Chapter 12 - Analyzing Conventionally Managed products

Question 1

Which organization carries out the classification of mutual funds in Canada?

Answer 1

The Canadian Investment Funds Standards Committee (CIFSC)

Question 2

Which type of mutual fund issues units and which type issues shares? How are most mutual funds structured?

Answer 2

A mutual fund corporation issues shares, a mutual fund trust issues units. Most are structured as a trust?

Question 3

What happens if a mutual fund trust leaves income in the fund undistributed to unitholders?

Answer 3

If the mutual fund dies bit pay out remaining income from investment activity (after deducting fund’s expenses) then the trust would have to pay tax at the top marginal rate.

Question 4

What are the 5 elements of a mutual fund firm that should be considered before selecting a company to invest in?

Answer 4

1. Personnel
2. Business
3. Philosophy
4. Process
5. Performance

Question 5

Why is it important for a mutual fund firm to have a large majority or 100% employee ownership?

Answer 5

Enables the firm’s interests to be aligned with those of the principal owners. The lesser the extent of outside ownership, the smaller the chance of intervention in the decision-making process.

Question 6

Describe the value investing philosophy.

Answer 6

To avoid paying large premiums for growth companies, you instead seek bargains in mature companies that are out of favour by purchasing a firm for less than what the assets in place are worth.

Question 7

Describe the growth investing philosophy?

Answer 7

Growth investors are more concerned with a firm’s future prospects than its present price. Even if a firm is trading at more than its intrinsic value, the firm may have above average prospects for future earnings growth.

Question 8

What are the 5 primary equity investing philosophies?

Answer 8

1. Value investing
2. Growth investing
3. Sector rotation
4. GARP (growth at a reasonable price)
5. Momentum investing

Question 9

How does momentum investing work?

Answer 9

Aims to capitalize on existing market trends by purchasing firms that have strong gains in earnings or stock price believing that this will translate into future strong gains as well. Typically high turnover as falling stocks are sold off.

Question 10

What is GARP?

Answer 10

Growth at a reasonable price - a value approach to buying earnings growth. GARP managers seek companies with projections of earnings growth and high increasing returns, but avoid stocks with high P/E and P/B ratios.

Question 11

What is the PEG ratio?

Answer 11

Price/earnings to growth ratio - P/E divided by earnings growth. Used by GARP managers as a yardstick to determine which companies are overpriced. A PEG of <1 implies that a stock is underpriced given earnings growth, while a PEG of >1 implies the stock is overpriced relative to its growth prospects.

Question 12

What are the 4 primary fixed income investing philosophies?

Answer 12

1. Basic interest rate anticipation
2. Value or security selection for bonds
3. Sector trading
4. High-yield investing

Question 13

How do fixed income managers utilize a basic interest rate anticipation philosophy?

Answer 13

Move between long-term government bonds and short-term T-bills based on a forecast for interest rates over a long time horizon.

Question 14

What does the value/security selection process for bonds look like as a mutual fund investment philosophy?

Answer 14

Fundamental and credit analysis, as well as quantitative valuation techniques of individual securities.

Question 15

What is the problem with style drift?

Answer 15

Style drift can occur when a manager invests in different style stocks at different market cycles. The more style drift that exists, the more difficult it becomes to separate the manager’s skill from coincidence, and it becomes more difficult to ascertain the fund’s appropriate risk level.

Question 16

What is a platform-traded fund?

Answer 16

PTFs are listed in Canada on Cboe Canada, and include both mutual funds offered by a prospectus and investment funds offered by an offering memorandum. They are often a class or series of an existing investment fund.

Question 17

What is a closed-end fund?

Answer 17

An actively managed fund that initially raises capital by selling units to investors, after which additional units are rarely issued. Once issued, units are listed for trading on a stock exchange. A NAVPS is calculated, but units are traded based on supply and demand with commissions paid to dealers for trading. Unlike with ETFs, there is no arbitrage-based link between the trading price and the NAVPS. They historically have traded at a discount to their NAVPS.

Question 18

Why is there no arbitrage-based link between the trading price of closed-end funds and the NAVPS?

Answer 18

Investors cannot buy units from or sell units to the fund (unlike with ETFs).

Question 19

Do closed-end funds typically trade at a premium to, on par with, or at a discount to the NAVPS?

Answer 19

Historically at a discount to the NAVPS.

Question 20

What is the primary advantage of closed-end funds over mutual funds?

Answer 20

After initial units are issued, fund managers are not concerned about additional flows of cash into or out of the fund, so managers can focus on executing their investment strategy with concerning themselves with redemptions/additions to the fund.

Question 21

What are “wrap products”?

Answer 21

Wrap funds - portfolios of managed products “wrapped” together and sold as a single product. Wrap accounts - accounts for which a qualified PM is authorized to select securities and execute trades on a client’s behalf (sounds like discretionary acct?)

Question 22

What are the two basic types of wrap products?

Answer 22

• Funds of funds - invest in portfolios of other managed products, usually mutual funds.
• Separately managed wraps - targets investors with higher levels of investable assets, accts are managed on a segregated basis, enabling a client to own individual securities. Client selects from a range of professional money managers to manage their portfolio.

Question 23

What is overlay management?

Answer 23

Service that combines several managed investment products into a single account that a single authority controls. This is in contrast to conventional portfolio construction which merely combines separate accounts for each managed product, multiplying the admin work involved.
(This is in contrast to single security selection)

Question 24

What are unified managed accounts (UMAs)?

Answer 24

Software tools and data feeds that eliminate the shortcomings associated with separately managed accounts.

Question 25

What is the definition of portfolio turnover?

Answer 25

The total value of securities bought and sold in relation to the portfolio’s overall net assets.

Question 26

What happens if a mutual fund’s turnover is expected to be more than 70% in future periods?

Answer 26

The prospectus includes a statement that explains how the tax consequences and trading costs associated with the turnover may affect the fund’s performance.

Question 27

Why does high turnover in a MF portfolio not always result in taxable capital gains distributions?

Answer 27

The higher turnover may be the result of the PM selling securities to realize gains against realized losses (or vice versa).