Investment and Portfolio

Management
Neveen Ahmed
Pooled Investment Funds
Pooled Investment Funds:
A Pooled Investment Vehicle, also known as a pooled fund, is an investment fund that uses funds
from many numerous individual investors. The funds are then combined into a single investment fund

Pooled
investment

Mutual Hedge
ETFS
Funds fund
Pooled investment funds
• Exchange Traded Fund (ETF)
• They hold a basket of assets, ETFs are more similar to equities than to mutual
funds. Listed on market exchanges just like individual stocks, they are highly
liquid: They can be bought and sold like stock shares throughout the trading day,
with prices fluctuating constantly.
• ETFs can track not just an index, but an industry, a commodity or even another
fund, investor can buy shares from other investor
• Continuously traded: Bought and sold intra day like regular shares
• Hedge Funds
• They invest in more risky assets like derivatives, long term, not subject to
regulation and hence can engage in more aggressive investment.
Mutual Funds
• Mutual funds are the common name for open-end investment
companies. They account for more than 90% of investment company
assets.
• They provide a lower cost for investing your money.
Mutual Funds
• Mutual funds are marketed to the public either directly by the fund
underwriter or indirectly through brokers acting on behalf of the
underwriter.
• Direct-marketed funds are sold through various offices of the fund,
over the phone, or over the Internet. Investors contact the fund
directly to purchase shares.
• About half of fund sales are distributed through a sales force. Brokers
receive a commission for selling shares to investors.
Investment Policies of Mutual Funds
• Each mutual fund has a specified investment policy, which is
described in the fund’s prospectus.
• For example, money market mutual funds hold the short-term, low-
risk instruments of the money market and bond funds hold fixed-
income securities.
Mutual Fund Example
Investor Amount invested in $ % of total Number of shares

Leena 6,000 6% 600

Yasmeen 4,000 4% 400
Ibrahim 20,000 20% 2000
Moataz 25,000 25% 2500
Steve 45,000 45% 4500

