Chapter 4 (Mutual Funds and Other Investment Companies): Section 4.3, 4.4, 4.5 and 4.6
Thus an exit fee that starts at 4% would fall to 2% by the start of your third year. These charges are known more formally as ____
"contingent deferred sales loads."
Many funds also are sold through ______ that sell shares in funds of many complexes.
"financial supermarkets"
The first ETF was the _____ a nickname for SPDR, or Standard & Poor's Depository Receipt, which is a unit investment trust holding a portfolio matching the S&P 500 Index.
"spider,"
A fund with a high portfolio turnover rate can be particularly _____
"tax inefficient."
Assets under management in the U.S. mutual fund industry were approximately _____ in early 2018, with roughly another $25 trillion managed by non-U.S. funds.
$18.7 trillion
These expenses, usually expressed as a percentage of total assets under management, may range from ___% to ____%.
.2% to 1.5%
Fund A has total operating expenses of _____%, no load, and no 12b-1 charges.
.25
The 12b-1 fees are limited to ____% of a fund's average net assets per year.
1
Typically, funds that impose back-end loads reduce them by ____ percentage point for every year the funds are left invested.
1
SEC rules require funds to disclose the tax impact of portfolio turnover. Funds must include in their prospectus after-tax returns for the past _____ periods.
1-, 5-, and 10-year
Some of the most well-known management companies are ____
Fidelity, Vanguard, and BlackRock
ETFs offer several advantages over conventional mutual funds. --->
First, as we just noted, a mutual fund's net asset value is quoted—and, therefore, investors can buy or sell their shares in the fund—only once a day. In contrast, ETFs trade continuously. Moreover, like other shares, but unlike mutual funds, ETFs can be sold short or purchased on margin
There are some disadvantages to ETFs, however. --->
First, while mutual funds can be bought at no expense from no-load funds, ETFs must be purchased from brokers for a fee. In addition, because ETFs trade as securities, their prices can depart from NAV, at least for short periods, and these price discrepancies can easily swamp the cost advantage that ETFs otherwise offer. While those discrepancies typically are quite small, they can spike unpredictably when markets are stressed.
_____ has no load but has .75% in management expenses and .5% in 12b-1 fees. This level of charges is fairly typical of actively managed equity funds.
Fund B
____ also hold other money market instruments such as commercial paper or bank CDs
Prime funds
Finally, _____ has .80% in management expenses, has no 12b-1 charges, but assesses a 6% frontend load on purchases
Fund C
For example, Vanguard's _____ fund invests in mortgage-backed securities, the _____ invests in intermediate-term municipal bonds, and the _____ fund invests in large part in speculative grade, or "junk," bonds with high yields.
GNMA Municipal Intermediate fund High-Yield Corporate bond
____ invest in securities worldwide, including the United States.
Global funds
_____ are willing to forgo current income, focusing instead on prospects for capital gains
Growth funds
_____, are typically riskier and respond more dramatically to changes in economic conditions than do income funds.
Growth stocks, and therefore growth funds
_____ is the ratio of the trading activity of a portfolio to the assets of the portfolio.
Turnover
For example, the _____ is a mutual fund that replicates the composition of the Standard & Poor's 500 stock price index.
Vanguard 500 Index Fund
Examples are ____ and ___
Vanguard's Windsor and Wellington funds
Notice that this measure of the rate of return ignores _____
any commissions such as front-end loads paid to purchase the fund
These funds are similar to balanced funds in that they hold both stocks and bonds. However, _____ may dramatically vary the proportions allocated to each market in accord with the portfolio manager's forecast of the relative performance of each sector. Hence, these funds are engaged in market timing and are not designed to be low-risk investment vehicles.
asset allocation funds
Instead, the fees are deducted from the ____
assets of the fund.
Until recently, turnover rates in equity funds typically were around 50% when weighted by _____
assets under management.
A ____ is a redemption, or "exit," fee incurred when you sell your shares.
back-end load
Of course, index funds can be tied to nonequity indexes as well. For example, Vanguard offers a ____ and ____
bond index fund and a real estate index fund.
Indeed, some municipal bond funds invest only in _____ to satisfy the investment desires of residents of that state who wish to avoid local as well as federal taxes on interest income
bonds of a particular state (or even city!)
