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Topic 5.

Investment companies:
5.1 Investment companies fundamentals, classification, investment objectives.
5.2. The main peculiarities of functioning of different types of investment funds
and investment trusts.
5.3. UCITs as investment funds regulated at European Union level .
5.4. Determination of investment companies efficiency.

Investment Companies - these companies are financial intermediaries that collect funds from
indivudual investors and invest those funds in a potetially wide range of securities or other assets.
An investment company invests the money it receives from investors on a collective basis, and
each investor shares in the profits and losses in proportion to the investor's interest in the investment
company. The performance of the investment company will be based on (but it won't be identical
to) the performance of the securities and other assets that the investment company owns.
Investment Companies:
Pooling of assets is the key idea behind investment companies.
Each investor has a claim to the Porfolio established by the investment company in
proportion to the amount invested.
These companies thus provide a mechanism for small investors to team up to
obtain the benefits of large-scale investing.
Investment companies perform several important function for their investors:
Administration & record keeping
Diversification & divisibility
Professional management
Reduced transaction costs
Administration & record keeping - Investment companies issue periodic status reports,
keeping track of capital gains distributions, dividends, investments, and redemptions, and they may
reinvest dividend and interest income for shareholders.
Diversification & divisibility - By pooling their money, investment companies enable
investors to hold fractional shares of many different securities. They can act as large investors even
if any individual shareholder cannot.
Professional management - Most, but not all, investment companies have full-time staffs of
security analysts and portfolio managers who attempt to achieve superior investment results for
their investors.
Reduced transaction costs - Investment companies can achieve substantial saving on
brokerage fees and commissions due to the large blocks of securities. Investment companies also
need to divide claims to these assets among those investors as they pool the assets of individual
investors.
Net Asset Value
Investor buy shares in investment companies, and ownership is proportional to the number of
shares purchased. The value of each share is called the net asset value or NAV.
NAV equals assets minus liabilities expressed on a per-share basis:
NAV= Market value of assets- Liabilities/ Share outstanding

NAV MarketValue Assets Liabil


Share outs tan ding
Example: $10,050,000 - $50,000 = $10 NAV
1,000,000 shares

Offering price = NAV + sales commission


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Example: $10 + ($10 * 5%) = $10.50 Offering Price

Investment companies can be classifed as either unit investment trusts or managed


investment companies
Investment Companies:
Managed Investment Companies
Managed Investment Companies; portfolio is managed
Board of directors, elected by shareholders, hires management company for fee of 0.2 to
1.5% of assets value
There are two types of managed companies: closed-end and open-end.
Open-end funds: funds that sell shares directly to investors and will redeem those shares
whenever investors wish to cash in
Closed-end funds: funds that issue shares to investors but do not redeem those shares; instead,
the funds shares are traded on a stock exchange
- Open-End Investment Companies (>90% of mutual funds),
- Closed-End Investment Companies (<10% of mutual funds),
In both cases, the funds board of directors which is elected by shareholders hires a
management company to sort the portfolio out for an annual fee that typically ranges from 0.2% to
1.5% of assets. This type of company in many cases is the firm that organized the fund.
Open-end and closed-end funds
A fund that issues or redeems shares at their net asset value (NAV). When investors
in open-end fund wish to cash out their shares, they sell back to fund at NAV.
A fund that do not issue or redeem shares. Investors in closed-end fund who wish to
cash out must sell their shares to other investors. Shares in this type of fund are traded at prices that
differ from NAV. This can be purchased through brokers just like other common stock.
Since the shares in closed-end funds are required in second market, prices for such
shares are commonly at premiums or discounted from the underlying NAV.
When discussing premiums or discounts on closed-end funds, it is worth to
emphasize the fact that the NAVs are generally reported on weekly basis. For such investment
companies the premiums and discounts from the reported NAV are accurate for closing prices on
the reporting day.
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
Offering Price and load
In contrast to closed-end funds, the price of opened-end funds cannot fall below
NAV. Because these funds stand ready to redeem shares at NAV. However, the offering price can
exceed NAV, if the fund carries a load.
A Load- a sales commission charged on a mutual fund.

How are Mutual Funds Organized?


