Assignment 11 - Portfolio Theory and Diversification Flashcards
a way that tax can be determined during distrib.
In disposing of shares acquired over a period of time and for different prices, this concept of assuming that the earliest acquired shares were those that were sold may be used.
first in first out (FIFO)
- Type of inv. fund that is organized as a partnership or LLC and operates as a flow-through income tax entity, often w/ S/T profits
- unregulated
- chg incentive fees in addition to mgmt fees
- accept only a # of limited investors who must be accredited
- may use leverage to magnify positions
- options futures may be used to control risk
- may be long/short in the same sec. at the same time to offset losses and max gains
hedge fund
Type of investor that follows buy-and-hold philosophy or uses $-cost averaging and does not try to beat the market
defensive investor
open-end inv. company, through which shares go in and out of constantly
large, complex inv. pools that are generally overseen and actively worked w/ by prof. inv. mgrs
mutual fund
MF’s Regulators
- sales = SEC through Sec. Act of 1933
- day-to-day ops = Inv. Company Act of 1940
- mgrs of MFs = Inv. Advisors Act of 1940
How do you invest in MFs?
- outright purchase
- through accumulation plans
- reinv. of divs and realized cap gains
- through ins. products
- through tax-adv’d retirement/education accts
Types of MF’s
- Growth Funds
- Aggressive Growth Funds
- Total Return Funds
- Option-Income Funds
- Internat’l Equity Funds
- Global Equity Funds
- Small Cap Funds
- Precious Metals Funds
- Sector Funds
- Type of MF’s
- targets cap appreciation using stk of large growth companies
growth funds
- Type of MF’s
- riskier than growth equity funds, investing in startups, emerging industries, and turnarounds
aggressive growth fund
- Type of MF’s
- invest in income-paying CSs but look to max. current return by writing call options on the stk they hold
option-income funds
- Type of MF’s
- invest in stk of foreign companies
internat’l equity funds
- Type of MF’s
- invest in CS of foreign and U.S. companies
global equity funds
- Type of MF’s
- invest in stk of smaller, lesser known companies
- some argue that small company stks have performed better than large company stks over the years
small cap funds
- Type of MF’s
- follow the rise and fall of the corresponding actual precious metals’ pricing
- may include stk in gold-mining companies, whose returns would correspond to the rise and fall of the price of gold
precious metals funds
- Type of MF’s
- invest in stk of companies in particular fields or industries such as fin. servs, health care, science and tech., nat’l resources, and utilities
sector funds
- Type of MF’s
- types are:
- growth and income funds
- income-equity funds
total return funds
- type of total return mutual funds
- invest in companies that are expected to show reasonable growth AND current divs
growth and income funds
- type of total return mutual funds
- invest in CSs w/ secure and reasonable div. yields
income-equity funds
- this type of bond invests primarily in taxable bonds
- NAV of these funds fluctuate w/ the current price of bonds in the portfolio
taxable bond funds
types of taxable bond funds
- U.S Treasury Bond Funds
- U.S. Gov’t Income Funds
- Ginnie Mae
- Corp. Bond Funds
- Junk Bond Funds
- Internat’l Bond Funds
- Global Bond Funds
- type of taxable bond funds
- these funds inv. in U.S. T-Bonds
- safe
- used to diversify a portf. of bonds in terms of duration
- provide call protection (NOT callable)
U.S. T-Bond Funds
- type of taxable bond funds
- these funds seek a higher yield by investing in a variety of U.S. T-Bonds, federally guaranteed securities and other gov’t securities
U.S. Gov’t Income Funds
- type of taxable bond funds
- funds invested mainly in gov’t-backed mrtg securities
Ginnie Mae
- type of taxable bond funds
- funds are invested in a portf. of high quality bonds
Corp. Bond Funds
- type of taxable bond funds
- these funds accept a higher risk in order to achieve a higher return by buying riskier, lower quality bonds
junk bond funds
- type of taxable bond funds
- contain bonds issued by foreign companies, gov’t or both
- expressed in the currency of the country which issues them
- exposed to fin., i/r, and currency risk
Internat’l Bond Funds
- type of taxable bond funds
- invested in bonds of foreign companies and countries as well as those originating in the U.S.
