R 27.1 Mutual Funds Flashcards
open-end mutual funds
open-end mutual funds are broken down into 4 main categories: money market funds, equity funds, bond funds, and hybrid funds.
Money market funds invest in short-term interest-bearing instruments, such as Treasury bills, commercial paper, and banker’s acceptances. Money market investors are typically risk averse. This category is an alternative to interest-bearing bank accounts and is often the “cash” portion of an investor’s asset allocation mix.
Equity funds invest solely in stocks. can be index fund, amount of tracking error is indicative of the success of a fund in tracking the desired index
Bond only Fixed income, hybrid mix of stocks and bonds
NAV= Assets-liabilities
When investors decide they want to buy shares of an open-end mutual fund, they will transact at the next available NAV, which is not calculated until after the market closes at 4:00 pm in New York City.
open-end fund investors have poor price visibility. They must place a market order to transact in shares of an open-end mutual fund.
dividend, LTCG & STCG all taxable
Dividends and capital gains are distributed to investors typically toward the end of the calendar year, but they can be automatically reinvested in the fund to purchase more shares. Investors often choose reinvestment if they do not need the cash flow for current consumption.
Management fee and other cost
Open-end mutual funds have a management fee and potentially a sales charge. The management fee covers the operational costs of the open-end mutual fund company, including the salaries of the management team. The expense ratio is calculated as the annual management fee divided by the AUM.
MF is lower in index compared to active.
Sales charges are commonly called loads. A front-end load is a set percentage that is charged to the investor upon initial investment in the fund. some funds impose a sales charge when the investor sells an investment in the fund. This is called a back-end load.
closed end mutual fund
Purchase of shares in an open-end mutual fund will increase the number of shares outstanding because new shares are created, but a closed-end fund’s number of shares remains static.
Investors who desire to purchase or sell shares of a closed-end fund do not transact directly with the fund company but rather with other investors.
Recall that investors who want to close their investment position in an open-end fund can simply redeem their shares from the fund company.
Both long and short positions can be taken in closed-end fund shares anytime, open end funds traded specific time with long only positions.
It is very common for a closed-end fund to trade at a discount to its actual NAV. In the case of a discount, an argument can be made that the discount arises because of management fees.
ETF
Exchange-traded funds (ETFs) are created by depositing shares with an ETF and then receiving shares of the ETF and advancement of Open end MF. Investors can put stop orders, limit orders, and even short selling in some cases.
ETFs typically trade at their NAV.
ETFs must disclose their holdings twice each day, which enables investors to have tremendous visibility into their underlying investments. Open-end mutual funds, on the other hand, disclose their holdings very infrequently, perhaps as delayed as once per quarter.
Trading behaviors (unethical) among mutual funds include late trading, market timing, front running, and directed brokerage.
Late trading occurs when orders are accepted after the 4:00 pm cut off trading time (in the United States for open-end mutual funds). It is possible for significant market events to occur shortly after 4:00 pm that would cause previously submitted trades to be reversed. Therefore, the acceptance of orders after 4:00 pm would be considered illegal and subject to prosecution.
Market timing occurs because some fund assets are not actively traded, thereby resulting in stale pricing when calculating NAV. If market prices are rising (falling) shortly before the 4:00 pm cut off, it may be profitable to buy (sell) at the NAV at 4:00 pm since the stale pricing means that the value of the shares is likely higher (lower) than the NAV. Market timing trades may result in sudden fluctuations in the fund’s size that will require the fund to maintain greater liquidity to satisfy redemptions (holding liquid assets such as cash would lead to reduced fund returns since cash generates little or no investment income). Although of potential concern to regulators if trading exceptions are made for market timing, the act of market timing is not illegal.
Front running involves trading ahead of a likely price increase or decrease due to a known upcoming trade to be made by the fund. It may involve the trader’s own account or favored clients or employees. Like late trading, front running is illegal, and is subject to prosecution.
Directed brokerage involves a quid pro quo whereby a mutual fund will direct trades to a broker in exchange for the broker investing its clients in the mutual fund. Although not illegal, it is a strongly discouraged practice.
