Introduction to Pooled Investment Flashcards
Net Asset Value (NAV)
Net asset value is an important concept in understanding how investment companies operate. Investment companies have assets that consist of the total market value of an investment company’s assets such as a variety of stocks and bonds. The market value of all the assets held by the investment company is determined at the end of each trading day. The value of all the liabilities for that day is then subtracted from the total assets to determine the investment company’s net asset value. Liabilities of the fund include redemptions, dividend payables, operation expenses, and management fees. Then the net asset value is divided by the number of outstanding shares of the investment company to arrive at the net asset value per share or the NAV.
For example, an investment company holds two common stocks (Company A and Company B). At the end of the day, Company A’s stock traded at $10/share and Company B’s stock traded at $20/share. The investment company holds 10 shares of each stock. So the total assets of the investment company at the end of the day was $300 = ($10 x 10 shares) + ($20 x 10 shares). If the investment’s total liabilities for the day was $50, then the net asset value would be $250 = $300 - $50. The per share NAV is $12.50 ($250 / 20 shares) at the close of the day.
Unit Investment Trust (UIT)
Some of the earliest pooled investments were unit investment trusts. A unit investment trust is an investment company that owns a fixed set of securities for the life of the company. That is, the investment company rarely alters the composition of its portfolio during the life of the company. Thus the portfolio is not managed, but instead is supervised. The management team has the ability to eliminate holdings, but only in extreme circumstances like drastic deterioration in credit quality, fraud or other irregularities.
Most unit investment trusts hold fixed-income securities that expire after the last security has matured. The trust is then liquidated and proceeds are sent back to the unit holders. The holder of UIT can redeem the units of the UIT to a fund or trust, rather than placing a trade in the secondary market. Life span for these companies can be as short as six months, for unit investment trusts of money market instruments, or as long as 20 years or more, for trusts of bond market instruments. Although UITs are less popular in the United States, they still draw European investors seeking to invest in fixed-income securities with a set maturity date.
Closed-End Funds
Unlike open-end investment companies, closed-end funds do not stand ready to purchase their own shares. Instead, the shares of these funds are traded in either an organized exchange or an over-the-counter market. Thus, an investor who wants to buy or sell shares of a closed-end fund must place an order with a broker.
Closed-End Fund Quotations
A closed-end fund’s shares are considered to be trading at discount when their market price per share is less than their NAV. The fund’s shares are considered to be trading at a premium when the shares’ market price is greater than the NAV.
Open-End Funds
Today, when people talk about mutual funds, they are typically referring to the open-end mutual funds. Open-end funds have historically been the most popular pooled investment vehicle in the United States. Unlike closed-end investment companies, open-end investment companies (or open-end funds) stand ready at all times to purchase their own shares at par or their net asset value. These professionally managed pooled investments are easily accessible to any investor. You can buy them directly from fund companies, or through brokers or advisers, retirement plans, or insurance vehicles.
Redemption Fee
A few funds charge a redemption fee, which usually is no more than 1% of the fund’s net asset value and is not typically levied if the investor owned the shares for more than a specified time, such as one year. Hence, the basic purpose of a redemption fee is to discourage investors from selling their shares soon after buying them.
Exchange Traded Funds (ETF)
Exchange traded funds (ETFs) have immensely grown in popularity over the last 20 years. It is worth noting that they are a type of open-end investment company . ETFs are traded in the secondary market in much the same way that individual stocks are traded on the exchange. Similar to a stock investment, shares of ETFs can be traded throughout the day any time the market is open as well as purchased on margin. An example of an ETF is the SPDR (pronounced as “spider”) that tracks the S&P 500.
Expense ratio of an ETF fund
An actively managed ETF fund may have an expense ratio between 0.03% to over 3.0%. An expense ratio represents all of the expenses of the ETF, such as management fees, divided by assets.
Money Market Funds
Money market funds hold short-term fixed-income instruments, such as bank certificates of deposit, commercial paper, and Treasury bills. These short-term investments are considered safe and offer slightly higher yields than passbook savings accounts. Money managers can only invest these funds in credit worth short-term instruments that mature in 90 days or less.
Municipal Bond Funds
Although municipal bond unit investment trusts have been available for many years, open-end municipal bond funds were first offered in 1976. Some municipal bond funds hold long-term issues from many states to create tax-free bond funds.
Separately Managed Accounts (SMAs)
More recently, in the high-net-worth investment space, Separately Managed Accounts (SMAs), also referred to as individually managed accounts, have become very popular as an alternative to mutual funds. SMAs offer investors greater advantages compared to traditional mutual fund investing. For this type of account, the investor pays a professional money manager to buy individual stocks, bonds, cash equivalents, and other investments, which are bought directly into the investor’s account.