The Mutual Fund
- A Corporation run by a Board of Directors
- Board of Directors voted in by Shareholders (investors)
- Sponsored the funds creator
Management company - runs daily operations
- Portfolio Manager (sometimes a team or a committee)
- Research Analysts (usually focus on a specific industry)
Asset management firms are typically
Mutual Fund Companies
Pension Fund Companies

Hedge Fund Companies

Insurance Companies

Subsidiaries of Commercial Banks


Investment advisor - oversees portfolio
Distributor - sells fund shares, distributes the shares to the public or to dealers
- Much the same role as an investment banker
- Mutual funds are technically continuous Initial Public Offerings must have an annual
prospectus & report
Custodian - safeguards funds assets
Transfer agent - executes transactions and maintains shareholder records
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Active Portfolio Management
The portfolio manager invests in securities of their choosing
The portfolio manager weights the securities as he or she sees fit
Keeping the portfolio within the restrictions stated in the prospectus
Passive Portfolio Management
Portfolio securities are made of all securities in the market (based on the portfolios
investment objective)
Portfolio securities are weighted based on each securitys market capitalization
Asset management companies typically have a risk and performance group that is
independent of the portfolio management teams
The role of the risk and performance group is
To calculate portfolio performance and compare it applicable index or benchmark
To calculate risk metrics and analyze the portfolio to determine if the return of the
portfolio is adequate for the amount of risk
To analyze the impact of active portfolio management

Unit investment trusts: They are essentially fixed and thus are called unmanaged. More
specifically, a unit trust is a pool of funds invested in a portfolio that is fixed for the life of the
fund. Sells to the public shares or unit in trust. These are called redeemable trust certificates.
Due to the portfolio composition is fixed, these trusts are referred to as unmanaged. The trust
life is dependent on the maturity of securities.
Other Investment Organization
Commingled funds
REITs ( Real Estate Investment Trust)
Hedge Funds etc.
Commingled Funds - This type of funds are partnerships for investors that pool their funds.
The management firm that organizes the partnership, for example, a bank or insurance company
manages the funds for a fee. They are similar in firm to open-end mutual funds and are commonly
used in trust accounts for which investors do not have large enough pools of funds to warrant
individual management.
Real Estate Investment Trusts - They are investment vehicles that are similar to closed-end
funds in that they invest in real estate or in bonds secured by real estate. REITs provide
financial leverage (with debt ratio of 70%) and offer an investor the possibily to invest in real
estate with professional management.
- Equity-invest real estate
- mortgage trust-invest in mortgage construction load.
Hedge Funds
Like mutual funds, hedge funds are vehicles that allow private investors to pool assets to be
invested by a fund manager, however they are not registered as mutual funds. They are open only to
wealthy or institutional investors. As hedge funds are only lightly regulated, their managers can
pursue investment strategies that are not open to mutual fund managers (i.e. Heavy use of
derivatives, short sales and leverage). They have more speculative polies than mutual funds
Exchange Traded Funds
ETF allow investors to trade index portfolios like shares of stock
Examples - SPDRs (S&P 500) and Webs

Potential advantages

Trade continuously

Lower taxes
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Lower costs

Potential disadvantages

Higher costs (price deviation from NAV)

Brokers fee
Mutual fund - corporation owned by shareholders, elect board of directors. Most Mutual fund
are created by investment advisory firms (Vanguard, Fidelity), or brokerage firms with investment
advisory operations (Schwab, Merrill Lynch). Investment advisory firms earn fees for managing
mutual funds.
This type of fund is the common name for an open-end investment company and they have a
specified investment policy.
i.e. Money market mutual funds hold the short-term, low-risk instruments of the money
market whereas bonds funds hold fixed-income securities. These types of funds can be classified by
investment policy.
Investment Policies
Money Market
Fixed Income
Equity
Balance & Income
Asset Allocation
Indexed
Specialized Sector

Premium: the amount by which a closed-end funds unit price in the secondary market is
above the funds NAVPS
Discount: the amount by which a closed-end funds unit price in the secondary market is
below the funds NAVPS

Load versus No-Load Funds


No-load mutual funds: funds that sell directly to investors and do not charge a fee
Front-end load mutual fund: mutual funds that charge a fee at the time of purchase,
which is paid to stockbrokers or other financial service advisers who execute transactions for
investors
Back-end load mutual funds: mutual funds that charge a fee if shares are redeemed within
a set period of time

