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Subject 4. Pooled Investments PDF Download
"Pooled investments" is a term given to a wide range of investment types, such as mutual funds, exchange traded funds, and separately managed accounts.
When you invest in a pooled investment, your money goes into an investment fund. You pool your money with others to help spread the risk. Professional fund managers then invest the money on your behalf in a highly competitive environment.
An investment company invests a pool of funds belonging to many individuals in a single portfolio of securities. In exchange for this commitment of capital, the investment company issues to each investor new shares representing his or her proportional ownership of the mutually held securities portfolio (commonly known as a mutual fund).
Mutual funds are classified according to whether or not they stand ready to redeem investor shares.
- An open-end mutual fund continues to sell and repurchase shares after its initial public offering. It stands ready to redeem investor shares at market value.
- A closed-end mutual fund operates like any other public firm. It is initiated through a stock offering to raise capital. Its stock trades on the regular secondary market and the market price is determined by supply and demand. A typical closed-end fund offers no further shares and does not repurchases the shares on demand (no funds can be withdrawn). Therefore, investors must trade in public secondary markets (e.g., NASDAQ) to buy or sell shares.
Various fees charged by mutual funds:
- They charge fees for their efforts of setting up funds. Sales commissions are charged at purchase (front-end load) as a percentage of the investment.
- A load fund has sales commission charges. A load fund's offering price = NAV of the share + a sales charge (7.5 - 8% of the NAV). The NAV price is the redemption (bid) price and the offering (ask) price equals the NAV divided by 1 minus the percent load.
- A no-load fund imposes no initial sales charge.
- Redemption fee (back-end load). A charge to exit the fund. This discourages quick trading turnover; these funds are set up so that the fees decline the longer the shares are held (in this case, the fees are sometimes called contingent deferred sales charges). Load funds generally charge no redemption fees.
- All mutual funds charge annual fees.
There are four types of mutual funds based on portfolio makeup.
- Money Market Funds. These funds attempt to provide current income, safety of principal, and liquidity by investing in diversified portfolios of short-term securities, such as T-bills, banker certificates of deposit, bank acceptances, and commercial paper. They generally allow holders to write checks again their account, so they are essentially cash holdings for holders. However, they are not insured in the same way as bank deposits.
- Bond Mutual Funds. Bond funds concentrate on various types of bonds to generate high current income with minimal risk. Bonds held include government bonds, high-grade corporate bonds, and junk bonds.
- Stock Mutual Funds. These funds invest almost solely in common stocks. Some funds focus on growth companies while others specialize in specific industries. Different stock mutual funds can suit almost any taste or investment objective.
- Passive mutual fund management is a long-term buy-and-hold strategy. Usually stocks are purchased with the intention that the portfolio's returns will track those of an index over time. The purpose is not to beat the index but to match its performance.
- Active mutual fund management is an attempt by the fund manager to outperform a passive benchmark portfolio on a risk-adjusted basis. Management fees are usually higher and there are usually more trading activities, which can cause tax consequences for investors.
- Hybrid/Balanced Funds. These funds diversify outside the stock market by combining common stock with fixed-income securities.
Other Investment Products
1. Exchange Traded Funds
Refer to Reading 58 (Introduction to Alternative Investments).
2. Separately Managed Accounts
The key difference between mutual funds and separate accounts is that, in a separate account, the money manager is purchasing the securities in the portfolio on behalf on the investor, not on behalf of the fund. Therefore, the investor can determine which assets are bought or sold, and when.
A mutual fund investor owns shares of a company (mutual fund) that in turn owns other investments, whereas an SMA investor owns the invested assets directly in his own name.
An investor in an SMA typically has the ability to direct the investment manager to sell individual securities with the objective of raising capital gains or obtaining losses for tax planning purposes. This practice is known as "tax harvesting"; its objective is to attempt to equalize capital gains and losses across all of the investor's accounts for a given year in order to reduce capital gains taxes owed.
Another major advantage of individual cost basis is the ability to customize the portfolio by choosing to avoid investing in certain stocks or certain economic sectors (technology, sin stocks, etc.).
3. Hedge Funds
A hedge fund is an investment fund, open to a limited range of investors, that undertakes a wider range of investment and trading activities than traditional long-only investment funds, and that, in general, pays a performance fee to its investment manager. Every hedge fund has its own investment strategy that determines the type of investments and the methods of investment it undertakes.
Unlike mutual funds, most hedge funds are not regulated. The net effect is that the hedge fund investor base is generally very different from that of the typical mutual fund.
Hedge funds employ many different trading strategies, which are classified in many different ways, with no standard system used. A hedge fund will typically commit itself to a particular strategy, particular investment types, and leverage limits via statements in its offering documentation, thereby giving investors some indication of the nature of the particular fund.
4. Buyout and Venture Capital Funds
Both funds take equity positions and plan a very active role in the management of the company. The equity they hold is private, and they don't have a long investment horizon.
- Buyout funds make only a few large investments in public companies with the intent of selling the restructured companies in three to five years.
- Venture capital funds buy start-up companies and grow them. They play a very active role in managing these companies.
Learning Outcome Statementse. describe mutual funds and compare them with other pooled investment products.
CFA® 2020 Level I Curriculum, 2020, Volume 4, Reading 51
User Contributed Comments 6
|gulfa99||Bond funds: how can a junk bond be classified as a low risk investment. The ratings are lower and default probability is higher..can someone explain|
|javasun||junkbonds are way cheaper, making them low-risk investment if you look at it from that perspective. risk here usually mean interest rate risk, not default risk. T-bonds have big interest rate risks although low default risks.|
|johntan1979||"Bonds held include government bonds, high-grade corporate bonds, and junk bonds."
Not just junk bonds. You took this statement out of context. Junk bonds are NEVER low risk but a diversified bond mutual fund containing junk bonds as part of the composite minimizes the risk.
|jonan203||don't take the word junk to literally, junk bonds are essentially high yield bonds with an investment grade below BBB or Baa.
junk status has more to do with a firms credit rating and coupon rate than being "cheaper" than investment grade bonds.
one of the greatest fixed income mutual funds of all time PTTAX, can invest up to 10% of its holdings in junk.
|TheCFAGuy||I understand Analyst Notes provides us where to find the info, but would it kill them to just copy and paste it? Doesn't hurt to read it twice anyways.|
|noname||hehe agree thecfaguy!|