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101 Concepts for the Level I Exam

Concept 64: Pooled Investment Products

Mutual fund is an investment pool of multiple investors, in which each investor has claim on income and value of the fund in proportion to the investment made by them.

Net asset value = value of assets – liabilities.

Open-end fund: A mutual fund that allows the issuance of new shares or redemption of existing shares, i.e. new investments are allowed. (No-load funds: Do not charge fees on redemption and fees for purchasing of shares; while load funds can charge either or both the fees). Purchases and sales are made with the fund.

Closed-end fund: No new investment money is accepted after inception. Purchases and sales are made on exchanges or over-the-counter. They can trade at significant discount to NAV due to imbalances in investor supply and demand.

Types of mutual funds:

  • Money market funds: Invest in short-term debt securities providing interest income and have very little risk.
  • Bond mutual funds: Invest in fixed-income securities and are further classified by maturities, issuers and credit ratings.
  • Actively managed stock mutual funds: Investments made with the motive to beat the benchmark index. For example, large cap, small cap, mid-cap etc.
  • Passively managed stock mutual funds: Investments made with the motive to track the index performance. For example, index funds.

Exchange traded funds are a pooled investment vehicle that are similar to closed-end funds. They often track an index and are passively managed. ETFs provide joint benefits of closed-end and open-end funds.

  • Special redemption process keeps market prices close to NAV, similar to an open-end fund.
  • Trade like closed-end funds (continuously traded with other investors).
  • Can be bought on margin, sold short and allow intraday positions to be taken.
  • Expenses are lower relative to mutual funds, but brokerage commissions need to be paid.
  • ETFs have less capital gains taxes as compared to open-ended funds, as securities need not be sold to meet redemptions.
  • ETFs pay out dividends in cash, while open-end funds allow reinvesting in additional shares.

Separately managed accounts (SMA)

  • Also known as “wrap account”, “individually managed account” and “managed account”.
  • Owned and managed according to the needs of a single investor.
  • Requires high initial investment.
  • Tax implications have to be considered when buying or selling.

Hedge funds

  • Pooled investments that are not regulated to the extent of mutual funds.
  • Investments required are quite high.
  • Strategies include: Long/short, market neutral, long/short bias, event driven, fixed-income arbitrage, global macro, convertible bond arbitrage etc.

Private equity (buyout funds and venture capital)

  • Privately held and play an active role in managing investments.
  • Leveraged buyout funds buy a public company, make it private, perform a turnaround thereby improving its valuation and later sell it to earn a profit. Typical time frames include three to five years.
  • VC funds make initial stage investments in startup companies.

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