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Declining redemption schedule: a fee schedule where the back-end load charge reduces with
each year an investor holds the fund (Fee may be based on the original amount purchased or the
value of the fund when it is redeemed)
Management Expense Ratio (MER)
Management expense ratio: the annual expenses incurred by a fund on a percentage
basis, calculated as annual expenses of the fund divided by the net asset value of the
fund; the result of this calculation is then divided by the number of units outstanding
Types of Mutual Funds
Types of Equity Mutual Funds
Growth Funds
Focus on stocks that have potential for above-average growth
Small Capitalization (Small-Cap) Funds
Focus on firms that tend to have more potential for growth relative to larger firms
Mid-Size Capitalization (Mid-Cap) Funds:
Focus on firms that are more established than small-cap firms
Dividend Funds
Focus on firms that pay a high level of dividends
Have less potential for high capital gains and exhibit less risk
Balanced Growth and Income Funds:
Contain both growth stocks and stocks that pay high dividends
Sector Funds
Sector funds: mutual funds that focus on stocks in a specific industry or
sector, such as technology stocks
More risky, as they are less diversified
Index Funds:
Index funds: mutual funds that attempt to mirror the movements of an
existing equity index
May not contain every stock in the index
International Equity Funds
Focus on firms that are based outside country
Expenses associated with managing an international equity fund are higher
Global mutual funds invest in stocks of both foreign firms and Canadian firms
Ethical Funds
Screen out firms viewed as offensive by some

Return and Risk of a Mutual Fund

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5.2. The main peculiarities of functioning of different types of investment funds and
investment trusts.

Open-End Investment Companies


Open-end investment companies (commonly referred to as mutual funds) continuously issue
and redeem ownership shares. The shares of an open-end fund do not trade in a secondary market or
on any organized exchange; instead, investors purchase shares from the company. Likewise,
investors redeem shares by selling them back to the company, where they are retired.
Thus, the equity capital and assets of a mutual fund are increased when shares are sold and are
reduced when shares are repurchased.
Open-end fund company shares are marketed in a variety of ways. Investors may purchase
shares directly from the fund or through a licensed broker.
Security regulations require that a prospectus be made available to the potential investor prior
to the actual sale. A prospectus details the investment philosophy of the fund, assesses the risks in
an actual investment, and discloses management fee schedules, dividend re-investment policies,
share redemption policies, past performance, etc. Any sales or redemption fees (i.e., loads) must
also be disclosed. Management fees for most mutual funds range from approximately 0.2% for
some index funds to more than 2% for some actively managed funds.
The prospectus is updated quarterly to provide current information to potential investors.
Generally, there are minimum initial investment dollar amounts and minimum subsequent
investment amounts; usually the latter is significantly smaller than the former.
Closed-End Investment Companies
Commonly referred to as closed-end funds, CEFs do not continuously issue or redeem
ownership shares. Initially, there is a public offering of shares, which is preceded by the issuance of
a prospectus as described above. Management expenses for most CEFs are in the 12% range
annually. Like most other initial public offerings, the shares are generally offered to the public by
licensed brokers. At this juncture, however, the similarity ends between closed-end and open-end
funds.
After the shares of the new closed-end fund are offered to the public, the fund invests the
proceeds from the initial public offering in accordance with the policy statement disclosed in the
prospectus. CEFs, however, do not sell new shares to interested shareholders, nor do they stand
willing to redeem shares from their investors. To obtain shares after a public offering is completed,
an investor must purchase shares from other investors in the secondary market (one of the
exchanges or the over-the-counter (OTC) market). There is no legal requirement that there be any
formal relationship between the price of the shares and the funds assets.
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The total market value of the companys assets less its liabilities (i.e., net assets) divided by
the number of shares outstanding is generally referred to as the net asset value (NAV) per share. A
common measure of the relationship between the price of the shares and the net asset value of a
closed-end fund is

