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Chapter 4

Chapter 4. Mutual Funds and the Institutional Environment. Chapter Summary. Objective: To give an overview of institutional investing and institutions’ role in portfolio selection and management Institutional investors: objectives & constraints Mutual funds and investment policies

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Chapter 4

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  1. Chapter 4 Mutual Funds and the Institutional Environment

  2. Chapter Summary • Objective: To give an overview of institutional investing and institutions’ role in portfolio selection and management • Institutional investors: objectives & constraints • Mutual funds and investment policies • Performance appraisal • Taxation & tax sheltering

  3. Institutional Investors

  4. Constraints in Portfolio Management • Liquidity • Investment horizon • Regulatory constraints (institutional investors) • The prudent person law • Limits on foreign holdings • Limits on individual firm holdings

  5. Services of Investment Companies • Administration & record keeping • Diversification & divisibility • Professional management • Reduced transaction costs • Increased investment opportunities

  6. Types of Investment Companies • Mutual funds • Closed-end • Open-end • Load funds • Commingled funds • Real estate funds • Real estate limited partnerships • Mortgage funds

  7. Types of Mutual Funds (Investment Policies) • Money market funds • Equity funds (income, growth) • Fixed-income funds • Balanced and income funds • Asset allocation funds • Index funds • Specialized sector funds

  8. Net Asset Value • Used as a basis for valuation of investment company shares • Selling new shares • Redeeming existing shares • Calculation:

  9. Open-End and Closed-End Funds: Key Differences Shares Outstanding • Closed-end: no change unless new stock is offered • Open-end: changes when new shares are sold or old shares are redeemed Pricing • Open-end: Net Asset Value(NAV) • Closed-end: Premium or discount to NAV

  10. Summary Reminder • Objective: To give an overview of institutional investing and institutions’ role in portfolio selection and management • Institutional investors: objectives & constraints • Investment policies • Performance appraisal • Taxation & tax sheltering

  11. Costs of Investing in Mutual Funds • Fee Structure • Front-end load • Back-end load • Operating expenses • Other charges (called ‘12b-1’ in US) • Distribution costs paid by the fund • Alternative to a load • Fees and performance

  12. Summary Reminder • Objective: To give an overview of institutional investing and institutions’ role in portfolio selection and management • Institutional investors: objectives & constraints • Investment policies • Performance appraisal • Taxation & tax sheltering

  13. A First Look at Fund Performance • Benchmark: Wilshire 5000 • Results • Most funds underperform • Not fair comparison because of costs • Adjusted Benchmark: Wilshire 5000 with passive management costs considered • The majority of funds still underperform

  14. Consistency of Fund Performance • Do some mutual funds consistently outperform? • Evidence suggests that some funds show consistent stronger performance • Depends on measurement interval • Depends on time period • Evidence shows consistent poor performance

  15. Sources of Information on Mutual Funds • Wiesenberger’s Investment Companies • Morningstar (PalTrak) • Investment Company Institute • Popular press • Investment services

  16. Exchange-Traded Funds • Passive vs Active investing • Low fees • Exchange index funds • Specialized ETFs (bonds, sub-indices and sectors) • International index funds

  17. Summary Reminder • Objective: To give an overview of institutional investing and institutions’ role in portfolio selection and management • Institutional investors: objectives & constraints • Investment policies • Performance appraisal • Taxation & tax sheltering

  18. The Canadian Tax System • Interest income taxed as ordinary income • Favorable dividend income treatment • Only 50% of capital gains taxed • Superficial loss rule • Imputed interest taxed as income

  19. Tax Deferral and Shelters • Tax-deferral option for capital gains • Tax-deferred retirement plans • Deferred annuities • Fixed annuities • Variable annuities • Tax shelters

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