Money market funds usually offer ____ and net asset value is fixed at $1 per share, so there are no tax implications such as capital gains or losses associated with redemption of shares.
check-writing features
Class I shares are sold to institutional investors. These are sometimes called _____ and carry no loads or 12b-1 fees.
class Y shares
Many funds offer "_____" that represent ownership in the same portfolio of securities, but with different combinations of fees.
classes
But larger funds tend to have lower expense ratios, so the average expense ratio weighted by assets under management is ____
considerably smaller, .59%.
The SEC requires that all funds include in the prospectus a _____ that summarizes all relevant fees.
consolidated expense table
For example, various funds will concentrate on ____
corporate bonds, Treasury bonds, mortgagebacked securities, or municipal (tax-free) bonds.
On the basis of those credits, the broker will pay for some of the mutual fund's expenses, such as _____
databases, computer hardware, or stock-quotation systems.
Shareholders do not receive an explicit bill for these operating expenses; instead, the expenses periodically are ____
deducted from the assets of the fund.
While capital gains or losses will normally be very small, this "____" of NAV has contributed to a shift in investor demand from prime to government funds.
floating
Comparative data on virtually all important aspects of mutual funds are available on Morningstar's Web site at www.morningstar.com. You should be aware of ____ general classes of fees.
four
A _____ is a commission or sales charge paid when you purchase the shares
front-end load
Funds may use 12b-1 charges instead of, or in addition to, ____ to generate the fees with which to pay brokers.
front-end loads
Mutual funds are generally marketed to the public either directly by the ____ or the ____
fund underwriter or indirectly through brokers acting on behalf of the underwriter.
Many balanced funds are in fact ____
funds of funds
Within that sector, however, there is considerable room for ____
further specialization.
In the aftermath of the financial crisis, prime funds are now subject to "_____" that allow funds to temporarily halt redemptions during periods of severe disruption.
gates
As their name suggests, _____ hold short-term U.S. Treasury or agency securities and repurchase agreements collateralized by such securities
government funds
On the other hand, many contend that these supermarkets result in _____ because mutual funds pass along the costs of participating in these programs in the form of higher management fees
higher expense ratios
Thus, _____ tend to hold shares of firms with consistently high dividend yields.
income funds
Not surprisingly, the average expense ratio of actively managed funds is considerably higher than that of _____, .78% versus .09% (weighted by assets under management).
indexed funds
Part of this decline probably reflects the shift from actively managed to _____
indexed funds
In contrast, _____ invest in securities of firms located outside the United States
international funds
Each mutual fund has a specified _____, which is described in the fund's prospectus
investment policy
An individual investor choosing a mutual fund should consider not only the fund's stated investment policy and past performance but also ____
its management fees and other expenses.
While the classification of these funds is couched in terms of income versus capital gains, in practice, the more relevant distinction concerns the ____
level of risk these funds assume
However, names of common stock funds often reflect ____
little or nothing about their investment policies.
Note the substantial return advantage of low-cost Fund A. Moreover, that differential is greater for ____
longer investment horizons.
By contrast, a _____ such as an index fund may have turnover as low as 2%, which is both tax-efficient and economical with respect to trading costs.
low-turnover fund
ETFs are often cheaper than mutual funds. Investors who buy ETFs do so through brokers rather than buying directly from the fund. Therefore, the fund saves the cost of marketing itself directly to small investors. This reduction in expenses may translate into _____
lower management fees.
In addition to operating expenses, many funds assess fees to pay for ____
marketing and distribution costs.
Many funds also specialize by ____, ranging from short-term to intermediate to long-term, or by ____, ranging from very safe to high-yield, or "junk," bonds.
maturity the credit risk of the issuer
Although expenses can have a big impact on net investment performance, it is sometimes difficult for the investor in a mutual fund to ____
measure true expenses accurately.
Funds are commonly classified by investment policy into one of the following groups: _____
money market funds, equity funds, sector funds, bond funds, international funds, balanced funds, asset allocation and flexible funds, and index funds.
For example, _____ hold the short-term, low-risk instruments of the money market (see Chapter 2 for a review of these securities), while bond funds hold fixed-income securities
money market mutual funds
However, as we have noted, many investors are willing to pay for financial advice, and the commissions paid to advisers who sell these funds are the _____
most common form of payment.
Instead of charging customers a sales commission, the broker splits management fees with the ____
mutual fund company.
In contrast, when small investors wish to redeem their position in an ETF, they simply sell their shares to other traders, with ____
no need for the fund to sell any of the underlying portfolio.
