2

University of Mauritius

Management Investment Companies

MA 2006(3): Alternative Investments
BSc (Hons.) Mathematics with Finance
Year 2 Semester 2
collects money from multiple investors creating one larger
account
invest in various securities within or across a variety of
industries.
Shares sold to the public each representing a portion of the
overall holding in the portfolio.

Lecture 3: Management Investment Companies

Open End (Mutual Funds)
Dr Nawdha Thakoor

3 4

Management Investment Companies Closed-End Investment Companies

Directors hire an investment advisor to manage the portfolio Offer a fixed number of shares for public purchase
Composition of the MIC portfolio will vary based on certain Shares made available in a single public offering after which
qualities they are bought or sold in secondary markets
Can be classified as closed end or open end Prices influenced by market conditions
Invest in various securities
Common stock
Preferred stock
Debt securities like bonds
 5 6

Open-End Investment Companies/Mutual Funds
Offer an unlimited amount of shares
Distributing them continuously
Enables the company to generate potentially an indefinite
amount of capital
Unlike closed end companies, open end allows investors to
redeem their shares or sell them back to the company rather
than trade them on secondary markets which often reduces the
capital.
Mutual Funds
A mutual fund is a professionally-managed investment
scheme, usually run by an asset management company that
brings together a group of people and invests their money in
stocks, bonds and other securities.
As an investor, you can buy mutual fund 'units', which basically
represent your share of holdings in a particular scheme.

7 8

Mutual Fund
As an investor, you can buy mutual fund 'units', which basically represent your
share of holdings in a particular scheme. These units can be purchased or
redeemed as needed at the fund's current net asset value (NAV). These NAVs
keep fluctuating, according to the fund's holdings. So, each investor
participates proportionally in the gain or loss of the fund.

These companies raise capital through issue of shares and the

money obtained from sale of share is invested directly in the
shares of other companies.
 9 10
- Benefits
Investing in a mutual fund offers you the
following benefits:
1.Small investments: With mutual fund investments, your money can be spread in small
bits across varied companies. This way you reap the benefits of a diversified portfolio with
small investments.
2. Professionally managed: The pool of money collected by a mutual fund is managed by
professionals who possess considerable expertise, resources and experience. Through analysis
of markets and economy, they help pick favourable investment opportunities.
3. Spreading risk: A mutual fund usually spreads the money in companies across a wide
spectrum of industries. This not only diversifies the risk, but also helps take advantage of the
position it holds.
4. Transparency and interactivity: Mutual funds clearly present their investment strategy
to their investors and regularly provide them with information on the value of their
investments.
5. Liquidity: Open ended funds can be bought and sold at their market value as they have
their units listed at the stock exchange.
11
As a single investor, if you want to invest Rs 10,000
per month in the equities, there are very limited
build a diversified portfolio of various company shares.
would like to grow their money.
A Mutual Fund company pools money from these
investors for investment in a particular scheme with a
specific objective.
Open-end Mutual Funds
These funds buy and sell units on a continuous basis and, hence,
allow investors to enter and exit as per their convenience. The
units can be purchased and sold even after the initial offering
(NFO) period (in case of new funds). The units are bought and
sold at the net asset value (NAV) declared by the fund.
Investor
1
Investor
2
Investor
3
12
In an open-ended Mutual fund, a number of outstanding units
goes up or down every time the fund house sells or repurchases
the existing units. This is the reason that the unit capital of an
open-ended mutual fund keeps varying. The fund expands in size
when the fund house sells more units than it repurchases as
more money is flowing in.
On the other hand, the fund's size reduces when the fund house
repurchases more units than it sells. An open-ended fund is not
obliged to keep selling new units all the time. For instance, if the
management thinks that it cannot manage a large-sized fund
optimally, it can stop accepting new subscription requests from
investors. However, it has to repurchase the units at all times.
 13 14

One term frequently encountered in a discussion of an investment company

Investment companies receive special tax treatment. Their earnings (i.e., is its net asset value. The net worth of an investment company is the total
dividend and interest income received) and realized capital gains are exempt value of its stocks, bonds, cash, and other assets minus any liabilities (e.g.,
from taxation. accrued fees). The net asset value of any share of stock in the investment
company is the net worth of the fund divided by the number of shares
outstanding. Thus, net asset value may be obtained as follows:
Dividends, interest income, and realized capital gains (whether they are
distributed or not) of the investment companies must be reported by their
shareholders, who pay the appropriate income taxes.
net asset value
The asset value of a
For this reason, income that is received by investment companies and capital share in an investment
gains that are realized are distributed. The companies, however, offer their company; total assets
stockholders the option of having the fund reinvest these distributions. While minus total liabilities
divided by the number of
shares outstanding.
easy, convenient means to accumulate shares.

