Ch 8: Investm Companies Flashcards
investm company
corp/trust through which investors may require an interest in large, diversified portfolios of secs by pooling their funds with other investors’ funds and buying shares/units of the fund
3 types of investm cos
- Mgmt investm cos
- Unit Investm Trust (UITs)
- Face amount certificate cos (FACs)
FACs
contract between an investor and an issuer in which the issuer guarantees payment of a stated/fixed sum to the investor at some set date in the future
In return for this future payment, the investor agrees to pay the issuer a set amt of money either as lump sum or periodic installments.
JUST KNOW THAT THIS SEC IS 1 OF THE 3 TYPES.
UITs
an unmanaged investm co. organized under a trust indenture.
UITs:
- DO NOT have board of directors
- DO NOT employ an investm adviser
- DO NOT actively manage their own portfolios (trade secs)
IMPORTANT FEATURES OF UITs:
- UITs are NOT actively managed; no BOD or investm adviser
- UIT shares (or units) must be redeemed by the trust
- UITs are investm companies as defined under the Investm Co. Act
UITs: issue or trade?
UIT issues only redeemable secs (known as UNITS orr SHARES OF BENEFICIAL INTEREST) each of which reps an undivided interest in the portfolio.
Once the specified total is raised, trustees use investor’s money to purchase secs designed to meet the UIT’s stated obj. The trustees must maintain secondary markets in the units, thus allowing unit holders the ability to redeem their units at NAV.
Without an adviser, the portfolio remains FIXED.
UITs are sold by prospectus.
mgmt investm cos
actively manages a securities portfolio to achieve a stated investm objective
can be either open or closed
both closed-end and open-end cos sell shares to the public; the difference between them lies in the way they raise capital and how investors buy and sell their shares (in primary and secondary mkts). so basically:
- initial raising capitalization
- how they’re priced + bought/sold
NAV
(value of all assets - liabilities) / # of sh understanding
NAV per share computation is critical to the buying and selling of open-end cos; has little to do with close-ended funds
***definition of “investm company” DOES NOT include…
holding companies
special term only used for mgmt cos…
diversified/undiversified
diversified investm co is one that meets the following 75-5-10 requirement:
- at least 75% of the fund’s total A must be invested in cash and secs issued by cos other than the investm co itself or its affiliates
- 75% must be invested in such a way that…
1) NOR MORE THAN 5% OF THE FUND’S TOTAL A are invested in the secs of any 1 issuer AND
2) no more than 10% of the outstanding voting secs of any 1 issuer is owned (by the 75%)
Open-End Investm Companies Initial Capitalization (the way they raise capital from investors)
Open endeds/mutual funds DO NOT specify the exact # of shares it intends to issue. It registers an open offering with the SEC
open-end investm co. can raise an unlimited amt of investm capital by continuously issuing new shares. AND bc the shares area ALWAYS A NEW ISSUE, it’s required to deliver a PROSPECTUS PRIORT TO/CONCURRENT WITH THE SALE.
Money invested goes to the issuer (the MF). 1 other point is that open-end cos COMMONLY ISSUE COMMON STOCK!!! Money raised from issuance of common stock is then used by PMs to invest in secs meeting that fund’s obj
***so an open-end investm co can by preferred stock and bonds, but…
it cannot issue any security other than common stock
Closed-End Investm Companies Initial Capitalization (the way they raise capital from investors)
close-ended investm companies conduct a common stock offering to raise capital. For the initial offering, the co. registers a FIXED # OF SHARES with the SEC and offers to the public for a limited time through underwriting group (similar to IPO)
fund’s capitalization is FIXED unless additional public offerings made later.
Investors CANNOT REDEEM shares back to the co. Investors close their position by selling them in the 2nd market just like trading stocks. 1 exception to this (details to come)
Close-end funds can also issue bonds and pref stock. Therefore, cap structure of a closed-end co can resemble a corp - common stock , pref stock, and bonds!