A more recent innovation is ____ that, like actively managed mutual funds, attempt to outperform passive indexes.
nontransparent actively managed ETFs
Purchases made with soft dollars are _____, so funds with extensive soft-dollar arrangements may report artificially low expense ratios to the public
not included in the fund's expenses
Around ____ of all ETFs changed hands on that day at prices less than one-half of their closing price, and ETFs accounted for about two-thirds of all canceled trades.
one-fifth
Thus, if you plan to hold your fund for a long time, a ______ may be preferable to recurring 12b-1 charges.
one-time load
BlackRock also offers several bond ETFs and a few commodity funds such as ______. For more information on these funds, go to www.iShares.com.
ones for gold and silver
And, reinforcing this problem, some ETFs may be supported by ____
only a very small number of dealers.
As with _____, investors are not explicitly billed for 12b-1 charges.
operating expenses
They organize an entire collection of funds and collect a management fee for ____
operating them
Often that index measures the performance of an illiquid and thinly traded asset class, so the ETF gives the investor the ____
opportunity to add that asset class to his or her portfolio.
These are mutual funds that primarily invest in shares of ___
other mutual funds.
Investment returns of mutual funds are granted "_____" under the U.S. tax code, meaning that taxes are paid only by the investor in the mutual fund, not by the fund itself.
pass-through status
The income is treated as _____ as long as the fund meets several requirements, most notably that virtually all income is distributed to shareholders.
passed through to the investor
These are nominally debt securities, but with ____
payoffs linked to the performance of an index.
This is because such charges are ______, which reduces net asset value.
periodically deducted from the portfolio
These advisers can help investors select ____ (as well as provide other financial advice).
portfolios of low- or no-load funds
ETFs also offer a _____ over mutual funds
potential tax advantage
Moreover, while both prime and government retail money market funds maintain net asset value at $1.00 per share, _____ now must calculate and report net asset value.
prime institutional funds
Money market funds are classified as ____
prime versus government
Equity funds commonly will hold a small fraction of total assets in money market securities to ____
provide the liquidity necessary to meet potential redemption of shares
Each investor must choose the best combination of fees. Obviously, _____ funds distributed directly by the mutual fund group are the cheapest alternative, and these will often make most sense for knowledgeable investors.
pure no-load nofee
The ______ is measured as the increase or decrease in net asset value plus income distributions such as dividends or distributions of capital gains, all expressed as a fraction of net asset value at the beginning of the investment period.
rate of return on an investment in a mutual fund
However, the fund may have paid its broker needlessly high commissions to obtain its soft-dollar "_____."
rebate
Shareholders pay for these expenses through the ____
reduced value of the portfolio.
This can trigger capital gains taxes, which are passed through to and must be paid by the _____
remaining shareholders.
It measures the fraction of the portfolio that is "_____" each year.
replaced
If these funds had to ____, competitors could take advantage of their buying and selling programs.
report portfolio holdings on a daily basis
Some equity funds, called ____, concentrate on a particular industry.
sector funds
For example, Fidelity markets dozens of "_____," each of which invests in a specific industry such as biotechnology, utilities, energy, or telecommunications. Other funds specialize in securities of particular countries
select funds
When large numbers of mutual fund investors redeem their shares, the fund must ____
sell securities to meet the redemptions.
These charges are used primarily to pay the brokers or financial advisers who ____
sell the funds to the public.
This is because of the practice of paying for some expenses in ____
soft dollars.
The _____ means that the stockbroker effectively returns part of the trading commission to the fund
soft-dollar arrangement
While these assets are certainly at the very safe end of the credit-risk spectrum, they are nevertheless riskier than government securities and are more prone to ____
suffer reduced liquidity in times of market stress
If they drop out of the market during a period of turmoil, prices may ____
swing wildly.
Other even more exotic variations are so-called _____ such as exchange-traded notes (ETNs) or exchange-traded vehicles (ETVs)
synthetic ETFs
Static allocation life-cycle funds maintain a stable mix across stocks and bonds, while ____ gradually become more conservative as time passes and the date of a particular milestone such as retirement draws nearer
target-date funds
One 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.
Investors who rely on their broker's advice to select their mutual funds should be aware that this advice may suffer from a conflict of interest if ____
the broker receives compensation for directing the sale to a particular fund
The table shows _____
the cumulative amount in each fund after several investment horizons.
On the other hand, the rate of return is affected by ____
the fund's expenses and 12b-1 fees.
Thus, the investor's rate of return equals ____
the gross return on the underlying portfolio minus the total expense ratio
The impact of the higher trading commission shows up in net investment performance rather than _____
the reported expense ratio.