15 16

The net asset value is extremely important for the valuation of an investment Net Asset Value
company, for it gives the value of the shares should the company be liquidated. The asset value of a share in an investment company.
Changes in the net asset value, then, alter the value of the investment
if the
asset value will increase, which may also cause the price of the investment The share price of a mutual fund is based on its net asset value
(NAV) per share, which is obtained by

Net asset value per share

NAV is often associated with mutual funds, and helps an investor determine if
the fund is overvalued or undervalued. When we talk of open-end funds, NAV
is crucial. NAV gives the fund's value that an investor will be entitled to at the
time of withdrawal of investment. In case of a close-end fund, which is a
mutual fund with fixed number of units, price per unit is determined by market
and is either below or above the NAV.
 17 18

Net Asset Value

The asset value of a share in an investment company.

19 20

Consider the following report

 21 22

23 24

Common Mistakes that Mutual Fund Investors do:

Common Mistakes that Mutual Fund Investors do:
1. Failing to have a good understanding of the objectives, policies and risk of the funds
investors buy. This can lead to unsuitable and unexpected losses.
4. Failing to follow a consistent long-term programme of buy-and-held investing.
The first and most important question, and one that is frequently overlooked, has more to
do with you than the list of mutual funds offered for purchase through your broker. The Investing for a short term hurts the investor. Investing for a shorter time frame puts you at
mutual fund buying process should start with the investor addressing his or her goals; this a disadvantage, as you cannot make use of the fact that the longer you invest in the
includes answering questions about your investment objectives, risk-preference, and time market, the higher are the chances of making good returns.
horizon.
5. Failing to start planning early through retirement, without letting time work for
2. Investing in the wrong funds, even though they may be in the right categories. investors to the greatest extent possible.
Losers will tend to exhibit high costs, excessive sales charges or poor management.
If you are saving for retirement 30 years hence, what the stock market does this year or
3. Buying volatile funds that were top performers over the most recent year or quarter. next shouldn't be the biggest concern. Even if you are just entering retirement at age 70,
Funds that beat their peers over the short run usually had to take big risks to get your life expectancy is likely 15 to 20 years. If you expect to leave some assets to
there. your heirs then your time horizon is even longer.
Beating the market is not a strategy. Good strategies take into accounts how much risk
you are willing to take, what you are saving for, how far out you need the money. Mutual
funds with higher expected returns may have higher risks.
 25 26

Fees
1 2 3

Several Receives Takes Initial Fees Pay for the services in Independently
Delegate all
approach responsibility assistance from a decision associated with the form of a other charges
that can to a financial third party eg independently ongoing transaction fee or
be taken brokerage firm with a self- management of expenses collected by
advisor
while directed your investment the mutual fund and
investing approach pay to the broker
in mutual
funds

27 28

Load fee Fees and expenses obviously affect the return earned by the
Sales charge levied by mutual funds. investor.
no-load mutual fund An example of load fee:
A mutual fund that does not charge a commission for buying or
selling its shares. A 6% load fee is charged on ABC mutual fund. John has $3,000 to
invest. Assume the return on the mutual fund is 10% per year,
load fund after 30 years, how much money will John have in that investment
A mutual fund that charges a commission to purchase or sell its account assuming annual compounding?
shares.
Answer: 6% load means only $2,830 ($3000/1.06) is really invested.
The difference, $170 needs to be paid as the front load. John will
have 2830*(1+10%)^30=$49,382 in 30 years.
 29
Now assume John invested this $3,000 in a no-load fund.
At the same annual return, how much money will John
have in that account?
Answer:
No load means John invests all of the $3,000. After 30 years John will have
3000*(1+10%)^30=$52,348
Note the different gets compounded over time. A $170 front load becomes a difference
of $2,966 in account value 30 years down the road.
A load fee of 6% means the annual return is decreased.
What is the annual return when the load fee is taken
into consideration?
Answer:
3000*(1+r)^30=49,382=> r=9.7863%
In this case the load fee translates in to a 0.2147% annual return rate loss.
30
However, a no-load fund does not mean it does not charge other fees. There
are plenty of other fees mutual funds can charge.
Redemption fee: Charged when shareholders redeem their shares.
Exchange fee: Charged when shareholders exchange to another fund
within the same fund group.
Account fee
accounts. E.g. a fee charged for balance less than $3000.
Purchase fee: Charged when shares are purchased. Different from a
sales load because this fee goes to the fund, not a broker.
Management fees
investment portfolio.
12b-1 fees: Paid to cover distribution expenses, such as marketing fees.