Indirect Investment in Financial Assets
• It involves the buying and selling the shares of investment companies those, in turn, hold portfolios of securities.
• Here, investors are purchasing the ownership interest in that portfolio managed by investment company and have the right to get dividends, interest, capital gains on a pro rata basis. Also, investors have the obligation to pay company’s expense and management fees on a pro rata basis which will be, in fact, deducted from the earnings of the portfolio.
Classification of Investment Companies
• Unit Investment Trusts
• Closed-End Investment Companies
• Open-End Investment Companies (Mutual Funds)
Unit Investment Trust
“An unmanaged form of investment company, holding (mainly tax-exempt) fixed income securities, offering investors diversification and minimum operating cost.”
– Fixed income security portfolio put together by a sponsor and handled by an independent trustee.
– Redeemable trust certificates which indicates the claim against the
securities are sold to investors at a price = NAV + commission.
– Securities remain almost unchanged.
– The trust ceases to exist when securities mature and also sponsor makes the market for those investors who want to sell the unit. It is possible to find secondary market among brokers and dealers.
– These are sold back at NAV.
– Capital preservation is the main objective.
– Theses trusts are passive investment strategy.
Closed-End Investment Companies
• Investment company with fixed capitalization whose shares are traded in organized and unorganized stock exchanges.
• Generally sells no additional shares after the IPO. That’s why capitalizations are fixed.
• Closed-end funds are actively managed (active investment)
• Investors buy & sell these shares from exchanges through brokers paying market price + brokerage commission.
• Market price depends on supply and demand and it could be more or less than the NAV.
• Market price > NAV, closed end fund share selling at a premium
• Market price < NAV, share selling at a discount
Open-End Investment Companies (Mutual Funds)
“An investment company whose capitalization constantly changes as new shares are issued and outstanding shares are redeemed.”
• Mutual funds can be bought directly from the investment company or indirectly from sales agent, different financial institutions. Shares can be bought and sold at NAV at the end of the trading day of the market when NAV is calculated. (page 58).
• Mutual funds are Actively managed fund.
• These funds may be affiliated with an underwriter who has the right to distribute shares to the investors through brokers/dealers.
Mutual Funds (Continued)
• Mutual funds are corporations.
• Investment company Trustee/Directors Mgt
• Mgt. manages the fund and handles the administrative jobs.
• In terms of underlying assets, mutual funds are divided into 2 types-
• Money Market Funds & b) Equity, Bond & Fixed Income Funds
• In terms of sales fee, funds are also divided into 2 types-
a) Load Funds (with sales fee), b) No-Load Funds (without sales fee)
• But both the 2 funds charge the operating expenses.
• Performance of mutual funds are evaluated through benchmarking, efficiency and consistency of performance.
Exchange-Traded Funds (ETFs)
“An index fund holding a diversified portfolio of securities, priced and traded on organized stock exchanges.”
• It is a sort of closed-end fund.
• It is a passive investment.
• Traded at a price close to NAV.
• Tax advantages exist in this case.
Differences among Close-End Funds, Mutual Funds & ETFs
• Page 72, Chapter 3