the price of
the mutual fund shares or the so called “NAVPS” or Net Asset Value per Share.

In the given example, Jay-Ar invests 50,000.00. Let us say that the Net Asset Value
per Share is P1.00. At this price, Jay-Ar will get 50,000.00 shares. For Jay-Ar’s
investment to go up by 8% at the end of the year, then the NAVPS should go up to
P1.08. For it to go up by 15%, then the NAVPS should go up to P1.15.

You would earn from the increase of the price of each share. Such increase is
caused by the gains derived from all dividends, rise in the value of its stock portfolio,
and/or interests. The NAVPS varies per Mutual Fund Company.

Lesson 1.3: THE PROFESSIONAL FUND MANAGER: WHERE AND HOW FUNDS
ARE INVESTED

Who Manages the Mutual Fund Investment?

Mutual funds in the Philippines are actively managed by Professional Fund

Managers.

So if there is a need to buy and sell stocks and bonds, It is the professional fund
manager that does all that. Fund managers are experts in securities and they will do
the trading in behalf of all the investors. In exchange, investors pay annual fees and
other charges to cover for the operation of the fund.

The fund managers are usually assigned by the mutual fund board of directors. They
are selected based on their credentials and experience in investing.

In actively invested funds, the manager decides when to buy and sell securities.
They also decide which securities to buy and sell based on risk profile of the
investors.

Their decision making process is limited by the rules and regulations set by the
board of directors and the Securities and Exchange Commissions (SEC). All mutual
funds in the Philippines are regulated by SEC. A fund’s performance ultimately

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depends on the ability of the fund managers to pick the right securities. It also
depends on their choice on when to buy and sell these securities.

Some types of mutual funds are also passively invested (i.e Index Funds). A
passively invested fund also has a fund manager. However, the fund manager does
not decide how the fund should be allocated. Instead, there are preset criteria for the
distribution of funds.

With an index fund for example, the fund is allocated in a specified index in the
market. The local index funds in the country are invested in the Philippine Stock
Exchange Index (PSEi). The funds are distributed in the top 30 companies listed in
the index.

NAME TICKER CATEGORY

Aboitiz Equity Ventures, Inc. AEV Holdings

Aboitiz Power Corp. AP Power

Alliance Global Group, Inc. AGI Holdings

Ayala Corporation AC Holdings

Ayala Land, Inc. ALI Real estate

Bank of the Philippine Islands BPI Bank

BDO Unibank, Inc. BDO Bank

Bloomberry Resorts Corporation BLOOM Holdings

DMCI Holdings, Inc. DMC Real estate

Emperador Inc. EMP Food and Beverage

First Gen Corporation FGEN Power

Globe Telecom, Inc. GLO Telecommunications

GT Capital Holdings, Inc. GTCAP Holdings

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NAME TICKER CATEGORY

International Container Terminal Services, Inc. ICT Logistics

JG Summit Holdings, Inc. JGS Holdings

Jollibee Foods Corporation JFC Food and Beverage

LT Group, Inc. LTG Holdings

Manila Electric Company MER Power

Megaworld Corporation MEG Real estate

Metro Pacific Investments Corporation MPI Holdings

Metropolitan Bank & Trust Company MBT Bank

PLDT Inc. TEL Telecommunications

Puregold Price Club, Inc. PGOLD Commerce

Robinsons Land Corporation RLC Real estate

Robinsons Retail Holdings, Inc. RRHI Holdings

San Miguel Corporation SMC Food and Beverage

Security Bank Corporation SECB Bank

SM Investments Corporation SM Holdings

SM Prime Holdings, Inc. SMPH Real estate

Universal Robina Corporation URC Food and Beverage

***as of August 2020

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Fund managers however cannot trade just any way they like. They are bound to
follow the investment objective found in the prospectus.

A prospectus is a document that shares information about the investment, its

objective, risks, costs, shares being offered, and other policies.

So for an example, a bond fund can only purchase bonds. It is not allowed to hold
stocks. Likewise, a stock fund may be limited to buying only stocks that are traded in
the Philippine Stock Exchange.

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Where is the Funds Invested?

Each mutual fund has a specific underlying asset. More of the details will be
discussed in Module 2 - Types of Mutual Funds.

Basically, an equity fund for example is solely invested in the Philippine Stock
Market. A bond fund is invested in the Philippine Bond Market. Mutual funds are
commonly classified according to their underlying assets and the criteria for
choosing where the assets should be invested.

