12 -- Part 4: Mutual Funds and Exchange-Traded Funds
Information about CEFs can be found in print and online.
You can quickly determine whether the fund trades at a discount or a premium relative to NAV by looking at the fund's name.
The year-to-date return is based on the fund's NAV as well as the fund's share price.
Suppose Fund A has an NAV of $10.
It sells at a 20% discount if its share price is $8.
The fund is trading at a discount.
If the fund were priced at $12 per share, it would be trading at a premium of 20%.
The figure shows information about closed-end funds on the website.
If you know what to look for and your timing is good, some deeply discounted CEFs are a great way to earn attractive returns.
You pay 80 cents for each dollar's worth of assets if the fund trades at a 20% discount.
If you can buy a fund at a wide discount and then sell it when the discount narrows or turns to a premium, you can increase your return.
Even if the discount does not narrow, the yield on your investment is higher than it would be with an open-end fund.
If the CEF trades at $8, it will be a 20% discount from its NAV.
If it was a no-load, open-end fund, it would be trading at its higher NAV and thus would yield only 10%.
When investing in CEFs, pay attention to the size of the premium and discount.
You should keep an eye out for funds trading at deep discounts because that feature can enhance returns.
One last point to keep in mind is closed end funds.
New issues of closed-end funds and funds that sell at steep premiums are not to be avoided.
When new CEFs are brought to the market as IPOs, never buy them.
Because IPOs are brought to the market at hefty premiums, it's necessary to cover the underwriter spread.
If the shares fall to a discount, or at the minimum, to their NAVs within a month or two, you will lose money.
You should analyze a CEF just like any other mutual fund, except for the premium or discount.
Check out the fund's expense ratio, portfolio turnover rate, past performance, cash position, and so on.
The his tory of the discount can be studied.
CEFs don't continuously offer new shares to investors so you probably won't get a prospectus.
Return performance is a part of the mutual fund process.
Growth in capital, dividends, and capital gains are all important aspects of return.
It is possible to judge the investment behavior of a fund and appraise its performance in relation to other funds and investments.
Different measures that investors can use to assess mutual fund returns will be looked at here.
Because risk is so important in defining the investment behavior of a fund, we will look at mutual fund risk as well.
There are three possible sources of return for an open-end mutual fund.
Some mutual funds derive more income from one source than from another.
For example, we would expect income-ori ented funds to have more income than capital gains distributions.
Portfolio turnover rate is the number of shares bought and sold by the fund to the total number of shares held in the fund's portfolio.
The fund has been doing a lot of trading and has a high turnover rate.
M13_SMAR3988_13_GE_C12.indd 528 gives a brief overview of the fund's investment activity.
The top part of the report runs from "Net asset value, beginning of period" to "Net asset value, end of period."
The amount of dividends and capital gains distributed to the shareholders is revealed in this part.
After the fund has met all operating expenses, the net investment income is paid out.
When the fund receives dividends or interest payments, they are passed on to shareholders in the form of dividends.
The fund accumulates all of the income for the period and then pays it out on a prorated basis.
If a fund earned $2 million in dividends and interest and had one million shares, each share would receive an annual dividend payment of $2.
The tax exempt nature of the mutual fund makes it possible for the individual investor to pay taxes on dividends.
The amount of taxes due on dividends will depend on the source of the funds.
If these distributions are derived from dividends earned on the fund's common stock holdings, then they are subject to a preferential tax rate of 15% or less.
If these distributions are derived from interest earnings on bonds, dividends from REITs, or dividends from most types of preferred stocks, then they do not qualify for the preferential tax treatment, and instead are taxed as ordinary income.
Suppose the fund bought stock a year ago for $50 and sold it for $75 per share.
Capital gains of $25 per share is what the fund has achieved.
It would have realized a total cap ital gain of $1,250,000 if it held 50,000 shares of this stock.
The fund has one million shares and each share is entitled to a capital gains distribution.
The security holdings were actually sold and the capital gains actually earned, so these distributions only apply to realized capital gains.
The net asset value of the fund moves with the price of the fund's holdings.
When an investor buys into a fund at $10 per share, the fund's NAV will be quoted at $12.50.
The capital gain is $2.50 per share.
If the fund were to sell its holdings, it represents the profit that share holders would receive.
The return for closed-end investment companies is derived from the same three sources as for open-end funds, and from a fourth source as well: changes in price discounts or premiums.
The third element of return, change in share price, is made up of both the change in net asset value and the change in price discount or premium.
A simple but effective measure of performance is to describe mutual fund returns in terms of the three major sources: dividends earned, capital gains distributions received, and change in price.
We can convert the fund payoffs into an investment horizon of one year or less.
The figures from Table 12.2 are used to show the com putations.
A hypothetical no-load, open-end fund paid 55 cents per share in dividends in 2016 It cost $24.47 at the beginning of the year and rose to $29.14 by the end of the year.
It provides a handy indication of yield and captures all the important elements of mutual fund return.
On the basis of a beginning investment of $24.47, the fund produced an annual return of 28.5%.