where D - is the percentage difference between the net asset value per share and the market
value or price per share (MV).When NAV exceeds the MV, the D is called a discount. When MV
exceeds NAV, the D is called a premium.
Closed-end funds (CEFs) can provide investors with the opportunity for attractive income and
capital appreciation.
A CEF can be purchased two ways:
1. During its IPO, through a participating firm. You will pay a sales charge on your overall
investment in an IPO.
Purchasing a CEF during its IPO may provide a number of advantages, including:
- Exclusive access to new or timely investment ideas that may not currently be available in
other products or easily accessible to retail investors.
- Higher distribution potential than offered by existing CEFs or other products, since new
CEFs may be able to capitalize on current market conditions more easily.
An opportunity to buy into a specific fund at NAV, less applicable sales charges, since not all
CEFs tradeat discounts.
Whether you decide an IPO or secondary market purchase is appropriate, be sure to carefully
consider the objectives, risks and expenses of the particular fund before investing.
2. In the secondary market, you can access CEFs through your financial advisor or trading
platform, like any company that is listed on an exchange; purchases on the secondary market may
be subject to transaction fees or other costs.
Intraday purchases and sales
Like the stock of an individual company, CEFs can be bought and sold throughout the day.
The market price is driven by supply and demand, which often fluctuates throughout the day.
Opportunity to buy at a discount
CEFs on the secondary market may trade at a premium or discount to their NAV. A CEFs
market price is based on a number of factors, including distribution rate, type of investments,
performance or market conditions.
Purchasing at a discount may allow investors to benefit from price appreciation if the discount
narrows over time, or if they later sell the CEF at a higher price. There is no guarantee a CEFs
discount will narrow or be eliminated.
Not all CEFs trade at a discount, however. A CEF trading at a premium, or above its NAV,
may do so for a number of reasons, including having a superior distribution rate compared with its
peers, providing access to a market with limited availability, or exhibiting strong historical NAV
performance.
Trading flexibility
CEF investors may be able to better target their ideal purchase or sale price through trading
tools such as limit orders (an order to buy or sell a set number of shares only at a specified price or
better).
Like a traditional open-end mutual fund, a closed-end fund is a professionally managed
investment company that pools investors capital and invests in stocks, bonds or other securities
according to an overriding investment objective. But they differ from open-end funds in several
significant ways.

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Focus on income
Many CEFs are designed with the primary goal of providing income. Income-focused CEFs
pay out monthly or quarterly dividends, potentially providing an attractive stream of income to
investors. Investors can choose to receive dividend payments or have them reinvested in the fund
through a dividend reinvestment program. Over time, reinvested dividends can potentially help
drive total return through the power of compounding.
Exchange-traded
CEFs look like open-end funds, but trade like stocks. A CEF raises a fixed amount of capital
at inception through an initial public offering (IPO). After the IPO, shares of the fund change hands
on an exchange (such as the New York Stock Exchange) just like the stocks of individual
companies. When an investor wants to buy or sell shares of a CEF, the investor trades with other
buyers or sellers on the exchange, instead of with the sponsor company.
Investing in closed-end funds may be a bit confusing for an inexperienced investor. Since
these securities sell at discounts or premiums, it requires the ability to determine the intrinsic value
of the underlying securities to conclude whether or not making the investment makes sense. This
adds an additional layer of risk and goes against the theory that markets are efficient.

Similarities of the open-end and closed-end funds


Both funds are managed by seperate entities known as investment advisors that are
registered by the SEC.
Both can come in many varities.
They are subject to SEC registration and regulation are are subject to numerous
requirements imposed for the protection of investors.

Unit Investment Trusts


Commonly referred to as UITs, these investment companies offer an unmanaged portfolio
of securities. They are not management companies as are both open- and closed-ends and have no
board of directors, corporate officers, or an investment adviser to render advice during the life of the
trust.

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A UIT typically will make a one-time "public offering" of only a specific, fixed number of
units (like closed-end funds). Many UIT sponsors, however, will maintain a secondary market,
which allows owners of UIT units to sell them back to the sponsors and allows other investors
to buy UIT units from the sponsors.
A UIT will have a termination date (a date when the UIT will terminate and dissolve) that is
established when the UIT is created (although some may terminate more than fifty years after they
are created). In the case of a UIT investing in bonds, for example, the termination date may be
determined by the maturity date of the bond investments. When a UIT terminates, any remaining
investment portfolio securities are sold and the proceeds are paid to the investors.
A UIT does not actively trade its investment portfolio. That is, a UIT buys a relatively fixed
portfolio of securities (for example, five, ten, or twenty specific stocks or bonds), and holds them
with little or no change for the life of the UIT. Because the investment portfolio of a UIT generally
is fixed, investors know more or less what they are investing in for the duration of their investment.
Thus, the UITs securities will not be sold or new ones bought, except in certain limited
situations such as bankruptcy of a holding. UITs are assembled by a sponsor and are sold through
brokers to investors. They generally issue units (shares) as intended for a set period of time before
the primary offering period closes.
Stock trusts are generally designed to provide capital appreciation and/or dividend income
until their liquidation date. In contrast, bond trusts are designed to pay monthly income. When a
bond in the trust is called or matures, the funds from the redemption are distributed to the clients via
a return of principal. The trust continues paying the new monthly income amount until another bond
is redeemed. This continues until all the bonds have been liquidated.