Global Bonds Funds
types of Municipal Bond Funds
- Nat’l Municipal Bond Funds
- State Municipal Bond Funds
- type of Municipal Bond Funds
- invest in bonds and other securities issued by states, cities, and other municipalities throughout the nation
Nat’l Municipal Bond Funds
- type of Municipal Bond Funds
- invest only in securities of a particular state
- enables residents of the state to buy a fund for their state only and thus have tax-free int. income from the fund for fed’l, state, and local income tax purposes
State Municipal Bond Funds
Hybrid funds are….
diversified in terms of debt or equity and also in terms of types of assets held
- Asset Allocation funds
- Balanced funds
- Flexible Portf. funds
- Income-Mixed funds
- type of Hybrid funds
- maintain a specific weight of stks, bonds, and other instruments, such as money mkt.
- allow diversification of types of assets in a single fund, eliminating the need to purchase multiple funds
asset allocation funds
- type of Hybrid funds
- diversified portf of stks, bonds and PS
- have the objective of preserving the principal invested and paying reasonable income while achieving L/T growth by re-allocating assets into the fund
- flexible in asset weighting in order to achieve inv. growth (opposite of asset allocation)
balanced funds
- type of Hybrid funds
- supercharged balanced funds
- may chg their asset allocation more rapidly
- may hold up to 100% of their asset in a single type of asset
flexible portf. funds
- type of Hybrid funds
- goal = high current income
- invests in solid dividend-paying stks and bonds
income-mixed funds
- highly liquid assets that resemble savings accts
- safe, liquid and convenient
- usually used for the cash portion of a portf
- not guaranteed or insured by FDIC
money mkt mutual funds
2 types of money mkt mutual funds
- taxable MMfs
- tax-exempt MMFs
- type of money mkt mutual funds
- pay taxable dividends
taxable MMFs
- type of money mkt mutual funds
- pay divs that may be tax-exempt on the fed’l and/or state/local level
tax-exempt MMFs
passively managed fund that duplicates or tracks a specific group of stks, bonds or other securities
may be based on # of stk indexes
index fund
PROS of index funds
- signif. lower expense ratios than actively mngd funds
- low turnover rate of securities =in fewer sales of stks by the fund= lowers pass-through cap gains for s/h
- aligns w/ efficient mkt hypothesis of investing which implies that you can’t beat the mkt by actively managing a securities portf.
CONS of index funds
- many active managers have outperformed the mkt - argument exists against index funds
- distinct lack of inv. choice as the fund will likely be mirroring a single index of securities
- funds are at the mercy of ups and downs of the index which they mirror
- index funds with the added distinction of mkt speculation based on supply and demand
- may pay a premium or discount to a particular underlying index fund b/c it is bought and sold in the open mkt
- can be traded through limit orders, sold short, and bought on the margin
- not redeemable from funds, like MFs are
- operating costs may be lower than those of MFs
Exchg Traded Funds (ETFs)
operate w/ the obj. of minimizing the impact of income taxes on the returns to their s/hs by:
- buy and hold strategies (cap gains)
- emphasizing lower yielding sec.
- tax efficient selling
tax-managed MFs
buy and hold strategies….
minimizes the realization/distrib of cap gains
emphasizing lower yielding securities….
having less current divs paid each year, thus lowering overal taxes
tax-efficient selling….
- selling for L/T cap gains rather than S/T which defers taxes
- realizing losses in the same yr as gains to offset cap gains
monitoring MF performance
- admin costs or the expense ratio s/b monitored
- Total Return = annual income divs pd, realized cap gain distribs, and price fluctuations of fund’s shares
- volatility of MF prices
Total Return…
- annual income divs pd, realized cap gain distribs, and price
- cumulative total return
- average annual total return
- type of total return
- MF is the total chg in value of a fund over a period assuming reinv. of divs pd and realized cap gains
cumulative total return
- type of total return
- compound annual rate of return over a period to cause the initial share value to = the value at the end of the period
average annual total return
taxes on MFs distrib.
- ordinary income divs and qualified divs - taxed to s/h
- tax-exempt int. divs are not included in gross income except for AMT purposes for certain private activity municipal bonds
- cap gains divs are taxed to s/h in the yr in which they are received
- reinvested divs are considered constructively received and are taxed to s/h currently; unless a qualified plan
how is tax determined?
- specified identification method
- FIFO
- Avg cost methods:
- double-category method
- single-category method
- a way tax is determined
- if s/h can adequately identify the group from which the shares sold came, that basis and period can be used to determine gains
specified identification method
PROS of Hedge Funds
- typically pay above-avg returns according to advocates
- they have low correlations w/ other asset classes and thus reduce total portf risk to indiv. mkt shocks/changes
CONS of Hedge Funds
- costs are high to partic.
