Pooled Investments 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.
NAV=Assets−Liabilities/Shares Outstanding
Unit Investment Trust
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.
Unit Investment Trusts are passively managed. The professional management happens in the beginning for the asset selection. After that, no changes will be made to the portfolio except payment of interest and principal. Passive management results in lower management costs due to less turnover costs. UIT’s are not traded on an exchange, but they do have liquidity at the end of the day like traditional mutual funds.
Mutual Funds
Mutual funds are investment companies that take the pooled assets of multiple investors and purchase a variety of securities in accordance with stated objectives. Some mutual funds, known as closed-end funds, make an initial offer of a set number of shares that are then traded exclusively in the secondary market (traded between investors). In contrast, open-end funds continuously offer and redeem new shares to the public at the fund’s net asset value. For open end funds this purchase and sale occurs with the fund company and the investor.
Closed-End Funds
The Investment Company Act of 1940 provides two classifications for investment companies: unit investment trusts and managed investment companies. Both closed-end and open-end funds fall under the classification of managed investment companies.
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.
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.
Growth funds
Growth funds typically include common stocks with expected growth potential. Growth funds are more volatile due to the volatility of security prices within these funds and they do not pay dividends. These funds are ideal for investors with higher risk tolerance who seek long-term growth and long-term capital gains.
Aggressive growth funds
Aggressive growth funds include risky securities such as small company stocks that have great future appreciation potential, alternative investments such as derivatives, arbitrage strategies and futures, Initial Public Offerings (IPOs), and bonds from leverage buy-outs. Investors are seeking high rates of return and must have a high tolerance to assume risk.
Value funds
Value funds pool together securities that are considered undervalued in the marketplace whereby a security’s intrinsic value exceeds its current market value. The funds’ objectives are to provide current income and moderate long-term growth. Stocks chosen for these funds have low price/earnings ratios and higher than average dividend payouts. Value funds are good for investors with a moderate risk profile.
Balanced funds
Balanced funds are open-end companies that hold both equity (stocks) and fixed-income securities (bonds). These funds seek to minimize investment risks without unduly sacrificing possibilities for long-term growth and current income. Balanced funds typically hold relatively constant mixes of bonds, preferred stock, and convertible bonds to produce income and common stocks for growth. Funds allocate stocks and bonds in percentages to meet their fund’s objectives. For example, funds with a greater concentration of common stocks will have a higher risk and return profile and less current income. These funds can be appropriate for people who are ready for more growth than bond funds, but not entirely comfortable with the risks associated with stock funds.
Flexible income funds
Flexible income funds seek to provide liberal current income. Often, these funds will periodically alter their proportions in an attempt to time the market and gain current income.
Asset allocation funds
Asset allocation funds also attempt to time the market but in doing so, focus on total return instead of current income. The most significant new type of an asset allocation fund is the so-called target funds. These funds are targeted to a specific time horizon. “Mutual Fund 2020, 2025, etc.”. These funds are of particular interest for retirement and college funding goals.
Sector funds
Sector funds invest in specific sectors of the economy. Examples include energy, medical technology, financial services, computer technology and leisure to name a few. These funds are not well diversified because investments in the same sector are positively correlated.
Specialized Funds
A few specialized stock funds concentrate on the securities of firms in a particular industry or sector. These are known as sector funds. For example, there are:
chemical funds
aerospace funds
technology funds, and
gold funds.
Other specialized stock funds deal in securities of a particular type. Examples include funds that:
hold restricted stock
invest in over-the-counter stocks, or
invest in the stocks of small companies.
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.
The best way to think about SMAs is that an individual investor is buying their own separate version of a mutual fund. This typically requires much higher minimums than a fund and it also requires a broker to execute the trades the manager recommends.
Most money managers charge a quarterly fee based on the amount of assets under management. For this fee, the investor receives professional management with a focus on adequate diversification and the proper risk-reward tradeoff.
Advantages of Separately Managed Accounts (SMAs)
1) Individual security selection - The money manager of an SMA is buying investments for an individual investor, rather than a mutual fund. This puts more control into the hands of the investor and allows the manager to select securities based on the investor’s personal needs.
2) Social responsibility investing - The investor can specify any investment restrictions based on their social and environmental objectives or personal values. For example, an investor might choose to avoid any stock related to alcohol or tobacco.
3) Tax management - SMAs provide the investors with greater ability to dictate their own tax destiny. For example, an investor can choose whether to employ a tax efficient strategy or provide input as to when capital gains are realized.
4) Cost – Since SMAs have higher minimums they can be scaled for larger investors, and they only charge a fee for the investment management. This reduces cost by stripping away the added costs associated with mutual funds; for example, marketing, accounting, and trading costs.