Many mutual fund investors have their dividends reinvested in the fund.
You can still use holding period return with slight modifications.
You have to keep track of the number of shares acquired through reinvestment.
Let's move on to the next example.
If you initially bought 200 shares in the mutual fund and were able to acquire them through the fund's reinvestment program at an average price of $26.50 a share, that's what you're assuming.
Thus, the $460 in dividends and capital distributions resulted in a 31$0.55 + $1.752 gain.
The market value of the stock holdings at the beginning of the period would be compared to the market value at the end of the period.
The rate-of-return measure that you can use to compare the performance of this fund to other funds and investment vehicles is provided by this holding period return.
It is sometimes necessary to assess the performance of mutual funds over extended periods of time, instead of using one-year holding periods.
The time value of money makes it inappropriate to use the holding period return as a measure of performance.
We can use the present value-based internal rate of return procedure to determine the fund's average annual compound rate of return.
We want to find the annual rate of return over the full three-year period.
The fund had a price of $24.26 at the beginning of the period and was trading at $29.14 at the end of the period.
The discount rate that will equate the annual dividends/capital gains distributions and the ending price in year 3 to the beginning price of the fund is something we want to find.
An annual rate of return of 13.1% was provided by the mutual fund in Table 12.2, using standard present value calculations.
The beginning price of the fund is 24.2% and the present value of the cash flows is 13.1%.
It helps us assess fund performance and compare it to other investments.
According to SEC regulations, if mutual funds report historical returns, they must use a standardized format that uses fully compounded, total-return figures similar to those obtained from the above present value-based calculations.
The funds are not required to report such information, but if they do cite performance in their promotional material, they must follow a full-disclosure manner of presentation that takes into account not only dividends and capital gains distributions but also any increases or decreases in the fund's NAV that have occurred over
NAVs have traditionally been used to report the returns of CEFs.
The return measures ignored price premiums and discounts.
It is becoming more and more common to see return per for mance expressed in terms of actual market prices, a practice that captures the impact of changing market premiums or discounts on holding period returns.
The greater the premiums or discounts and the greater the changes in these values over time, the greater their impact on reported returns.
Market-based and NAV-based holding period returns are not uncommon for CEFs.
The returns on CEFs are the same as they are on open-end funds.
When using actual market prices to measure return, all you need to do is substitute the market price of the fund for the NAV in the holding period or internal rate of return measures.
NAV-based and market-based measures of return are used by some CEF investors to see how changing premiums affect the returns on their mutual fund holdings.
NAV-based return numbers are generally viewed as the preferred measure of performance.
NAV-based measures give a truer picture of the fund's performance because fund managers have little or no control over premiums or discounts.
Most mutual funds are so diversified that their investors don't have to worry about the risks associated with individual securities.
Most funds are still exposed to a lot of systematic risk.
Because of their diversi fied nature, mutual fund portfolios tend to perform like the market or the segment of the market that the fund targets.
Market risk is still an important ingredient for most types of mutual funds.
The general market has an effect on the investment performance of a mutual fund.
If the market is going down and you anticipate that trend to continue, you might want to put any new investment capital into a money fund.
The fund's management practices are an important risk consideration.
The risk of a loss in capital is less for conservatively managed funds than it is for aggressively managed funds.
The riskier the investment goals of the fund, the greater the risk of instability in the net asset value.
A conservatively managed portfolio does not eliminate price fluctuations.
The securities in the portfolio are subject to market risks.
These risks are less with funds that have more conservative investment objectives.
Discuss the different types of risk that mutual fund shareholders are exposed to.
After reading this chapter, you should know what MyFinanceLab is.
They can invest with a limited amount of capital and get investor services that are not available elsewhere.
The redemption fee is 12(b)-1 variable annuities.
Front-end loads are one of the costs that are one-time.
Management fees and others are paid annually.
Fund costs can drag down fund performance.
Fund selection begins with assessing the investor's needs and wants.
The funds have to offer with regard to investment objectives, risk exposure, and investor services.
From this short list of funds, the investor can narrow his or her choices by aligning his or her needs with the types of funds available and applying the final selection tests: fund performance and cost.
Various measures of return can be used to gauge the annual rate of return from a mutual fund.
It's important for mutual fund investors to be aware of risk.
Market risk still remains because most funds tend to perform much like the market, or like that segment of the market in which they specialize, even though a fund's extensive diversification may protect investors from business and financial risks.
MyFinanceLab will give you further practice, as well as videos, animations, and guided solutions.
The information on the Blackrock website can be used to describe the iShares Conservative Short Term Strategic Fixed Income ETF.
Use the factsheet to describe the fund's holdings, average duration, and rebalancing rules.
The process of creating an exchange traded fund.
Pick the one that is less risky for each pair of funds.
A person just won a lottery.
After receiving 10 million Indian rupees, she is spending countless nights without sleep thinking about how she is going to spend the money.
She decided to invest the money in an open-end fund, a closed-end fund, and an exchange traded fund.