These products are a bit controversial, as the ETF is then exposed to risk that in a period of financial stress the investment bank will be unable to fulfill its obligation, leaving investors without ____
the returns they were promised.
The pass-through of investment income has one important disadvantage for individual investors. If you manage your own portfolio, you decide when to realize capital gains and losses on any security; _____
therefore, you can time those realizations to efficiently manage your tax liabilities
A fund's short-term capital gains, long-term capital gains, and dividends are passed through to investors as ____
though the investor earned the income directly
This is the dominant investment company today, accounting for ____% of investment company assets.
87
The simple average of the expense ratio of all equity funds in the U.S. was ____% in 2017.
1.25
Loads are paid only once for each purchase, whereas _____ are paid annually.
12b-1 fees
These ____ are named after the SEC rule that permits use of these plans
12b-1 fees
These funds are still transparent in the sense that they must disclose portfolio composition each day. At the end of 2017, there were ____ actively managed ETFs registered with the SEC.
194
About ____% of equity funds in 2018 were indexed.
25
By 2018, about $_____ was invested in more than 1,800 U.S. ETFs.
3.4 trillion
However, in the last decade, asset-weighted average turnover has dropped considerably, falling to _____% in 2017
30
For example, a $100 million portfolio with $50 million in sales of some securities and purchases of other securities would have a turnover rate of _____%.
50
For example, each $1,000 paid for a fund with a 6% load incurs a sales charge of $60 and fund investment of only $940. You need cumulative returns of ____ just to break even.
6.4% of your net investment (60/940 = .064)
These charges, which are used primarily to pay the brokers who sell the funds, may not exceed _____%, but in practice they are rarely higher than 6%.
8.5
Each offers an array of open-end mutual funds with different investment policies. In 2018, there were about 8,000 mutual funds in the U.S., which were offered by more than ____ fund complexes
800
____ tries to match the performance of a broad market index.
An index fund
In 2014, however, the SEC gave permission to ____ to offer an actively managed "nontransparent" ETF that is required to report its portfolio composition only once each quarter, the same frequency at which mutual funds disclose their portfolio holdings, and that product, called NextShares, began trading in 2016
Eaton Vance
____ invest primarily in stock, although they may, at the portfolio manager's discretion, also hold fixed-income or other types of securities.
Equity funds
Some funds are designed to be candidates for an individual's entire investment portfolio.
Balanced Funds
_____ invest in equity and bond funds in proportions suited to their investment goals.
Balanced funds of funds
Other companies such as _____ have also indicated interest in sponsoring nontransparent ETFs, but to date, these products constitute only a tiny sliver of the broad ETF market
BlackRock
The market leader is ______, which uses the product name iShares for its funds. The firm sponsors ETFs for several dozen equity index funds, including many broad U.S. equity indexes, broad international and single-country funds, and U.S. and global industry-sector funds
BlackRock
As the name suggests, these funds specialize in the fixed-income sector
Bond Funds
______, first introduced in 1993, are offshoots of mutual funds that allow investors to trade index portfolios just as they do shares of stock.
Exchange-traded funds (ETFs)
Typically, _____ shares have front-end loads and a small 12b-1 fee, often around .25%
Class A
_____ shares rely more on 12b-1 fees, commonly 1%, and often charge a modest back-end load.
Class C
_____ are sold through the mail, various offices of the fund, over the phone, or, more so, over the Internet. Investors contact the fund directly to purchase shares
Direct-marketed funds
Until 2008, _____ were required to track specified indexes, and ETFs tracking broad indexes still dominate the industry.
ETFs
At least two problems were exposed in this episode. First, when markets are not working properly, it can be hard to measure the net asset value of the ETF portfolio, especially for ____
ETFs that track less liquid assets.
______ means that capital gains or losses are being realized continually, and therefore that the investor cannot time the realizations to manage his or her overall tax obligation
High turnover
______ have become increasingly important distribution channels for funds in recent years
Independent financial planners
Many funds have an international focus
International bonds
____ are balanced funds in which the asset mix can range from aggressive (primarily marketed to younger investors) to conservative (directed at older investors).
Life-cycle funds
_____ are the costs incurred by the mutual fund in operating the portfolio, including administrative expenses and advisory fees paid to the investment manager.
Operating expenses
_____ have loads that range up to 3% of invested funds.
Low-load funds
_____ manage a family, or "complex,"of mutual funds
Management companies
______ that includes performance data also must include after-tax results
Marketing literature
These funds invest in money market securities such as Treasury bills, commercial paper, repurchase agreements, or certificates of deposit.
