12. Perennial Favourites Flashcards
4 basic types of investment companies
- CEF (closed end funds, known as LIC in NZ and AUS)
- Mutual Funds (open end funds)
- Unit investment trust (UIT)
- ETF (exchange traded fund)
CEF (4)
Closed end fund - type of investment company whose shares are traded on the open market
Bid-ask spread
Active fund
Closed to new shareholders
CEF Process
proceeds raised through IPO, no more capital raising after that, will invest capital in other companies (typically stocks unless speciality commodity CEF)
Is a CEF active or passive?
Active - investment management team, regularly buying and selling with market (sell overpriced, buy underpriced)
Ways that capital can increase in CEF
Capital gain from stocks (selling for profit), borrowing money, offering secondary share issue, rights offering.
CEF’s can be…
liquidated –> resulting in capital outflow
Open-end/Mutual fund (4)
Not traded on stock exchange
No bid-ask spread
Open for new investors
Much larger than CEF
Process of entering closed-end/mutual fund
Approach the company and they will issue new shares (buying more securities from companies –> increasing AUM), they are unable to issue new units without purchasing additional securities
Process of exiting open-end/mutual fund
return shares to the fund manager –> no need to sell on stock market
Similarities between CEF and Mutual Fund (4)
- Professional Managers
- Expense Ratio - they will charge fees for services
- Both have portfolios of underlying assets
- Offer income/capital gains distribution (if securities within fund pay dividends)
ETF (3)
Exchange Traded Fund
Hybrid of Mutual and CEF
Traded on stock exchange - but you can create and redeem additional shares as an authorised participant (AP)
Process of creating additional units in an ETF
AP will approach company to purchase, AP will purchase all underlying assets of the ETF and exchange them with ETF issue for units.
Inverse ETF (3)
designed to produce returns opposite to underlying index (e.g. index increase 2.5%, inverse ETF will fall 2.5%)
utilises derivatives
similar to a short position (expect the index to fall)
Leveraged ETF
Over-investing in underlying index by borrowing money
ETF price fluctuates like…
a stock
ETFs are generally what type of fund?
passive
Most ETFs are open end funds but some are…
UIT
Characteristics of a UIT
Unit Investment Trust
* fixed termination date
* holdings are fixed unless there is corporate action (rights offering, etc.)
* do not lend out shares, cannot borrow, no board of directors and accumulate cash dividends to pay out quarterly (no reinvestment)
* fixed number of units –> redeemable
* not listed
* bond UITs more common than stock UITs
ETFs may be converted back into
units of underlying assets
Convertibility of ETF mens that
prices do not stray far from the NAV of the fund for an extended period of time
NAV =
net assets/number of units
For CEF’s the unit price may be
different from NAV
Purpose of ETFs
passively track a market index
Are ETFs liquid?
Yes - most are liquid and heavily traded due to low T-costs (low bid-ask spreads and price impact)
Why is the demand for ETFs so high?
expense ratio generally too low
Pitfalls of ETF (3)
- enable poor market timing
- trading ETF cheaper, but if done too frequently is costly
- proportion of a firm’s shares held by ETF’s tends to reduce the information efficiency of that stock
How do ETF’s tend to reduce the information efficiency of that stock?
Stocks held by ETF are unavailable for public trading, hence less market research able to be done if only (e.g. 50% of a whole companies shares is available for trading) leading to low information and decreased information efficiency.
Defined Benefit (DB)
guarantees a specific payout upon retirement
Providers of especially defined benefits struggle to…
meet the benefit promises they have made to current and former workers
DB are a huge cost for
companies and it affects their market valuations
Defined contributions are becoming more popular than DB’s since ____ as…
2000, as it shifts the investment risk of their obligations to the employee/worker
Differences between DB and DC plans?
DB defines the benefits payable to the employee in retirement while a DC plan defines the contribution made by the employee
With DB plans, benefits known in advance
With DC plans, total amount at retirement date is unknown – financial crisis may reduce the amount in the account
DRIPs or DRPs
Dividend Reinvestment Plans
What do DRIPS provide?
The opportunity for an investor to reinvest their dividend in the company by purchasing additional shares –> no requirement for cash dividend to be paid, company completes this on your behalf
DRIPS are generally…
commission free
How many shares do you need to hold to participate in a DRIP?
1 –> in US can purchase directly from company, in NZ must purchase directly from broker
Do ETFs participate in DRIPs?
Yes, all dividends reinvested into ETF
Restrictions with DRIPs
if shares are purchased sometimes restriction on how soon you can sell that share
Benefits of DRIPs
will provide share on same day dividend is paid, cash dividend payment sometimes delayed
If you own a stock that pays cash dividends, you signed up for the DRIP long ago. You then sell the stock after the ex-dividend date but prior to the payment date, will you receive dividend?
Yes –> sold after the last day trading with dividend rights, entitled to a cash dividend
