Fund Industry 2

  1. Mutual Fund (RIC)
    • 1. Each fund is a separate company, known as a registered investment company (RIC)
    • 2. Investors own % of both assets & liabilities
    • 3. Typically don't pay taxes or have any employees
  2. Net Asset Value (NAV)
    = (Assets - Liabilities)/# of Shares Outstanding

    Calculated daily
  3. Offering Price
    Amount paid by investor for a share.

    =NAV + sales load (If applicable)
  4. Fund Liabilities (3)
    1. Generated by short selling or option writing in complex funds

    2. Generated when fund borrows money for redemptions or to create leverage

    3. Fees fund will pay to providers of services such as custody, IM, etc.
  5. Redemptions
    By law, fund must be willing to buy back shares from investors every day NYSE is open

    Cash value to investor based on end of day NAV
  6. Daily Redemptions (Complexity)
    • 1. Computing NAV requires entering all transactions, reconciling holdings, recording liabilities, and valuing all positions within a very tight time frame. 
    • 2. Funds must be structured in a way that allows them to raise cash quickly & easily to meet any level of withdrawal requests
  7. Revenue Act of 1936
    Guidelines that allow funds to pass taxes to shareholders
  8. Investment Company Act of 1940 (1940 Act)
    Determined structure of mutual funds. Funds are often called '40 Act funds.

    • 1. Limits borrowings - Can not exceed 1/3 of value of assets. Most funds only borrow to meet short term cash needs. 
    • 2. Standards for diversification
  9. Diversified Funds
    Covers most funds

    For 75% of assets, can not put more than 5% of assets in a single investment and do now own more than 10% of voting securities for any single company. 

    They can do anything with remaining 25%
  10. Nondiversified Funds
    Focus on single industry sector or very small high-growth companies. Often have a tough time raising cash.
  11. SEC Redemption Rules
    Funds may not invest more than 15% of their assets in illiquid securities (cannot be sold within 7 days). MMFs have a 5% threshold
  12. MF Pass-Through Tax Status - Rules (4)
    • 1. Diversification rule (<5% investment in single company with 50% of assets)
    • 2. 10% ownership rule (cannot own more than 10% of single company voting stock)
    • 3. Distribution - Funds must distribute 90% of interest, dividends, realized cap gains each year. 
    • 4. Income - At least 90% of fund's income must come from business of investing in securities & currencies (fund can't invest in apartment buildings and get tax favorability).
  13. Corporate Double Taxation
    Company pays corporate income taxes + shareholders pay personal income tax on dividends
  14. MF = Virtual Company
    Fund doesn't have any employees. Fund hires companies to do all of the work (investment advisor, custodian, etc.). Board of directors is responsible for negotiating contracts with service providers.
  15. Mutual Fund Board of Directors (2)
    • 1. Average is 8 members
    • 2. Responsible for contract negotiation with service providers (IM, custodian).
    • 3. 50% of members must be independent - only they approve advisory contract.
  16. Proxy Statement
    Explains questions investors are being asked to vote on. Often called proxy voting because shareholders can submit their vote by absentee ballet (by proxy).

    Typically larger issues like changing fundamental investment policies, increasing the mgmt fees of the fund, and/or hiring a new manager or auditor
  17. Fund Management Company (Sponsor) (3)
    • 1. Fund Creation - creates fund, provides seed capital. 
    • 2. Brand Name - Fund family/complex. Typically all same board of directors (Dreyfus)
    • 3. IM - investment manager/advisor - Responsible for portfolio management. Some may hire subadvisor to make investment decisions.
  18. Gartenberg Standard
    Roadmap to evaluate fund management company (board of directors must evaluate contract each year)
  19. Gartenberg Standard Factors (6)
    • 1. Nature & quality of services
    • 2. Profitability of fund to advisor
    • 3. Indirect profits to advisor
    • 4. Economies of scale as fund grows
    • 5. Fees charged on comparable funds
    • 6. Independence of the directors
  20. Fund Service Providers - Links to Investors

    Sells fund shares to investors either directly or through intermediaries.
  21. Fund Service Providers - Links to Investors

    Transfer Agent
    Keeps track of shareholder positions and answers questions from investors
  22. Fund Service Providers - Administration

    Holds securities in the fund's portfolio.
  23. Fund Service Providers - Administration

    Fund Accountant
    Maintains the fund's books & records and computes NAV nightly. 
  24. Fund Service Providers - Professional Services

    Legal & Audit
    Legal - guidance on compliance with regulations

    Audit - Evaluates financial statements & operational procedures. Must be independent.
  25. Affiliated Transactions
    Transactions between fund and an affiliate of the management company. Generally prohibited by 1940 Act.