Differences btw Unit Inv. Trusts (UITs) and Mutual Funds


Unit Inv. Trusts (UITs) Mutual Funds
Have a termination date Never expire
Make a one-time public offering of No fixed amount.
fixed amount of units Diversification is essencial . It must hold a
Buy and hold a fixed portfolio of min. Nr. of diff. Securities
stocks, bonds etc. concentrated in a particular Can sell and buy securities frequently.
industry. Have shares of stocks of a few Have an inv. advisor
companies. (Dogs of Dow Approach)
Buy or sell at the end of the trading day.
Can not buy or sell securities
frequently.
Does not have an inv. Advisor
You can buy or sell at any time

Exchange-Traded Funds
ETFs are investment companies registered under the Investment Company Act of 1940 as
either open-end funds or UITs. Regardless of a funds organizational structure, all existing ETFs
issue shares only in large blocks (such as 50,000 ETF shares) called creation units.
An investor such as a brokerage house or large institutional investor purchases a creation unit
with a portfolio deposit equal in value to the NAV of the ETF shares. After purchasing a Creation
Unit, an investor often splits it up and sells the individual shares on a secondary market. This
permits other investors to purchase individual shares) in the secondary market. Management fees
for ETFs are generally similar to those of low-cost index mutual funds.

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Investors who want to sell their ETF shares have two options: (1) they can sell individual
shares to other investors on the secondary market, or (2) they can sell the Creation Units back to the
ETF (in creation unit aggregations etc.).
Finally, ETFs generally redeem Creation Units mainly by giving investors the securities that
comprise the portfolio instead of cash. So, for example, an ETF invested in the stocks contained in
the Dow Jones Industrial Average (DJIA) would give a redeeming shareholder the actual securities
that constitute the DJIA instead of cash. Because of the limited redeemability of ETF shares, ETFs
are not considered to beand may not call themselvesmutual funds.

An ETF, like any other type of investment company, will have a prospectus. All investors that
purchase Creation Units receive a prospectus.
Closed-end funds and exchange-traded funds (ETFs) both trade on an exchange, but that is
where the similarities end. First, CEFs are actively managed, while ETFs are overwhelmingly
passive investments designed to track specific indexes. Second, a CEF has a fixed pool of capital
and number of shares outstanding based on what was raised during its IPO; assets and shares of an
ETF vary as investors buy or sell shares.
Closed-end funds and exchange-traded funds (ETFs) both trade on an exchange, but that is
where the similarities end. First, CEFs are actively managed, while ETFs are overwhelmingly
passive investments designed to track specific indexes. Second, a CEF has a fixed pool of capital
and number of shares outstanding based on what was raised during its IPO; assets and shares of an
ETF vary as investors buy or sell shares.

5.3. UCITs as investment funds regulated at European Union level .

The Undertakings for Collective Investment in Transferable Securities Directive


2009/65/EC is a consolidated EU Directive,[ that allows collective investment schemes to operate
freely throughout the EU on the basis of a single authorisation from one member state. EU member
states are entitled to have additional regulatory requirements for the benefit of investors.
The objective of the original UCITS Directive 85/611/EEC, adopted in 1985, was to allow for
open-ended funds investing in transferable securities to be subject to the same regulation in every
Member State. It was hoped that once such legislative uniformity was established throughout
Europe, funds authorised in one Member State could be sold to the public in each Member State
without further authorisation, thereby furthering the EUs goal of a single market for financial
services in Europe.
The reality differed somewhat from the expectation due primarily to individual marketing
rules in each Member State that created obstacles to cross-border marketing of UCITS. In addition,
the limited definition of permitted investments for UCITS weakened the marketing possibilities of a
UCITS. Accordingly, in the early 1990s proposals were developed to amend the 1985 Directive and
more successfully harmonise laws throughout Europe. These discussions, although leading to a
draft UCITS II directive, were subsequently abandoned as being too ambitious when the Council of
Ministers could not reach a common position.
In July 1998 the EU Commission published a new proposal which was drafted in two parts (a
product proposal and a service provider proposal), which sought to amend the 1985 Directive.
These proposals were finally adopted in December 2001, and are known as "UCITS III", which are
now in force. Interestingly, LuxAlpha, an alleged "feeder fund" to Bernard Madoff's firm, was a
UCITS-regulated fund.
Management Directive
The Management Directive 2001/107/EC, seeks to give management companies a European
passport to operate throughout the EU, and widens the activities which they are allowed to
undertake. It also introduces the concept of a simplified prospectus, which is intended to provide

