Chapter 12: Riskier Mutual Funds Products

Explain whether hedging the value of the Canadian dollar is an advantage or a disadvantage to an investor who has bought units of a global equity fund.

Hedging the value of the Canadian dollar eliminates, or greatly reduces, the volatility in a global mutual fund's unit value that might be caused by changes in the value of the Canadian dollar relative to other currencies. Investors who want additional diversification across currencies will not want the fund to be hedged. Other investors who do not wish to bear the risk of greater volatility will prefer the fund to be hedged. In this sense, hedging is neither an advantage nor a disadvantage. It depends upon the objectives of the investor.

Name and describe three different types of Canadian equity funds. How do they differ in terms of risk?

- "standard" funds (least risky): hold equity securities in keeping w/ their investment objective and the manager's stock selection philosophy. The portfolio manager may buy and hold stocks for long-term growth or may seek out stocks that are temporarily undervalued for one reason or another. The portfolios of standard equity funds generally reflect the market as a whole - index funds: index fund managers do not pick and choose stocks. They consist of portfolios whose only goal is to mimic a market index. In Canada, that index is usually the S&P/TSX Composite Index. In the U.S., it is often the S&P (Standard and Poor's) 500 Index - growth funds (most risky): seek out the shares of smaller firms and other firms that have the potential for growth (these firms tend not to pay dividends)

Target-date funds

- MF that adjusts its asset mix to move from more risky to more conservative as the maturity date of the fund approaches (target-based funds or life-cycle funds) - structured on the assumption that risk tolerance declines as investors grow older

International Funds

- MFs that invest anywhere in the world except in Canada - objective of an international bond fund, on the other hand, will be to earn interest income with some capital gains over a somewhat shorter horizon

International funds vs. global funds

- both allow investors to have investments outside of Canada - global fund however will hold Canadian securities along with non-Canadian because Canada is part of the global economy -international fund will only hold non-Canadian securities so an international fund does not hold securities from its country of origin

Specialty Mutual Funds

- category of funds that specialize in a particular industry (sector fund) or a distinctive type of security - these funds offer a lower level of diversification than other MFs and may therefore be riskier - goal is to earn capital gains

Describe and compare and contrast the composition of the different types of equity mutual funds.

- equity MFs invest in the common and preferred shares of publicly-traded companies - equity MFs as a group have the goal of earning capital gains, sometimes with a current dividend income component - Canadian equity mutual funds can be categorized into three fairly distinct types: "standard" equity funds, equity growth funds and equity index funds

List and describe the investment objectives, comparative returns and the volatility of the different types of equity mutual funds.

- equity growth funds pursue capital gains (some dividend income may be earned, but probably not much) - an equity index fund has the goal of generating capital gains & intends to do this by constructing an investment portfolio designed to mimic a particular stock market index - balanced MFs have the objective of earning current income and capital gains while at the same time preserving capital - new type of balanced fund has emerged in recent years: target-date funds. These funds have a maturity date and the risk of the fund decreases as the maturity date approaches - the primary objective of a global equity fund is to earn capital gains over the long term - investment objectives of specialty MFs is to concentrate investments in securities or industries to a far greater degree than other funds to achieve better returns than diversified investments - avg return performance of equity funds parallels that of the TSX Index, and equity and growth funds are much more volatile than returns on money market funds - since balanced MF are composed of both bonds and equities, their returns generally fall between bond fund returns and equity fund returns

Glide path

- formula that defines the change in the asset allocation mix of a target date fund over time, based on the number of years remaining to the target date - the closer the target date, the more conservative the asset mix

Describe the two main types of fund wrap accounts.