    Example - Fund mgmt company owned by bank. The IM may not buy bank shares for fund's portfolio.
  26. Registered Investment Advisors
    1940 Investment Advisers Act. RIAs must submit form ADV with the SEC for counseling others on investing in securities. Mutual Fund Managers managing 40 Act funds must be registered as RIAs. 
  27. SEC Code of Ethics for RIAs (mutual fund managers) - Access Persons
    • 1. Standard of Business Conduct - comply with laws/regulations
    • 2. Protection of MNPI
    • 3. Limits on personal investing
    • 4. Limits on gifts/entertainment
  28. CCOs (Chief Compliance Officer)
    Required by SEC for each IA & MF

    Ensure IA comply with laws/regulations.

    Develop and enforce policies & procedures to ensure compliance. 

    Report to board of directors and are paid by the funds
  29. Brokerage Account
    • 1. Own securities directly
    • 2. Great deal of control
    • 3. Provide specific buy/sell instructions
  30. Trust Account (4)
    • 1. Own securities directly 
    • 2. Professionally managed by IA or trust department of bank (caters to HNW clients)
    • 3. Fees / services include bill payment, mortgage services, etc.
    • 4. HNW clients only
  31. SMA (individually managed account, managed account, WRAP account (non MF)) (6)
    • 1. Own securities directly
    • 2. Designed for individuals who want a trust account but don't have enough $
    • 3. Professionally managed
    • 4. Account size between 100k - 250k
    • 5. Sponsored by brokerage firms (keep portfolio records, prepare performance reports, buy/sell securities)
    • 6. Typically based on model portfolios with small customization (i.e. Standish Muni)
  32. 1940 Act Investment Companies (4)
    • 1. Open End Mutual Funds
    • 2. Closed-End Mutual Funds
    • 3. Exchange Traded Funds (ETF)
    • 4. Unit Investment Trusts
  33. Closed End Funds (3)
    • 1. Collect money from investors and issue new shares one time at creation. 
    • 2. Shares are listed for trading on stock exchange for buying/selling on open market (no new sales/redemptions)
    • 3. Price per share is determined by supply/demand and is often less than NAV
  34. Exchange Traded Funds (ETF) (4)
    • 1. Hybrid open/closed end fund
    • 2. Like Closed End - Shares traded on exchange
    • 3. Like Open End - ETF able to adjust number of shares outstanding - Shares normally trade close to NAV.  
    • 4. Very tax efficient - most use passive investment approach based on an index (minimal capital gains, trading costs)
  35. Unit Investment Trusts (UIT) (5)
    • 1. Don't hire investment manager
    • 2. Sponsor selects portfolio of securities at creation and it doesn't change throughout UITs life (normally have a limited life span)
    • 3. Investors can cash in their shares at NAV at any time or can sell positions on the open market or can wait until end of life liquidation.
    • 4. Very tax & cost effective - No unexpected capital gain distributions. No trading, no investment advisor, no board of directors. 
    • 5. Typically come with a sales load to offset low fees
  36. Hedge Funds (7)
    • 1. Not registered as 40 Act fund. Do not have to register with SEC.
    • 2. Investors can only redeem at certain times (twice per year for many funds)
    • 3. Typically use aggressive investing techniques such as leverage as not governed by SEC restrictions
    • 4. Higher return / higher risk
    • 5. No independent board of directors
    • 6. Pass thru investment (tax) like MFs
    • 7. Structured as partnerships. Not required to distribute income like mutual funds.
Card Set
Fund Industry 2
Fund Industry 2