Investors cannot redeem shares of a close-end fund, BUT there is an exception! 1 type of close-end funds called…
interval funds; key facts:
- it’s a closed-ended investm co, registered under the Act
- unlike other closed-end funds, interval funds do NOT TRADE on 2nd market
- they’re called interval funds bc at certain intervals, which may be anything from monthly to annually, investors are allowed to sell a portion of their shares back to the fund at NAV
- 1 benefit of these funds is that the PM can take certain illiquid positions a MF manager might not take bc there is no need for daily liquidity with an interval fund
- in general, these would be MORE SUITABLE FOR AN INVESTOR WITH A LONGER TERM HORIZON
Business Development Company (BDC)
type of closed-end investm co regulated under the Act; these are creates by an act by Congress
purpose was to create a new vehicle in the promotion and development of small businesses.
It does not have the flexibility of regular closed-end funds bc at least 70% of its A must be invested “eligible” assets.
ELIGIBLE PORTFOLIO COMPANY includes ANY issuer that does NOT have any class of secs listed on a national securities exchange; The exception is for issuers with a class of secs listed on a national sec exchange if they have an aggregate MV of outstanding voting and non-voting common equity of less than $250M.
The most significant difference between a closed-end fund and a BDC?
for eligible assets, the BDC must make available significant managerial assistance.
In other words, in addition to being an investm co, a BDC is also an operating company.
*****biggest difference between open-end and CEFs…
how they’re priced; only the open-end co. whose price is solely dependent upon that calculation of NAV
*** CEFs trade in the 2nd market (exchange or OTC); price based on supply and demand of shares. As a result, their buying + selling price does NOT fully relate to NAV of shares (market price of a closed-end fund is independent of the fund’s NAV)
closed-end investm co are commonly known as…
publicly traded funds
after stock is distributed, anyone can buy./sells hares in 2nd market (either on exchange or OTC)
supply and demand determine the bid and ask prices
Close-end fund shares usually trade at a premium/discount to the shares’ NAV
bid vs ask price
bid - price at which an investor can sell
ask - price that an investor can buy
pricing open-end investm co shares
any person who wants to invest in the co buys shares DIRECTLY FROM THE CO/UNDERWRITERS at the PUBLIC OFFERING PRICE (POP)
POP
public offering price for mutual funds/open ended funds
MF’s POP is the NAV per share plus any applicable sales charge.
no secondary trading of shares in these
open-ended investm co sells…
redeemable secs
when investors liquidate their shares, the co. redeems them at their NAV; for each share an investor redeems, the co sends the investor money for the investor’s proportionate share of the co’s net assets.
Therefore, a MF’s capital SHRINKS when investors REDEEM shares.
Each investor’s share in the fund’s performance is based on the # of shares owned. MF shares may be bought in either full/fractional units (unlike stock, which must be bought in full units only). So think of MF shares in terms of DOLLARS rather than # of shares owned.
Since CEFs trade like corporate stock, fractional shares are not available
Forward pricing
open-end investm cos (MFs) must compute their NAV per share at least once per day as of the close of the mkts.
Price is determined based on forward pricing principle (next computed NAV per share)
how often is NAV calculated for CEFs?
weekly (not daily) since their price is independent to NAV
FINRA prohibits underwriters from assessing sales charges more than…
8.5% of POP on the purchase of open-end investm co shares.
historically, MFs change FRONT-END LOADS of up to 8.5% of the money invested (POP); today, few charge that much. Instead, funds may charge a BACK-END LOAD when funds are withdrawn.
Some funds charge ongoing fees under section 12b-1 of the Investm Co Act.
*** the term for the expense of buying/selling MF shares is called…
sales charge/sales load/charge/load
Costs to purchase MFs
ALL sales commissions and expenses for open-ended funds are contained in the POP/other fees.
Sales expenses include: commissions for managing underwriter/BDs/registered reps, advertising expenses.
MFs use different methods to collect fees for sales of shares and for compensating sales persons on an ongoing basis (trailer commissions):
- front-end loads (POP - NAV) - CLASS A SHARES
- back-end loads (contingent deferred sales loads) - mostly B SHARES
- level loads (asset-based fees; provides trail commissions to the RR servicing the acct) - C SHARERS
Class A Share fees
front-end load
charges added to NAV at time an investor buys shares.
most common way of paying for distribution services that a funds underwriter and BDs provide
Breakpoints
these are a schedule of quantity purchase discounts a MF offers
MFs that offer breakpoints must disclose their breakpoint schedule in thee prospectus and how an acct is valued for breakpoint purposes.