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more accessible and comprehensive information in a simplified format to assist the cross-border
marketing of UCITS throughout Europe.
Product Directive
The primary aim of the Product Directive 2001/108/EC is to remove barriers to the cross-
border marketing of units of collective investment funds by allowing funds to invest in a wider
range of financial instruments (including derivatives), which subject the same regulation in every
Member state. All UCITS funds must comply with the same investment limits.
A collective investment fund may apply for UCITS status in order to allow EU-wide
marketing. The concept is to create a single funds market across the EU. The aim is that with a
larger market the economies of scale will reduce costs for investment managers which can be
passed on to consumers.
Throughout Europe approximately 6.8 trillion are invested in collective investments. Of
these funds about 76% are UCITS.
UCITS IV
The proposal of UCITS IV Directive [6] was approved by the European Parliament on 13
January 2009 and also by the Council of the European Union as the Directive 2009/65/EC,[7] to be
implemented on 1 July 2011. This updated the UCITS III Directives by introducing the following
changes,
Notification Procedure
Key Investor Information Document
Adapted Framework for Mergers
Master-feeder Structures
Cooperation between Member State Supervisory Authorities
Management Company Passport

UCITS V
On 23 July 2014 the European Union adopted directive 2014/91/EU ("UCITS V") on the
coordination of laws, regulations and administrative provisions relating to undertakings for
collective investment in transferable securities as regards depositary functions, remuneration
policies and sanctions.
UCITS V can be compared with the Alternative Investment Fund Managers Directive
("AIFMD") (European Union Directive 2011/61/EU), which is a parallel regulation for hedge funds
and alternative investments.
UCITS V introduces new rules on UCITS depositaries, such as the entities eligible to assume
this role, their tasks, delegation arrangements and the depositaries liability as well as general
remuneration principles that apply to fund managers.
The depositary as a specific function under UCITS legislation (rather as it does under
AIFMD). The depositary may delegate its safekeeping functions (but not other depositary functions
to a third party custodian.

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Fig. 8: Breakdown of UCITS Funds by Domicile

Problem 1
The ANZUS Growth and Equity Fund is a low-load fund. The purchase price quotation for
this mutual fund is $56.00, and the front-end load is 2.5%. What is the NAV? If there are 12.5
million shares outstanding, what is the current market value of assets owned by ANZUS fund?
Solution:
NAV = $56 (1 - .025) = $54.60
Market value of assets = $54.60 x 12.5 M = $682.5 M
4-38
P Problem 2
r2A sector fund specializing in commercial bank stocks had average daily assets of $1.2
billion in 2004. This fund sold $650 million worth of stock during the year and its turnover ratio
was 45. How much stock did this mutual fund purchase during the year?
Solution:
Turnover = X / $1.2 B = .45
X = $540 M
Since this is less than the $650 M in sales, this is number used in calculating turnover.
4-39In the previous problem, suppose the annual operating expense ratio for the mutual fund
in 2004 is 1.25% and the management fee is 0.85%. How much money did the funds management
earn during 2004? If the fund doesnt charge any 12b-1 fees, how much were miscellaneous and
administrative expenses during the year?