Use the site to find funds that match the desired portfolio and investment objectives of each fund.
A year ago, an investor bought 200 shares of a mutual fund.
The fund has paid dividends of $0.90 per share and a capital gains distribution of $0.75 per share over the past year.
The no-load fund now has a net asset value of $9.10 and the investor's holding period return is given.
If all the dividends and capital gains distributions are reinvested into additional shares of the fund, you can find the holding period return.
Andy bought shares from the Exemplar Canadian Focus fund six months ago.
The NAV was $5.24 and the offer price was $6.50 at the time.
The NAV is $7.88 and the price is $8.65.
Find its three-year average annual compound rate of return.
Find the fund's holding period return for the three years on the basis of this information.
Find the fund's average annual compound rate of return over the last three years.
The fund's May 30, 2016 prospectus is the Growth Fund.
This information can be used to find the holding period return.
Find the fund's rate of return over the last 5 and 10 years.
If the LM&C fund has a front-end load charge of 5%, then the four return figures should be changed.
You can use the website to select four mutual funds--a value fund, a single country equity fund, an emerging markets bond fund, and a single currency bond fund-- that you think would make good investments.
Why did you pick these funds?
For the last year and the past five years, list the funds' holding period returns.
One year ago, Super Star Closed-End Fund had an NAV of $10.40 and was selling at an 18% discount.
The NAV is $11.69 and it is a 4% premium.
Super Star paid dividends of $0.40 and had a capital gains distribution of $0.95.
Super Star's NAV-based holding period return is for the year.
Super Star's holding period return is based on the market.
Assume the fund started the year at an 18% premium and ended it at a 4% discount, and repeat the market-based holding period return calculation.
The Well-Managed Closed-End Fund had a good performance in 2016
The fund was trading at a discount at the beginning of the year and a premium at the end of the year.
Three years ago, you invested in the Future Investco Mutual Fund by purchasing 1,000 shares at a net asset value of $20.00 per share.
You reinvested all dividends and capital gains distributions because you didn't need them.
You are selling your 1,100 shares for $22.91 per share.
Gary invested in the Aberdeen Global II Sterling Bond Fund by purchasing 200 shares at an NAV of PS663.81.
All interest and capital gains distributions will be reinvested.
One year ago, you invested in the OhYes Mutual Fund by purchasing 1,000 shares of the fund at a net asset value of $25.00 per share.
The fund paid dividends of $1.50 and capital gains of $2.00.
The NAV is $26 today.
The purchase of shares in a closed-end mutual fund is something you are considering.
The latest close is $20.00 and the NAV is equal to $22.50.
You are a British investor who bought 500 shares of Acumen Conservative Portfolio fund a year ago.
You received PS3.00 in dividends per share, one-third of which was from dividends from the stocks the fund held and the remaining two-thirds from interest earned on bonds in the fund portfolio.
The effective rate for dividends in the UK is 10% because income from ordinary dividends is taxed more favorably than interest on cash savings or fixed interest.
The reverend decided to invest on his own because religious organizations aren't known for their generous retirement programs.
He wants to set up a program that will allow him to supplement the church's retirement program and at the same time provide some funds for his child's college education, which is 12 years away.
He doesn't want to break investment records, but he does want to provide some backup for his family.
Mark Thomas believes that with careful planning, he can probably invest about $250 a quarter, even though he has a modest income.
He has $15,000 in a savings account that he would be willing to use to start this program.
He doesn't want to take a lot of risk because of his investment objectives.
He approaches you for investment advice because his knowledge of investments extends to savings accounts, Series EE savings bonds, and a little bit about mutual funds.
Discuss the types of funds you would consider, the investment objectives you would set, and any investment services you would seek in your answer.
He has worked as a professor at a well-known university for more than two decades and she is the head of the Italian history division at Mondadori.
Both of them have above average wages and are approaching retirement age.
The children are financially independent from their parents.
Every month, Giacomo and Chiara have been saving a specific amount in their savings account.
The savings amount to almost 80,000 euro.
Giacomo will receive more than enough from the pension plan to cover their living expenses after he retires.
They love to travel and would like to go to exotic locations, but they haven't been able to because they are busy.
As they approach retirement, they have decided that they want to invest their savings into a more profitable instrument that will ensure a continuous inflow of money for them to spend on vacations.
They plan to take a vacation trip every two months, and each trip will cost them about 1,500.
They decided to invest into a mutual fund after talking to a financial consultant.
The primary data variables are the net asset value and the year-to-date returns.
The NAV is the price you get when you sell shares or the price you pay when you buy no-load funds.
You can create a spreadsheet model similar to the one in Table 12.2 to analyze the MoMoney Mutual Fund data over the next three years.
Finance and look up data on the Fidelity Magellan Fund.
The funds are large in the United States.
Click the Basic Chart link to see how the funds have performed over the last five years.
You can plot another fund's performance on the same chart by entering the ticker symbol of the other fund into the box.
The top 10 holdings of each fund are shown in the link.