Mutual Funds Types and

Features
CHAPTER 18: Mutual Funds: Types
and Features

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Types and Features of Mutual Funds
Money Market Funds
• Objective: Liquidity with some income
• Short-term securities
• NAVPS usually set at $10
• Subject to interest rate risk

Fixed Income Funds

• Objective: Income and minimal safety
• Bonds and debentures of various maturities
• Subject to interest rate risk

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Types and Features of Mutual Funds
Balanced Funds
• Objective: Safety, income, capital appreciation
• Mixture of stocks and bonds (rarely 50/50)
• Subject to market risk and interest rate risk

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Types and Features of Mutual Funds
Equity Funds
• Objective: Capital gains
• Invest in common shares
• Subject to market risk
• Fund managers can follow a growth or value approach
• There are small-cap, mid-cap, micro-cap, large-cap
• Foreign or international funds are subject to market and foreign
exchange risk

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Types and Features of Mutual Funds
Specialty
• More narrowly focused and concentrate their assets into one
main area – a specific industry or region.
• Subject to market risk plus the risk of an industry, a commodity
or region.
• Examples: real estate, ethical, science and technology, health
care, precious metals.

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Types and Features of Mutual Funds
Index Funds
• Match the performance of an underlying index, such as the
S&P/TSX Composite.
• Much lower MERs than other funds.
• Passive investment approach.
• Long-term capital gains is the primary focus.

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Types and Features of Mutual Funds
Target-date Funds (Life Cycle funds)
• Unlike regular mutual funds, these have a maturity date and a
glide path.
• Maturity date is selected when buying fund based on some goal
eg retirement.
• Glide Path –the asset allocation changes from higher risk to
lower risk as the maturity date approaches.

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Risks Associated with Mutual Funds
The higher the risk the greater the return.
Lowest to Highest Risk:
Lowest risk Money Market Funds
Fixed Income Funds
Balanced Funds
Equity Funds
Highest risk Specialty Funds

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Indexing and Closet Indexing
Indexing: This is a passive style of investing that purchases
securities that make up or closely replicate the performance of
an Index such as the S&P TSX Composite.

Closet Indexing: does not really replicate the market, but stays
close to the market weightings by industry sector, country or
region.

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Taxation Issues
Mutual funds can generate taxable income in a couple of ways:

• Through the distribution of interest income, dividends and

capital gains realized by the fund; and
• Through any capital gains realized when the fund is eventually
sold.

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Taxation Issues: Annual Distributions
• An investor purchases a large cap equity fund with a NAVPS of
$15 per share.

At the end of the first year the fund distributes:

– $0.75 in dividends
– $0.35 in distributed capital gains

• The investor receives a T3 from the fund indicating the amount

reportable to Canada Revenue Agency (CRA).
• The investor reports an additional $1.10 in income.

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Taxation Issues: Annual Distributions
A client purchases the Canadian Equity Growth fund as part of her
non-registered holdings. At the end of the year, the fund distributes
capital gains of $4 when the NAVPS is $18.

• What impact does the capital gains distribution have on the

NAVPS of the fund?
• What are the tax implications for the client?

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Taxation Issues: Capital Gains
• What impact does the capital gains distribution have on the
NAVPS of the fund?
– The NAVPS will fall by the amount of the distribution to
$14.

• What are the tax implications for the client?

– The full distribution of $4 per share is taxable in the client’s
hands.
– The tax consequences are $4 × 50% × marginal tax rate.

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Taxation Issues: Reinvested Distributions
• An investor buys $5,000 of TBA Equity fund units 4 years ago
and reinvests all fund distributions into additional fund units.
• The investor sells the fund this year when the holdings are
worth $12,000.
• The investor received a total of $2,500 in reinvested dividends
over the holding period.

• Will the investor report a capital gain of $7,000?

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Taxation Issues: Reinvested Distributions
• The increase in fund value is made up of two factors:
– the reinvestment of (already taxed) income
– a capital gain

Revise the ACB:

– The portion of the increase due to reinvestment must be
added to the original investment.
– New ACB = $5,000 + $2,500 = $7,500

Capital Gain:
– $12,000 - $7,500 = $4,500 and not $7,000

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 Taxation Issues – Adjusted Cost Base
• An investor purchases 500 shares of a convertible preferred
share for a total cost of
• $8,500. Each share is convertible into four common on or
before the end of 2015.
• The common shares increase to $25 per share and the
company forces conversion.
• Calculate the adjusted cost base of the common shares

ACB = Total cost / Number of common shares

= $8,500 / (500 X 4)
= $4.25
Note: the increase cost of the common shars has nothing to do
with calculation the ACB.

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Systematic Withdrawal Plans
Which withdrawal plan(s) provide variable dollar returns over the
life of the plan?

Ratio withdrawal plan: based on a fixed percentage

Fixed-Period Withdrawal Plan : fixed amount is withdrawn

over a pre-determined period of time.
Life expectancy adjusted withdrawal plan: amount is adjusted
to meet income needs over life span.

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Modified Dietz Method
This method is used to calculate the actual rate of return earned by
the portfolio manager. Unlike total return, it does account for cash
flows such as deposits, withdrawals and reinvestments. It takes
into account the amount of time that the investment was held in the
portfolio.
ROR = (MVE – MVB – F) / (MVB + FW)
Where:
MVE: the market value at the end of the period.
MVB = the market value at the beginning of the period.
F = the sum of the cash flows within the period.
FW = the sum of the cash flows multiply by its weight.

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