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Solution:
Management fee = 0.0085 x $1.2 B = $10.2 M
Misc. & admin. expenses = (0.0125 - 0.0085) x $1.2 B
= $4.8 M
Problem 3
Consider a mutual fund that manages a portfolio of securities worth $ 120 mn. Assume that the
fund owes $ 4 mn to its investment advisers and owes another +$ 1 mn for rent, wages due and
miscellanous expenses. The fund has $ 5 mn shareholders. What is the net asset value of the
portfolio?
Answers 1
NAV= (120-5)/5= $ 23 per share
Problem 4
An open-end fund has a net value asset of $ 10.70 per share. It is sold wth a load of 6%. What
is the offering price?
Offering price=NAV/(1-load)
10.70/(1-0.06)
11.38
Problem 5
Would you expect a typical open-end fixed-income mutual fund to have higher or lower
operating expenses than a fixed income unit investment trust?
The unit investment trust should have lower operating expenses. Because the investment trust
portfolio is fixed once the trust is established, it does not have to pay portfolio managers to
constantly monitor and rebalance the portfolio as perceived needs or opportunities change.
Problem 6
Rate of Return
ROR=(NAV1-NAVo+I+CGD)/(NAVo)

If a fund has an initial NAV of 20 at the start of the month, makes income distributions of $
0.15 and capital gain distributions of $ 0.05, and ends the month with NAV of $ 20.10. What is
the rate of return?
ROR=(20.10-20.00+0.15+0.05)/20.00
ROR=0.015 or 1.5%
Example-12b-1 Fee
The Equity fund sells class A shares with a front-end load of 4% and class B shares with 12b-1
fees of 0.5 % annually as well as back-end load fees that start at 5% and fall by 1% for each full
year the investor holds the portfolio until the fifth year. Assume ROR on the fund portfolio net
of operating expenses is 10% annually. What will be the value of a $ 10,000 investment in class
A and B shares if the shares are sold (a) 1 year, (b) 4 years, (c) 10 years and which fee structure
provide higher proceeds?
Solution-12b-1 Fee
Inv in Class A is (10,000x4)/100=400
Class A after 4% commission 10,000-400= 9600
Investment grow with 10% earn, 9600x (1.10)n
1 year: $ 10,560 4 year: 14,055.36
10 year : 24,899.93
After 12b-1, net return is 9.5%
Investment grow with the following
10,000 (1.095)n (1-percentage exit fee)
Year 1 (1-0.04): $ 10,512 year 4 (1-0.01): 14,232.89
Year 10: 24,782.28
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Comment
In one year time, the class A shares are better choice. The front-end and back-end loads are
equal, however the class A shares do not have to pay the 12b-1 fees.
For four years, the class B shares dominate because the front-end of the class A shares is
more costly than the 12b-1 fees.
For 10 years, class A dominates
In this case, one time front-end load is less expensive than the continuing 12b-1 fees
Problem1-ch 4
Consider a mutual fund with $200 mn in assets at the start of the year and with 10mn shares
outstanding. The fund invests in a portfolio of stocks that provides dividend income at the end
of the year of $ 2mn. The stocks included in the funds portfolio increase in price 8%, but no
securities are sold and there are no capital gains distributions. The fund charges 12b-1 fees of
1%, which deducted from portfolio assets at year-end.
a) what is NAV at the start and end of the year?
b) What is the ROR for an investor in the fund?
Answer 1-ch
a) Start of year NAV = $20
Dividends per share = $0.20
End of year NAV is based on the 8% price gain, less the 1% 12b-1 fee:
End of year NAV = $20 (1.08) (1 0.01) = $21.384
b) Rate of return = ($21.384-$20+$0.20)/$20= 0.0792 = 7.92%
Problem 2- ch 4

You purchased 500 shares of the new fund at a price of $45 per share at the beginning of the
year. You paid a front-end load of 6%. The securities in which the fund invests increase in value
by 14% during the year. The Funds expense ratio is 1.4%.
a) What is your ROR on the fund if you sell your shares at the end of the year?
Answer 2- ch 4
As an initial approximation, your return equals the return on the shares minus the total of the
expense ratio and purchase costs: (14% 1.4% 6%) = 6.6%
But the precise return is less than this because the 6% load is paid up front, not at the end of the
year.
To purchase the shares, you would have had to invest: [$22,500/(1 .06)] = $23,936. The
shares increase in value from $22,500 to: [$22,500 (1.14 0.014)] = $25,335.
The rate of return is: [(25,335 23,936)/23,936] = 5.84%

One of the most important elements of financial markets, that have a great effect on efficiency
of market, the investment company. The main task of these companies is making portfolio by using
of other companies' securities. They aim to hedge risk for shareholders. There are several ratios that
introduced and utilized for evaluating the efficiency of the investment companies.

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