Chapter 8 - Mutual Funds Flashcards
Name the four elements an investor an investor must consider before selecting a mutual fund?
- People
- Philosophy
- Process
- Performance
What are the two methodologies to Style Analysis?
- Returns-based style analysis
- Holdings-based style analysis
What is Returns-based style analysis?
- An analysis developed by William Sharpe which determines a funds investment style by comparing its returns to a similar passive style index.
- It is the easiest style analysis to us, requiring only monthly returns
- Use Returns Style when a fund is using Derivatives. HSB has no way to account for their use.
What is Holdings-based style analysis?
- Holdings-based analysis examines each stock in the portfolio and maps it to a style at a specific point in time.
- The analysis can be done base on market cap or different valuation ratios.
- The most accurate Style
based analysis. - The only methodology to use for funds with fewer than two years of history.
What are the two fund costs?
- Explicit Costs
- Implicit Costs
What are Explicit Costs and explaing the three primary categories?
Explicit costs are those that are directly borne by the investor. They fall into three categories:
- Management fees,
- Operating costs
- Sales charges.
Explain he management expense ratio (MER) and what explicit cost it encompasses?
The MER is the total of management fees and operating expenses paid by a fund, and is expressed as a percentage of its average net assets.
How can the value of a fund MER change?
- Type of Fund:
- Based on the complexity of the investments being managed the funds MER can change.
- Bond Funds (Lower MER)
- Foreign Equity (Higher MER) - Size of the Fund:
- Portfolios with few AUM have higher fees due to economies of scale. - The Manager of the Fund:
- Some firms outsource their management to a specialist firm.
- This tends to make the funds more expensive, the most expensive option would be if the fund has utilized a sub-advsior.
What are Implicit Costs?
- Trading costs are implicit costs, measured by brokerage fees and turnover, and are not expensed in the MER.
- For example: A stock purchased for $1,000 plus $30 in commissions will be kept on the fund’s books as costing $1,030. This represents a higher break-even hurdle for a manager to overcome.
How might Trading Costs (Implicit Costs) affect a portfolios return?
- A fund with a high turnover on their portfolio will experience higher trading costs and therefore require a higher return to exceed these costs.
- Brokerage fees may vary based on the size of the firm.
- Funds with larger AUM will be able to negotiate lower fees than smaller ones
What are taxable distributions from Mutual Funds?
If over the course of a year the fund generates capital gains (or losses) that exceed their expenses they distribute the excess income to their unit holders.
How will a merger of two funds affect their unit holders?
- The risk return/profile of the new fund may be significantly different than the original fund.
- Depending on the structure of the merger, tax loss carry-forwards that could be used by the fund to shelter future capital gains may be lost.
- The Income Tax Act rules indicate both capital and non-capital losses of a terminating fund can be used to reduce capital gains only in the tax year in which the merger takes place.
- Investors might find their asset allocation strategies in chaos if a fund they have been merged into follows a different path than the one they bought.
- The new manager may sell securities in the merged fund to create the portfolio in his own image or dispose of assets that are deemed incompatible with the investment policy of the surviving fund, generating large brokerage fees and
triggering taxable capital gains. - The performance history of the merged fund may disappear, leading to an upward bias in the surviving fund’s return
history.