Money Market Funds
_____ are the common name for open-end investment companies
Mutual funds
_____ have no front-end sales charges.
No-load funds
For example, if a fund has an initial NAV of $20 at the start of the month, makes income distributions of $.15 and capital gain distributions of $.05, and ends the month with NAV of $20.10, the monthly rate of return is computed as _____
Rate of return = $20.10 − $20.00 + $.15 + $.05 / $20.00 = .015, or 1.5%
If we denote the net asset value at the start and end of the period as NAV0 and NAV1, respectively, then _____
Rate of return = NAV1 − NAV0 + Income and capital gain distributions / NAV0
____ concentrate on a particular part of the world
Regional funds
The ______ allows the managers of socalled 12b-1 funds to use fund assets to pay for distribution costs such as advertising, promotional literature including annual reports and prospectuses, and, most important, commissions paid to brokers who sell the fund to investors.
Securities and Exchange Commission
____ are traditionally classified by their emphasis on capital appreciation versus current income
Stock funds
Some funds have even more narrowly defined mandates. For example, some bond funds will hold primarily ____ bonds, others primarily mortgage-backed securities
Treasury bonds
The average maturity of these assets tends to be ___
a bit more than 1 month.
Brokers or financial advisers receive ____ for selling shares to investors. (Ultimately, the commission is paid by the investor. More on this shortly.)
a commission
Investment in an index fund is a low-cost way for small investors to pursue _____—that is, to invest without engaging in security analysis
a passive investment strategy
About half of fund sales today are distributed through ____
a sales force.
Large investors can exchange their ETF shares for shares in the underlying portfolio; this form of redemption also avoids ____
a tax event.
Because the S&P 500 is _____, the fund buys shares in each S&P 500 company in proportion to the market value of that company's outstanding equity.
a value-weighted index
When you invest through a mutual fund, however, the timing of the sale of securities from the portfolio is out of your control, which reduces your ____
ability to engage in tax management
Starting in 2008, the SEC granted approval for so called _____ with other investment objectives, for example, focusing on attributes such as value, growth, dividend yield, liquidity, recent performance, or volatility.
actively managed ETFs
The _____ are computed accounting for the impact of the taxable distributions of income and capital gains passed through to the investor, assuming the investor is in the maximum federal tax bracket.
aftertax returns
By managing a collection of funds under one umbrella, these companies make it easy for investors to _____ and to switch assets across funds while still benefiting from centralized record keeping.
allocate assets across market sectors
Loads effectively reduce the ____
amount of money invested
Spiders gave rise to many similar products such as "_____" (based on the Dow Jones Industrial Average, ticker DIA), "______" (based on the NASDAQ 100 index, ticker QQQ), and "_____" (World Equity Benchmark Shares, which are shares in portfolios of foreign stock market indexes)
diamonds cubes WEBS
A portfolio manager earns soft-dollar credits with a brokerage firm by ____
directing the fund's trades to that broker
In the wake of this incredible volatility, the stock exchanges canceled many trades that had gone off at what were viewed as _____
distorted prices.
The fund buys shares in securities included in a particular index in proportion to ___
each security's representation in that index
_____ invest in companies of developing nations.
emerging market funds
These balanced funds hold both ____ and ____ in relatively stable proportions.
equities and fixed-income securities
Alternatively, investors may choose to hire a _____ who charges directly for services instead of collecting commissions
fee-only financial manager
Chapter 3 briefly discussed the so-called _____ of May 6, 2010, when the Dow Jones Industrial Average fell by 583 points in seven minutes, leaving it down nearly 1,000 points for the day. Remarkably, the index recovered more than 600 points in the next 10 minutes.
flash crash
However, rather than invest in those assets directly, the ETF achieves this exposure by entering a "_____" with an investment bank in which the bank agrees to pay the ETF the return on the index in exchange for a relatively fixed fee
total return swap
Unlike mutual funds, which can be bought or sold only at the end of the day when NAV is calculated, investors can ____
trade spiders throughout the day, just like any other share of stock.
Therefore, 12b-1 fees (if any) must be added to operating expenses to obtain the ____
true annual expense ratio of the fund
Another advantage is ____ for all funds purchased from the supermarket, even if the funds are offered by different complexes.
unified record keeping
If you do buy a fund through a broker, the choice between paying a load and paying 12b-1 fees will depend primarily on ____
your expected time horizon