Lesson 1.4: FACTORS AFFECTING THE MUTUAL FUNDSHARE PRICES

Factors Affecting the Mutual Funds Share Prices

The share prices or NAVPS fluctuate according to the performance of the fund
manager in investing the funds. It is also affected by conditions in the market where
the funds are invested.

Company polices may also affect the NAVPS. If the mutual fund company for
example takes a large percentage of as management fee, the growth of the NAVPS
will be slower compared to mutual fund companies with much lower management
fees.

1. Profits earned or losses booked from the underlying investments

When the underlying investments in a Mutual Fund book profits, the NAV of the
Mutual Fund rises. In case the market falls and the fund’s underlying investment
losses get booked, the fund NAV falls.
NAV changes occur when Mutual Fund managers actually realize profits or losses.

2. Fund expenses

Mutual Funds get managed by professional asset managers for a yearly fee. These
fees are referred to as “Management Fees” and get deducted from the NAV of the
Mutual Fund. Management expenses reduce the NAV of a Mutual Fund.

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3. The type of Fund

It is where the “The higher the risk, the higher the return” applies. Depending on the
fund you choose, its risk and potential growth, affect the share prices of the funds.

4. Dividend pay-outs

When a Mutual Fund pays out a dividend, the NAV of the fund reduces. Mutual Fund
dividends work on a redemption basis. The amount of reduction in the NAV is
directly proportional to the percentage of dividend paid out.

5. Investor entry or exit

If investors book their profits and exit the fund at a high NAV, the NAV drops for the
existing investors. The reverse is also true.

When new investors enter the fund at low NAVs, the fund’s NAV decreases further
for the existing investors. The NAV decreases as the number of units has now
increased.

Lesson 1.5: MUTUAL FUNDS REGULATION

How Mutual Funds are Regulated

- Mutual funds in the Philippines are governed by R.A 2629 or the Investment
Company Act

- Mutual fund companies are regulated by the Securities and Exchange

Commission (SEC). As with other companies that offers securities investment
opportunities, mutual fund companies need to follow certain rules set by the SEC on
how the company makes use of the funds they pool from the investors. They are
asked to regularly send reports and documents to the government and to the
investors. Failure to do so usually means penalties, and they might even have their
licenses revoked and their operations suspended.

- The SEC also administers the licensing examination of the mutual fund solicitors
or sales representatives. Applicants who pass the examination and provide the

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requirements are given a license to sell mutual funds. They are called “Certified
Investment Solicitor” or “CIS”.

- Moreover, mutual fund companies are regularly audited by independent auditor.

And the assets of the mutual fund are held by a third party custodian bank.

Who is the Auditor?

The job of the independent auditors is to review the financial statements of a

company and determine whether such statements reflect the true financial position
of that company.

Who is the Custodian Bank?

Mutual funds are allowed by law to appoint a custodian, usually a commercial bank,
to hold all the fund’s assets (cash and securities) for safekeeping.

1. receives the certificate of new acquisitions made by the fund manager

2. pays for securities purchase
3. delivers securities sold
4. releases cash to pay for fund expenses
5. and accepts dividends and interest payments from the issuers of securities held in
the fund’s portfolio

Are gains in Mutual Funds in the Philippines Taxable?

No. - Gains realized by investors upon redemption of their shares in a mutual fund
have been excluded from the definition of gross income effective January 1, 1998,
and are, therefore, not subject to personal income tax stated in R.A. # 8424,
otherwise known as the Tax Reform Act of 1997.

This benefit alone makes it more profitable investing in a mutual fund.

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References:

Mayo, H. (2019). Basic Finance: an introduction to financial institutions, investments,

and management. Cengage
Reilly, F. (2019). Investment Analysis and Portfolio Management 11th ed. Cengage
Stamp, H. (2018). Investment Management. Larsen and Keller
Stewart, D. (2019). Portfolio Management: Theory and practice. John Wiley and Sons
3 G E Learning (2019). Portfolio Management and Security Analysis. 3 G E Learning

https://www.sec.gov/reportspubs/investor-
publications/investorpubsassetallocationhtm.html
https://www.investopedia.com/terms/n/navpershare.asp
https://www.pifa.com.ph/mf_101.html
http://my.spc.edu.ph:70/e_books/Business%20Admin/Financial%20Management/Mutual
%20Funds.pdf
https://pesolab.com/compare-mutual-funds-list-of-philippines-mutual-fund-companies/

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