Suppose the mutual fund decided to buy a portfolio of small company

stocks and divided the fund on 10,000 shares then each mutual fund
share worth 100,000/10,000= 10$
Investment Policies of Mutual Funds
• Management companies manage a family of mutual funds. They
organize an entire collection of funds and then collect a management
fee for operating them.
• By managing a collection of funds under one umbrella, these
companies make it easy for investors to allocate assets across market
sectors and to switch assets across funds while still benefiting from
centralized record keeping.
Mutual Fund can categorized as:
• Open end funds
• Open-end funds are mutual fund. They don't have a limit as to how many shares they can issue. When an
investor purchases shares in a mutual fund, more shares are created, and when somebody sells his or her
shares the shares are taken out of circulation. If a large number of shares are sold (called a redemption),
the fund may have to sell some of its investments in order to pay the investor.
• Accept new investment
• Trade at NAV, redeemed
• Bought and sold based on closing prices
• Closed end funds
• It is launched through an IPO in order to raise money and then traded in the open market just like a stock
• Trade at , below or above NAV
• Don’t accept new investment
• Continuously traded: Bought and sold intra day
Classification of Mutual Funds
• Funds can be classified into one of the following groups.
• Money Market Funds
• Equity Funds
• Sector Funds
• Bond Funds
• International Funds
• Balanced Funds
• Index Funds
Classification of Mutual Funds
Money Market Funds
• Money market funds invest in money market securities such as
commercial paper or certificates of deposit. The average maturity of
these assets tends to be a bit more than 1 month.
Classification of Mutual Funds
Equity Funds
• Equity funds invest primarily in stock, although they may, at the
portfolio manager’s discretion, also hold fixed-income or other types
of securities.
• Equity funds commonly will hold between 4% and 5% of total assets
in money market securities to provide the liquidity necessary to meet
potential redemption of shares.
Classification of Mutual Funds
Equity Funds
• Equity funds are further classified into the following:
• Income Funds: These funds tend to hold shares of firms with high dividend
yields.
• Growth Funds: These focus on prospects for capital gains.
• Main difference between these funds concerns the level of risk these
funds assume. Growth funds are riskier than income funds.
Classification of Mutual Funds
Sector Funds
• Sector funds concentrate on a particular industry. These funds invests
in a specific industry (such as, biotechnology, utilities, energy, or
telecommunications). They may specialize in securities of particular
countries.
Classification of Mutual Funds
Bond Funds
• Bond funds specialize in the fixed-income sector. For example, these
funds concentrate on corporate bonds, Treasury bonds, mortgage-
backed securities, or municipal bonds.
• Many bond funds also specialize by maturity, ranging from short-term
to intermediate to long-term, or by the credit risk of the issuer
(ranging from very safe to “junk,” bonds).
Classification of Mutual Funds
International Funds
• These funds have international focus.
• Global funds invest in securities worldwide, including the United States
• International funds invest in securities of firms located outside the United
States
• Regional funds concentrate on a particular part of the world
• Emerging market funds invest in companies of developing nations
Classification of Mutual Funds
Balanced Funds
• Balanced funds are designed to be candidates for an individual’s entire
investment portfolio. These funds hold both equities and fixed-income
securities in relatively stable proportions.
• Life-cycle funds are examples of balanced funds. In these funds, the asset
mix can range from aggressive (primarily marketed to younger investors) to
conservative (directed at older investors).
Classification of Mutual Funds
Balanced Funds
• Life-cycle funds can be further differentiated as the following:
• Static allocation life-cycle funds: These funds maintain a stable mix across
stocks and bonds.
• Targeted-maturity funds: These funds gradually become more conservative
as the investor ages.
Classification of Mutual Funds
Index Funds
• An index fund is a type of mutual fund that tracks a particular market
index: the S&P 500, Russell 2000.
• An index fund tries to match the performance of a broad market
index. The fund buys shares in securities included in a particular index
in proportion to each security’s representation in that index.
• Investment in an index fund is a low-cost way for small investors to
pursue a passive investment strategy—that is, to invest without
engaging in security analysis.
Classification of Mutual Funds
Index Funds
• An example of index fund is the Vanguard 500 Index Fund. This fund
replicates the composition of the Standard & Poor’s 500 stock price
index.
• Because the S&P 500 is a value-weighted index, the fund buys shares
in each S&P 500 company in proportion to the market value of that
company’s outstanding equity.
Mutual Funds
Costs of Investing in Mutual Funds
Costs of Investing in Mutual Funds
Operating Expenses
• Operating expenses are the costs incurred by the mutual fund in
operating the portfolio. These costs may include the following:
• Administrative Expenses
• Advisory Fees Paid to the Investment Manager
Costs of Investing in Mutual Funds
Operating Expenses
• Operating expenses are, usually, expressed as a percentage of total
assets under management. They may range from 0.2% to 2%.
• Shareholders of mutual funds do not receive an explicit bill for these
operating expenses. However, the expenses are periodically deducted
from the assets of fund. Shareholders pay for these expenses through
the reduced value of portfolio.
Costs of Investing in Mutual Funds
Marketing Expenses
• Mutual funds incur marketing and distribution costs. These charges
are used primarily to pay brokers and financial advisers who sell the
funds to public.
• Investors can avoid these expenses by buying shares directly from the
fund sponsor, but many investors are willing to incur these
distribution fees in return for the advice they may receive from their
broker.
Costs of Investing in Mutual Funds
Front-end Load
• A front-end load is a commission or sales charge paid when you
purchase the shares of mutual fund.
• These charges, which are paid to the brokers, may not exceed 8.5%,
but in practice they are rarely higher than 6%.
• Low-load funds have loads that range up to 3% of invested funds. No-
load funds have no front-end sales charges.
Costs of Investing in Mutual Funds
Front-end Load
• Loads effectively reduce the amount of money invested. For example,
each $1000 paid for a fund with a 6% load results in a sales charge of
$60 and fund investment of only $940.
Costs of Investing in Mutual Funds
Back-end Load
• A back-end load is a redemption, or “exit,” fee incurred when you sell
your shares. These charges are known more formally as “contingent
deferred sales charges”.
• Funds that impose back-end loads start them at 5% or 6% and reduce
them by 1 percentage point for every year the funds are left invested.
Thus, an exit fee that starts at 6% would fall to 4% by the start of third
year.
Costs of Investing in Mutual Funds
12b-1 Charges
• Securities and Exchange Commission (SEC) in the U.S. allows the
managers of some mutual funds to use their assets to pay for
distribution costs. These funds are called as 12b-1 funds and these
costs are called as 12b-1 charges.
Costs of Investing in Mutual Funds
12b-1 Charges
• As with operating expenses, investors are not explicitly billed for 12b-
1 charges. Instead, the fees are deducted from the assets of the fund.
• Therefore, 12b-1 fees (if any) must be added to operating expenses to
obtain the true annual expense ratio of the fund.
Costs of Investing in Mutual Funds
• Costs associated with investing in the mutual funds will lower the
return on an investment in a mutual fund.
• The rate of return on an investment in a mutual fund is measured as
the increase or decrease in NAV plus income distributions such as
dividends or distributions of capital gains expressed as a fraction of
NAV at the beginning of the investment period.
Costs of Investing in Mutual Funds
• If we denote the NAV at the start and end of the period as NAV0 and
NAV1, respectively, then:
Costs of Investing in Mutual Funds
Example 1
• Consider a fund with an initial NAV of $20 at the start of the month.
Assume that this fund 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 monthly rate of return?
Costs of Investing in Mutual Funds
Example 1
• The monthly rate of return is computed as follows:

• Notice that this measure of rate of return includes expenses such as

management fees, but ignores expenses such as front-end loads.
Costs of Investing in Mutual Funds
• The actual rate of return is affected by additional expenses, such as
front-end loads. This is because such charges reduce investor’s actual
rate of return. Actual rate of return should incorporate all expenses.
Costs of Investing in Mutual Funds
Example 2
• Consider a fund with $100 million in assets at the start of the year and
with 10 million shares outstanding. The fund invests in a portfolio of
stocks that provides no income but increases in value by 10%. The
expense ratio is 1%. What is the rate of return for an investor in the
fund?
Costs of Investing in Mutual Funds
Example 2
• The expense ratio is the annual fee that all funds charge their
shareholders. It expresses the percentage of assets deducted each
fiscal year for fund expenses. It may include 12b-1 fees, management
fees, administrative fees, operating costs, and all other asset-based
costs incurred by the fund.
Costs of Investing in Mutual Funds
Example 2
• The initial value of assets equals $10 per share [=$100 million/10
million shares].
• In the absence of expenses, fund assets would grow to $110 million.
• However, the expense ratio of the fund is 1%. Therefore, $1 million
will be deducted from the fund to pay for these fees, leaving the
portfolio worth only $109 million, and the NAV equal to $10.90 per
share.
Costs of Investing in Mutual Funds
Example 2
• The rate of return on the fund is only 9%, which equals the gross
return on the underlying portfolio minus the total expense ratio.
This lecture stops here
Mutual Funds
Mutual Fund Investment Performance