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International Asset Management > Lecture 2 > Flashcards

Lecture 2 Flashcards

1
Q

What are the parties involved in mutual funds?

A
  • bord of directors
  • investors
  • investment adviser
  • other parties
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2
Q

What is a fund?

A
  • pool of securities owned by fund investors
  • fund has no employees, but purchases services from third parties. Most important party is the investment adviser (fund manager)
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3
Q

Board of directors

A
  • Responsibility: Protect the interests of the fund’s shareholders
  • Relies on third-party service providers (fund has no employees)
  • Inside members: Employees from the investment adviser -> conflict of interests
  • Outside members: No relation with the investment adviser
  • Regulation requires 75% of independent directors
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4
Q

Investors

A

Retail investors:
• can own the fund’s shares in different accounts
• can purchase and sell the fund via different channels: fund company, broker, fund supermarket

Institutional investors:
• insurance companies
• foundations
• other mutual funds (fund of funds)
• wealthy individuals
• corporations
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5
Q

Investment adviser / investment management company

A
  • investment adviser makes the fund’s investment decisions
  • Value for fund investors depends on the skill of the fund manager and compensation
  • investment advisers typically run many different funds because of synergies
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6
Q

Other parties

A
  • distributor: performs the transaction in the fund’s shares with investors
  • transfer agent: keeps shareholder records
  • custodian: holds cash and securities of the fund
  • auditor: checks the fund’s annual report
  • legal advisers: prepare regulatory documents; draft and check contracts between the fund and service providers
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7
Q

Regulatory framework

A

Investment company act of 1940:
• major piece of legislation for mutual funds
• set the minimum requirement for the number of independent directors
• section 13: shareholders can vote on certain matters, e.g. change in investment policy
• section 17: securities need to be held in custody
• mutual funds cannot issue debt securities

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8
Q

Net asset value pricing (NAV)

A
  • Mutual fund shares can be purchased and sold at the fund’s net asset value
  • NAV is computed at the end of each trading day
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9
Q

NAV - Timing

A

Backward pricing:
• fund is priced before the orders are made
• problematic as price does not correctly reflect the information available to investors when they make their investment decision
• positive news: buy the fund’s shares
• negative news: sell the fund’s shares

Forward pricing:
• NAV is computed after the order has been received
• orders submitted before the market close are executed at the 4pm NAV
• orders submitted after the market close are executed at the subsequent day’s NAV

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10
Q

All-equity capital structure

A

According to the ICA of 1940 mutual funds are not allowed to issue debt securities and their ability to borrow money is limited

Advantage:
• Fund return corresponds to the return of the fund’s assets
• no funding risk
• not subject to downward spiral of deleveraging and falling security prices

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11
Q

Finacial stability: liquidity and leverage

A

• the possibility to purchase/sell fund shares at their NAV and the absense of leverage make open-end mutual funds stable investments
• However, still risk of asset fire sales depressing the prices of the fund’s assets
• To minimize this risk:
- funds should have some cash buffer
- invest in liquid securities

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12
Q

Closed-end funds

A

• differences to open-end funds:

  • number of fund shares is fixed
  • regulation allows for leverage
  • closed-end funds have an IPO
  • subsequently, the fund’s shares can only be traded in the secondary market
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13
Q

Investment objectives - asset classes

A

• equity funds:
- stocks
- regional focus
- investment topic, i.e. sustainability
• bond funds:
- debt securities
- different maturities
- type of bond issuer (companies, countries, …)
- riskiness of issues
- type of interest payments (fixed vs. variable)
• money market funds:
- money market instruments: short-term bonds, fixed deposit accounts, treasury note
• mixed funds
• target date funds
• funds of funds

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14
Q

Investment philosophy

A

• investment styles

  • small cap vs. large cap
  • value vs. growth
  • momentum

• active vs. passive

  • active funds: beat their benchmark
  • passive funds: replicate the return of an index
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15
Q

Choice of benchmark

A
  • investment companies have an incentive to strategically select a less risky benchmark that is likely to yield lower returns
  • there are often instances in which the reported benchmark does not match the fund’s portfolio holdings
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16
Q

Distribution policies of mutual funds

A

• distributing funds

  • pay out gains to their shareholders
  • distributions from the fund’s assets: interest payments, dividends
  • capital gains

• retaining funds
- do not pay out any gains to investors (reinvestment)

17
Q

Advantages and disadvantages of mutual funds

A

Advantages:
• Diversification
• Professional asset management
• Ready access to asset classes and market sectors

Disadvantages:
• (Persistent) high fee levels
• Tax inefficiency
• Inadequate disclosure

18
Q

Advantages and disadvantages of mutual funds:

Diversification

A
  • Portfolio contains many different securities
  • Portfolios are frequently rebalanced
  • Balanced funds allow even for diversification across asset classes with a singe investment
  • Broker fees can be avoided by trading with the investment management company directly
19
Q

Advantages and disadvantages of mutual funds:

Professional asset management

A
  • Fund managers usually perform better in analyzing a firm’s businesses and predicting future performance
  • Access to rich information for investment decision
  • Select securities that match the fund’s risk-return profile
20
Q

Advantages and disadvantages of mutual funds:

Ready access to asset classes and market sectors

A
  • Reduction of transaction costs by trading with the fund family directly
  • Access to securities that are hard to trade for retail investors (stocks in emerging markets)
  • Persistent investment in market sectors
  • Additional desired investment criteria
21
Q

Disadvantages of mutual funds:

High fee levels

A
  • Investors may not benefit even if fund generates positive before-fee returns
  • Some funds persistently charge large fees
  • Deferred costs can increase the costs to exit the fund
22
Q

Disadvantages of mutual funds:

Tax inefficiency

A
  • Fund investors have to pay taxes on distributions of the funds
  • Taxes do not depend on whether distributions are reinvested or paid out
23
Q

Disadvantages of mutual funds:

Inadequate disclosure

A
  • Only information that is available daily is the NAV per share
  • Number of shares is only available at quarter end
  • A fund manager may have sold stocks that have performed poorly and purchased stocks that have performed well
  • Falsified quarterly performance
  • Increased trading costs

International Asset Management (9 decks)

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