- highly illiquid
- highly leveraged
- not transparent
- have not been tested by severe economic conditions
a private equity firm that helps finance and advise startup companies
venture capital firms
a private equity firm under which the acquired company takes on debt b/c of the buyout
leveraged buyouts
a private equity firm that lends monies to a portf. company, w/ the loan having a fixed maturity date
mezzanine financing
inv. policy stmts include…
- asset classes deemed suitable for the portf.
- asset allocation targets for the approved asset classes
- personal factors and attitudes affecting the investor’s portf. and his/her time horizons
- risk-return
- diversif. standards
- CF
- liquidity
Inv. Objectives
- maximizing current income = current yield is most important
- preservation of cap = $ value of portf. should not decline over time
- reasonable current income w/ mod. cap growth = focuses on income and seeking cap gains
- L/T cap growth = cap gains over long peiod of time
- aggressive cap growth = max cap growth and make riskier inv. w/ considerable inv analysis and mgmt
- tax-advantaged inv. = higher income tax bracket investors; inv. are normally tax-free or tax-sheltered
Aggressive investment policies…
seeks to max returns and will accept more risk to do so
use timing of purchases and sales, risky inv. ventures, short selling, concentration of assets in selected securities, borrowing and other techniques to max overall return
defensive policies…
seek to min inv. risk and possibly accept correspondingly lower returns on their inv.
types of inv. vehicles
- directly owned assets
- assets held through fin. intermediaries
- assets held in qualified retirement plans
- IRA
- life insurance cash values
- inv. annuity cash values
- EE stk option and trusts
PROS of holding assets directly
TAX:
- cap gains are not realized until asset is sold or exchg’d in a taxable transaction
- l/t cap gains taxed at favorable rates
- cap assets get stepped up income tax basis at death
- planning can be done to postpone or completely avoid cap gains tax
- cap losses can mitigate or eliminate cap gains for tax purposes
CHOICES:
- investors have control over the inv. of their assets
CONS of holding assets directly
TAX:
- divs and taxable int. are taxable each yr they are received
- to reallocate assets, cap gains will be realized through the exchg necessary to do so
- MFs may produce cap gains to investors via turnover of assets
PROS holding assets in tax-advantaged plans
TAX:
- no taxes on cap gains until distrib. and for ROTH, no tax is realized at distrib.
- changes in asset allocation may be made tax-free w/in the vehicle
- distrib. can be deferred a long time, resulting in long periods of tax-deferred earnings
CONS holding assets in tax-advantaged plans
TAX:
- all inv. income will be taxed as ord. income when distrib. balances must be distrb. at some point (except ROTH)
- no step-up basis for death, and all distrib. are taxed as ordinary income
CHOICE:
- partic. must abide by the terms
PENALTY TAXES:
- if min distrib. not taken (50%); premature distrib. effected (10%)
- a non-tax-efficent way of buying shares just b4 a div is issued
- div is taxed to investor when issued, so the investor’s total fin. position is lowered by the tax on the div.
buying a div
the total operating expense of a MF divided by the fund’s net assets
used for evaluating MF admin costs and perf.
expense ratio
hedge funds that are structured to invest in other hedge funds
fund of funds
a %age of realized and unrealized gains of a hedge fund which the fund retains from investors’ positions in addition ot mgmt fees
incentive fees
total operating expenses of MF divided by the fund’s income
for evaluating MF admin costs and perf.
income ratio
the determination of whether assets s/b held directly or through tax-adv. vehicles
location analysis
calculated by dividing the smaller of the fund’s total purchases or total sales of sec. by its avg monthly assets
if 100% = fund has sold and replaced 100% of its assets over the period
turnover rate
explain why an investor is better off waiting until after the ex-dividend date to buy fund shares
- not tax efficient
- value of the shares will fall by the amt of the dividend payable, but div will be taxable to the purchasing s/h (unless tax-exempt)
why are hedge funds not tax-efficient vehicles?
- organized as LLCs or partnerships - operate as flow-through income tax entities
- therefore, profits and losses pass through to investors
- profits are S/T - therefore, taxed as ordinary income to taxable investors
common inv. constraints
- investor’s ability to risk loss of inv. income and principal
- degree of liquidity and marketability needed in the portfolio
- how well the investor is able to sustain the ups and particularly the downs in the securities markets
- the quality of available inv. mgmt services
- investor’s attitudes and emotional tolerance for risk
