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CH 17 Investment Companies (Mutual Funds and Hedge Funds)

Terms in this set (29)

Brief History of Mutual Funds
1924:First Mutual Fund was established in Boston
1970s:Money Market Mutual Funds became popular as an alternative to commercial banks deposits (due to interest rate ceilings imposed by regulators on banks)
1990's:Equity Mutual Funds became popular due to investors desire to earn returns during the bull stock market
Types of Mutual Funds
1.Open vs Closed ended
2.Long term vs Short Term
3.Passively vs Actively Managed
4.ETF's
Open ended vs Closed ended
Open:A fund for which the supply of shares is not fixed but can increase or decrease daily with purchases and redemptions of shares (90% of investment company assets)
Closed:Specialized investment companies that have a fixed supply of outstanding shares but invest in the securities and assets of other firms (ex-REIT)
Long Term vs Short Term Funds
Long term funds include stock funds, bond funds, and hybrid funds
Short term funds include taxable and nontaxable money market funds
(usually 80% to 20%) (during fin crisis 60/40)
money market mutual fund
funds consisting of various mixtures of money market securities.NAV is set at $1, dividends or new shares are paid out to investors to maintain NAV of $1
Passively Managed vs Actively Managed
Passive Management: holding a well-diversified portfolio without attempting to search out security mispricing
Active Management: Attempt to achieve higher returns than suggested by the risk level by forecasting broad markets and/or by identifying misplaced securities
Index Funds: hold securities in similar proportion as a specified major stock index
ETF's
Long-term mutual funds that attempt to track an index
Can be bought and sold throughout the day. Trade at a market price, not NAV. Can be purchased on margin and sold short. Investors can defer capital gains until the ETF is sold. Lower initial cost.
Mutual Fund Regulations
1. SEC
-The primary regulator
-Funds must file registration with SEC
-SEC requires funds to report trades by senior managers
-Since 2004, SEC requires that funds hire a Chief Compliance Officer to monitor the fund
2. National Association of Securities Dealers
-The NASD supervises mutual fund share distribution
3.Not Subject to oversight from state regulators
NAV
the net asset value of a mutual fund; equal to the market value of the assets in the mutual fund portfolio divided by the number of shares outstanding
How mutual funds work
investor ownership is proportional to the number of shares purchased
unlike stocks, mutual funds don't have a share price
Instead, every day the fund calculates NAV by marking to market
Load Fund
a mutual fund with an up-front sales or commission charge that the investor must pay
Operating Expense
typically given as an expense ratio, a percentage of assets under management
Front-end load
sales charge paid when you purchase the shares
Back-end load
sales charge paid when you sell the shares
12b-1 fees
fund assets used to pay for distribution costs (advertising, promotional literature, commissions paid to brokers who sell the fund to investors)
Active management
attempt to achieve higher returns than suggested by the risk level by forecasting brand markets and/or by identifying mispriced securities
Passive management
Holding a well-diversified portfolio without attempting to search out security mispricing
Index Funds
hold securities in similar proportion as a specified major stock index
Strategies that active managers might follow
1.Stock selection- includes individual stocks or industries
2.Market Timing- switching between risky assets and cash based on forecasts of market
3.Volatility Timing- attempting to predict future volatility and limiting exposure to it (minimize risk)
How has the industry changed over time
Fewer active funds, more $ flowing into passive funds
John Bogle
Pioneered index fund investing
founded vanguard
ultra low cost
Vanguard average expense ratio is 0.11%
Downsides to Passive Managment
1.Inability to express/remove support of companies
2.Common Ownership (airline example)
Hedge Funds
investment pools that invest funds for wealthy individuals and other investors 1
Classification of Hedge Funds
1.More risky
2.Moderate risk
3.Risk avoidance
More risky
Most aggressive , attempt to profit in many types of markets, use leverage and derivatives to accentuate price movements
Example: Macro Hedge Funds aim to profit from changes in global economics. They invest in equities, bonds, currencies, and commodities
Moderate Risk
More traditional, more similar to mutual funds
Example special situation hedge funds invest in event-driven situations such as mergers, hostile takeovers, or leveraged buyouts
Risk avoidance
Emphasizing consistent but moderate returns while minimizing risk
Example: Mkt neutral security hedge funds invest equally in long and short equity portfolios in particular market sectors. Thus, market risk is reduced, and profits can be obtained by carefully analyzing stocks. Leverage is used to magnify returns.
How to make money going long in a security?
1.Buy
2.Wait for increase
3.Sell
How to make money going short in a security?
1.Borrow security
2.Sell
3.Wait for decrease
4.Buy Security
5.Repay Debt
Note:Riskier than going long due to debt
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