Chapter 11 - Analysis of Conventionally Managed Products - 7% Flashcards
What is a conventionally managed product?
A conventionally managed product is a pool of capital gathered to invest in a portfolio of other securities according to a specific investment mandate. A management fee is paid to a professional money manager to carry out this mandate. A conventionally managed product is a long-only vehicle, holding just equities, bonds or cash.
What are Mutual Funds?
A mutual fund is an open-ended investment company that is structured either as a corporation or as a trust and that raises capital by issuing shares (in the case of a mutual fund corporation) or units (in the case of a mutual fund trust).1 The capital is used to purchase securities according to the fund’s investment mandate.
The classification of mutual funds in Canada is carried out by the Canadian Investment Funds Standards Committee (CIFSC),2 which comprises Canada’s major mutual fund database and research firms. As there are no industry-standardized categories for mutual funds in Canada,
the CIFSC has a self-imposed mandate to standardize the classifications of Canadian-domiciled mutual funds. As of April 2013, CIFSC had 52 categories for Canadian-domiciled mutual funds.
What are Closed-End Funds?
A closed-end fund is an actively managed fund that initially raises capital by selling units to investors, after which additional units are rarely issued. The manager of the fund uses the fixed pool of capital to purchase and manage a basket of securities according to a specific investment mandate, for which the manager is paid a management fee. In general, the management fee charged by a closed-end fund is lower than the management fee of a mutual fund with a similar investment objective.
What are Wrap Products?
Wrap products include wrap funds and wrap accounts. Wrap funds are portfolios of managed products “wrapped” together and sold as a single product. Wrap accounts are accounts for which a qualified portfolio manager is authorized to select securities and execute trades on behalf of a client. The securities can include mutual funds, pooled funds, or individual securities such as stocks and bonds.
What are the types of Wrap Products?
There are two basic types of wrap products:
• Funds of funds (FoFs) invest in portfolios of other managed products, usually mutual funds. Investors purchase units of the FoF but have no say over which funds or the weighting of those funds in the fund of funds. Most FoFs are designed to target a specific risk tolerance, which determines the relative weighting of the underlying funds. For example, a conservative fund of funds will have a greater weight in mutual funds that invest in debt securities than it will in mutual funds that invest in equity securities.
• Separately managed wraps (or simply wrap accounts) target investors with higher levels of investable assets. Accounts are managed on a segregated basis, thereby enabling the client to own individual securities. The client selects from a range of professional money managers to manage her portfolio. These programs have higher minimum investment requirements than other wrap products, usually starting in the $150,000 range.
What is Overlay Management?
Overlay management is a service that combines several managed investment products into a single account controlled by a single authority. Conventional portfolio construction, unlike overlay management, merely combines separate accounts for each managed product, multiplying the administrative work. This makes it difficult to efficiently rebalance portfolios or to customize investment solutions for clients. Under overlay management, customization and efficient rebalancing are possible.
What are Management Fees?
For any managed product, management fees reduce the return on the investment. Management fees vary within and among the various types of managed products, and they should not be the only consideration when choosing a managed product.
In general, management fees are lower on passively managed products such as index mutual funds than on actively managed products such as closed-end funds and equity mutual funds. The higher fee charged by active managers is compensation for, among other things, increased research costs associated with making investment decisions for the fund. However, by investing in actively managed products, investors expect to achieve a return greater than that of a passively managed investment.
What is Portfolio Turnover?
Portfolio turnover is defined as the total value of securities bought and sold in relation to the overall net assets of the portfolio. Higher turnover implies that more securities were bought and sold. Since trading costs are ultimately paid by the fund’s investors, higher turnover results in greater expenses and, all else being equal, a lower return.
What firm’s business measure should be tied to an investment manager’s annual bonus? A. Assets under management. B. Total firm revenue. C. Profitability of the firm. D. Return on the manager’s fund.
D is correct.
The bonus should be directly tied to performance of the fund, aligning with the interests of the fund investors. Managers are also more likely to outperform benchmarks in this arrangement.
Which of the following statements regarding PEG ratio (P/E divided by earnings growth) is true?
I. A PEG 1 implies that the stock is overpriced.
III. A PEG 1 implies that the stock is underpriced.
II and III.
GARP (growth at a reasonable price) managers use a yardstick called a PEG ratio. A PEG less than one implies that the stock price is less than it should be given its earnings growth and warrants closer attention; a PEG greater than one implies the stock is overpriced relative to its growth prospects.
What is true regarding closed-end funds?
A. They are usually issued at a discount but later sell at a premium.
B. They are usually issued at a discount and continue to sell at a discount.
C. They are usually issued at a premium but later sell at a discount.
D. They are usually issued at a premium and continue to sell at a premium.
C is correct.
A closed-end fund is an actively managed fund that initially raises capital by selling units to investors, after which additional units are rarely issued. Closed-end fund units are usually issued at a premium to their NAVPS. Over time this premium tends to turn into a discount.
Your client owns a unit of a wrap that invests in a portfolio of managed products. What wrap product does your client hold?
Fund of Funds.
Wrap funds are portfolios of managed products “wrapped” together and sold as a single product. Wrap accounts are accounts for which a qualified portfolio manager is authorized to select securities and execute trades on behalf of a client. Funds of funds (FoFs) invest in portfolios of other managed products, usually mutual funds. Investors purchase units of the FoF but have no say over which funds or the weighting of those funds in the fund of funds. In Separately managed wraps, accounts are managed on a segregated basis, thereby enabling the client to own individual securities.
Management fees tend to have a significant impact on the relative performance of mutual funds within which of the following categories? A. Emerging market funds. B. Canadian bond funds. C. Canadian equity funds. D. U.S. equity funds.
B is correct.
Management fees tend to have a significant impact on the relative performance of bonds funds (as well as index funds and money market funds). In general, bond funds have less scope to add value to outperform their competitors, and thus most of the difference in performance can be traced to a difference in management fees.
Which of the following is the most important factor to consider when selecting a mutual fund?
A. The size of assets under management.
B. The variability of returns since inception.
C. The portfolio manager and the investment team.
D. The performance of the fund compared to similar funds.
C is correct.
Evaluation of the portfolio manager and the investment team is the most important part of the mutual fund assessment process. Without a good portfolio manager leading a competent investment team, all other factors become unnecessary.
The manager of a fixed-income mutual fund uses fundamental analysis and credit analysis to make his investment decisions. Which fixed-income investing strategy is he using? A. Interest rate anticipation. B. Value or security selection. C. Sector trading. D. High-yield strategy.
B is correct.
Value or security selection for bonds involves fundamental and credit analysis and quantitative valuation techniques of individual securities. Fundamental analysis of a bond considers the nature of the security and its potential cash flow. Credit analysis evaluates the likelihood that the payments will be received as contracted, if at all, and considers industry conditions, the economy, and other macroeconomic factors, as well as factors specific to the issuer.