- fund wraps can be funds of funds or portfolio allocation services - with a fund of funds, the investor owns units of a pool of mutual funds, while in a portfolio allocation service, the investor owns units of several mutual funds in the proportions established through the allocation service - thus, in a portfolio allocation service, the investor actually owns units of the constituent mutual funds, rather than units of a fund holding other funds

Balanced Mutual Funds

- hold a diversified portfolio of different types of securities: bonds, stocks, and money market securities - often the fund manager will vary the proportions depending on market conditions - objective of earning current income and capital gains while preserving capital

Difference between a fund of funds and a portfolio allocation service

- if an investor owns a fund of funds, she owns units in just one fund. That fund owns units in many funds, chosen by the fund manager. Technically, the investor does not own the underlying funds directly - if the investor uses a portfolio allocation service, the portfolio manager of this service still chooses which mutual funds to purchase. But the client purchases units in each of the chosen funds separately, owning each fund directly

There are two reasons for holding cash or cash-equivalents:

- meet redemption demands of unitholders and be able to buy attractively priced securities should they become available - managers may want to take a defensive position - i.e. they are concerned about the performance of equity markets over the short run and do not want to put all the fund's assets at risk in that market and when they feel that market conditions have improved, fund managers will likely decrease their cash holdings by buying equities

Equity index fund

- primary goal of earning capital gains by constructing a portfolio designed to mimic a particular stock market index — often the S&P/TSX Composite Index in Canada - appeal to clients who believe strongly in market efficiency and think that portfolio managers generally lack the skills to beat the markets consistently - alternative to index funds are exchange-traded funds (ETFs)

Fund Wraps

- program that provides a series of portfolios with multiple mutual funds to reflect pre-selected asset allocation models - each model is designed to meet the needs of a group of investors sharing a similar client profile - it can be a fund of funds or a portfolio allocation service - generally outsources the management and security selection within each asset category to different managers

Market Risk

- refers to the risk of fluctuations in the market as a whole — if the stock market is in a slump, this will influence a fund that invests in stocks - even a highly diversified mutual fund has market risk

Foreign Exchange Risk

- risk that an unexpected change in exchange rates will alter the value of foreign assets or cash payments expected from a foreign source - applies to global MFs

Equity Growth Funds

- seeks out smaller firms that are expected to pay little or no dividends and to produce significant capital gains as their share prices increase - as a result, equity growth MF tend to have a lot of volatility and are suitable for investors with higher risk tolerance

Equity Mutual Funds

- seeks to earn some combination of current dividend income and capital gains - it generally invests in common shares of larger firms with strong dividend records and limited capital gains potential

Describe the features and key types of specialty mutual funds.

- specialty MFs tend to concentrate investments in specific securities/industries - specialty MFs are generally not well diversified and are exposed to the risk inherent to the industry or sector - fund wrap program provides a series of portfolios with multiple mutual funds to reflect pre-selected asset allocation models - in contrast to a balanced MF, a fund wrap generally outsources the mgmt and security selection within each asset category to different managers - from a trading point of view, there is no substantial difference between fund wraps and traditional MFs - fund wraps can be funds of funds or portfolio allocation services

Global Equity Funds

- type of global mutual fund that earns dividends and capital gains - the primary objective is to earn capital gains over the long term

Natural Resource Funds

- type of specialized fund that invests in the securities of companies engaged in natural resource industries - examples of such industries include mining, oil and gas, and forest products

Balanced Mutual Funds and market conditions

- when interest rates have peaked, managers want to be in fixed-income securities - when the stock market is set for an increase, they want to be in stocks - when both bond and stock markets are volatile, they will hold large amounts of money market securities. I.e. balanced mutual fund managers attempt to time the market to get the best returns depending on market conditions

Standard Equity Funds

MF composed of Canadian common stocks that seeks to earn some combination of dividend income and capital gains

Currency Forward Contract

contract between two parties that locks in the exchange rate for the purchase or sale of a currency on a future date

Small Cap Funds

small capitalization funds, which means that the market value of the equity of the firm is relatively low, probably because the firm is small

Precious Metals Funds

specialized MFs that focus on securities related to precious metals, such as gold and silver

Fund Of Funds

the investor owns units of a pool of MFs

Global Mutual Funds

they offer international diversification by investing in the economies of specific countries or regions anywhere in the world, including Canada

Portfolio Allocation Service

type of fund wrap where the client owns units of several MFs in the proportions established through the allocation service