Discounts may be the result of a single large investm, series of aggregated investments, or a promise to invest via LOI.
***WHO is eligible for breakpoints?
married couples, parents with minor children, corporations.
parents combined with adult children (even if they’re legally considered dependents) and investment clubs are NOT eligible.
FINRA PROHIBITS RRs from making/seeking higher commissions by…
selling investm co shares in a dollar amt JUST BELOW THE POINT AT WHICH THE SALES CHARGE IS REDUCED.
THIS IS A “BREAKPOINT SALE”
Letter of Intent (LOI)
person signs an LOI informing the investm co that he intends to invest the additional funds necessary to reach the breakpoint within 13 months
It’s a one-sided contract binding on the fund only. If customer does NOT invest enough money to complete LOI, he’s given the choice to either pay the sales charge difference or have the underwriter liquidate enough of the escrowed shares to do.
backdating the letter
fund often permits a customer to sign a LOI as late as the 90th day after an initial purchase. LOI may be backdated up to 90 days to include prior purchases but may NOT over more than 13 months in total.
customer who signs the LOI 60 days after purchase has 11 months to complete the letter
*KEY POINTS OF LOI
- letters of intent are good for max of 13 months and may be backdated 90 days
- if LOI is NOT completed, the sales charge amt that applies is based on total amt invested
- share appreciation and income paid by the fund do NOT count toward completion of the letter
Rights of accumulation vs LOI
Rights of acc (like an LOII) allows investor to reduce sales charged by reaching a breakpoint.
MAJOR DIFFERENCES:
- allow the investor to use prior share appreciation and reinvestm to quality for breakpoints and
- do not impose time limits
Combination privilege
MF co frequently offers more than 1 fund and refers to these multiple offerings as its family of funds.
Investor seeks a reduced sales charge by allowing the COMBINATION OF SEPARATE INVESTMENTS IN 2 OR MORE FUNDS within the same family to reach a breakpoint.
Class B shares
DO NOT charge a front-end sales charge/sales charge at time of purchase. so 100 cents of the invested dollar are invested.
DO impose a back-end charge for early redemption of shares.
In addition, there is an asset-based 12b-1 fee greater than those for Class A shares.
***Altho not a violation, regulators scrutinize large purchases of Class B shares. A purchase large enough to reach a significant Class A share breakpoint results in a low enough sales charge that, in just a few yrs, the lower operating expenses o the Class A shares will more than make up the difference in front-end cost. In practice, very few firms will accept an order for Class B shares in excess of $100K, particularly if the investor intends to maintain the position for a number of yrs.
Class C shares fees
have 1-yr 1% CDSC, a 0.75% 12b-1 fee, and a 0.25% shareholder services fee.
Since these fees are pretty high and never go away, these are known as “level loads”.
Class C shares good for ST horizons bc they become quite expensive to own if investing for more than 4 yrs.
12b-1 fees (asset-based distribution fees)
used to cover marketing + distributing the fund to investors costs
used to compensated RRs for servicing an acct (trailer commissions) but should NOT be confused with sales charges.
fee is dedicated quarterly as % fo fund’s avg total NAV.
MAX 12B-1 FEE IS 0.75% FOR DISTRIBUTION AND PROMOTION. FINRA permits funds to charge an additional 0.25% service fee. SO total of 1%, where only 0.75% of that is the 12b-1 fee.
No-load funds
funds that DO NOT charge any type of sales load.
no-load fund is permitted to charge redemption fees. charged if investor is going in and out of the fund too frequently.
combined amt of fund’s 12b-1 fees or separate shareholder service fees CANNOT EXCEED 0.25% of the fund’s avg annual net assets
misusing “no-load” terminology
fund that has a deferred sales charge or 12b-1 fee of more than 0.25% of avg net assets may NOT be described as a “no load fund”
***12b-1 fee is expressed as…
annual amt but is charged and reviewed quarterly
*** charged covered by 12b-1 fees include…
advertising, sales lit, and prospectuses delivered to potential customers, not fund-mgmt expenses
