Chapter 14 Investing in Mutual Funds Copyright © 2012 Pearson Canada Inc. 14-1.

Chapter 14

Investing in Mutual Funds

Copyright © 2012 Pearson Canada Inc. 14-1

Chapter Objectives

• Describe the advantages and disadvantages of mutual funds

• Identify the types of mutual funds

• Explain how to choose among mutual funds


Chapter Objectives (cont’d)

• Describe quotations of mutual funds

• Explain the difference between ETFs and mutual funds

• Explain the difference between segregated funds and mutual funds


Background on Pooled Investment Funds

• Pooled investment fund: an investment vehicle that pools together money from many investors and invests that money in a variety of securities


Background on Mutual Funds (cont’d)


• Equity mutual funds: funds that sell units, or shares, to individuals and use this money to invest in stocks

• Bond mutual funds: funds that sell units, or shares, to individuals and use this money to invest in bonds

• Balanced mutual funds: funds that sell units, or shares, to individuals and use this money to invest in a combination of stocks and bonds



• Money market mutual funds: funds that sell units, or shares, to individuals and use this money to invest in cash and investments that can be converted to cash quickly


• Advantages of Investing in Mutual Funds• Provide professional money management

• Simplify the process of record keeping

• Mutual funds are available everywhere

• Allow diversification with a small investment



• Disadvantages of Investing in Mutual Funds• Management fees and other costs vary substantially

among funds

• Investor has no control over the investments that are purchased and/or sold within the mutual fund

• Liquidity can be very low• Liquidity: the ease with which the investor can convert

the investment into cash without a loss of capital




• Net Asset Value per Share

• Net asset value (NAV): the market value of the securities that a mutual fund has purchased minus any liabilities and fees owed

• Any liabilities, such as expenses owed to the mutual fund’s managers, are subtracted to determine the NAV

• NAV is commonly reported on a per share basis



• Open-End versus Closed-End Funds• Open-End Funds

• Open-end mutual funds: funds that sell shares directly to investors and will redeem those shares whenever investors wish to “cash” in



• Closed-End Funds• Closed-end mutual funds: funds that issue shares to

investors but do not redeem those shares; instead, the fund’s shares are traded on a stock exchange

• Market price per share is determined by the demand for shares versus the supply of shares that are being sold



• Load versus No-Load Funds

• No-load mutual funds: funds that sell directly to investors and do not charge a fee

• Front-end load mutual fund: mutual funds that charge a fee at the time of purchase, which is paid to stockbrokers or other financial service advisers who execute transactions for investors



• Back-end load mutual funds: mutual funds that charge a fee if shares are redeemed within a set period of time

• Declining redemption schedule: a fee schedule where the back-end load charge reduces with each year an investor holds the fund

• Fee may be based on the original amount purchased or the value of the fund when it is redeemed



• Management Expense Ratio (MER)• Management expense ratio: the annual expenses

incurred by a fund on a percentage basis, calculated as annual expenses of the fund divided by the net asset value of the fund; the result of this calculation is then divided by the number of units outstanding



• Reported Components of MERs

• Management expenses: investment research, portfolio management, marketing costs, and profit

• Dealer/adviser compensation: fees paid to advisers and salespeople

• Administrative costs: transaction processing, client reporting, and audit and legal fees

• Relationship between Expense Ratios and Performance

Types of Mutual Funds (cont’d)• Types of Equity Mutual Funds• Growth Funds

• Focus on stocks that have potential for above-average growth

• Small Capitalization (Small-Cap) Funds• Focus on firms that tend to have more potential for

growth relative to larger firms

• Mid-Size Capitalization (Mid-Cap) Funds:• Focus on firms that are more established than small-cap

firms


Types of Mutual Funds (cont’d)


• Dividend Funds

• Focus on firms that pay a high level of dividends

• Have less potential for high capital gains and exhibit less risk

• Balanced Growth and Income Funds:

• Contain both growth stocks and stocks that pay high dividends



• Sector Funds

• Sector funds: mutual funds that focus on stocks in a specific industry or sector, such as technology stocks

• More risky, as they are less diversified

• Index Funds:

• Index funds: mutual funds that attempt to mirror the movements of an existing equity index

• May not contain every stock in the index



• International Equity Funds• Focus on firms that are based outside Canada

• Expenses associated with managing an international equity fund are higher

• “Global mutual funds” invest in stocks of both foreign firms and Canadian firms

• Ethical Funds• Screen out firms viewed as offensive by some

• Other Types of Equity Funds



• Types of Bond Mutual Funds• Canadian Bond Funds

• High-Yield Bond Fund

• Global Bond Funds

• Index Bond Funds

Return and Risk of a Mutual Fund


• Return from Investing in a Mutual Fund

1. Interest income distributions

2. Dividend distributions

3. Capital gains distributions

Return and Risk of a Mutual Fund (cont’d)


• Trade-off between Expected Return and Risk of Equity Funds

Exchange-Traded Funds• Share may of the same benefits of a mutual

fund• Diversification, economies of scale, and

marketability

• Differences:• Do not have a net asset value per share

• Trade on the stock exchange and have a share price

• Purchased in real time, whereas mutual funds are purchased at the end of the day


Exchange-Traded Funds (cont’d)

• Fee Structure

• Do not have a load structure

• Initial fee you pay is the brokerage commission for completing the transaction

• There is an ongoing MER


Exchange-Traded Funds (cont’d)

• Tax Efficiency

• Tend to be more tax efficient since there is not as much active trading in an ETF

There are many types of ETFs


Segregated Funds

• Insurance products that are regulated through the insurance legislation of the province in which they are sold

• Principal Protection

• Offer a guarantee on your deposits when the contract matures

• Usually matures 10 years after the date of purchase

• Deposit guarantee will be between 75 and 100 percent of deposits


Segregated Funds (cont’d)

• Death Benefit Guarantee• Creditor Protection• Assessing the Value of Protection• Any segregated fund will underperform its mutual

fund equivalent as a result of the difference in MERs

• Up to the individual investor to determine whether the benefits of owning a segregated fund outweigh the added costs


Chapter 14 Investing in Mutual Funds Copyright © 2012 Pearson Canada Inc. 14-1.

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Transcript of Chapter 14 Investing in Mutual Funds Copyright © 2012 Pearson Canada Inc. 14-1.