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Chapter 18: Mutual Funds: types and features - Coggle Diagram

- - - - “Investments might include Treasury bills, bankers’ acceptances, high quality corporate paper, and short-term bonds. Funds in this category include Canadian and U.S. funds”
      - All assets in a money market fund are invested in cash, cash-equivalent securities, and short-term debt securities.
      - “Money market funds add liquidity to a portfolio”
      - “To comply with National Instrument 81-102, funds designated as money market funds must maintain a minimum weighting of 95% of their total net assets in cash or cash-equivalent securities.”
      - “A feature of these funds is a constant share (or unit) value, often $10. ”
        
        “To keep their net asset value per share (NAVPS) constant, the net income of the fund is calculated daily and credited to unitholders. The earned interest is paid out as cash or reinvested in additional shares on a monthly (or sometimes quarterly) basis.”
      - risk is low;
        The main risk to these funds is interest rate risk. Fund managers try to maintain a stable NAVPS, but rapid increases in interest rates can reduce the value of the shares.
      - “Distributions received from a money market fund are taxable as interest income when they are held outside of a registered plan.
        
        Investors must add the interest to their income and pay tax on that portion at their marginal rate.”
      - The objective of money market funds is to achieve some income and liquidity
    - - “Fixed-income funds are designed to provide a steady stream of income and safety of principal, rather than capital appreciation”
      - “ Funds in this category must invest at least 95% of their non-cash assets in fixed-income securities.”
      - includes the following fund types
        
        “Canadian short-term fixed income
        
        • Canadian long-term fixed income
        
        • Canadian inflation-protected fixed income
        
        • Global fixed income
        
        • High-yield fixed income”
        
        “non-investment-grade credit rating”
      - “Their degree of volatility is related to the degree of interest rate fluctuation.
        However, fund managers may attempt to change the duration of the portfolio and the mix of low- and high-coupon bonds to compensate for changes in interest rates”
      - “Interest rate volatility is the main risk associated with this type of fund. Funds that invest in corporate bonds are also exposed to default or credit risk.”
      - “The primary source of returns from bond funds is interest income. ”
    - - “Balanced funds invest in both stocks and bonds to provide a balanced mix of income and capital growth.
      - “includes the following fund types”
        
        “Canadian equity balanced
        
        • Canadian neutral balanced
        
        • Canadian fixed income balanced
        
        • Global equity balanced
        
        • Global neutral balanced
        
        • Global fixed income balanced
        
        • Tactical balanced”
      - “ Fixed-income securities provide stability and income, and a broadly diversified group of common stock holdings provide diversification, dividend income, and growth potential.”
      - “In most cases, the prospectus specifies the fund’s minimum and maximum weighting for each asset class. For example, a balanced fund may specify a weighting of 60% equity and 40% fixed income.”
        
        “Asset allocation funds have similar objectives to those of balanced funds, but they differ in that they typically do not have to hold a specified minimum percentage of the fund in any class of investment. ”
    - - following types
        
        “Canadian, U.S., and global equity
        
        • Canadian dividend
        
        “Canadian dividend funds provide tax-advantaged income with some possibility of capital appreciation. ”
        
        “The income from these funds is in the form of dividends, which have the tax advantage of receiving the dividend tax credit”
        
        “Dividend funds invest in preferred shares as well as high-quality common shares”
        
        • Canadian and U.S. small- and mid-cap equity
        
        “maller companies are considered to have higher potential for growth than large, well-established ones”
        
        “tend to reinvest profits into expansion, they do not usually pay dividends”
        
        “Distributions in this type of fund are usually in the form of capital gains.”
        
        “companies with capitalization below those of the hundred largest Canadian companies”
        
        • International, European, and emerging markets equity
        
        • Asia Pacific equity”
        
        “Greater China equity
        
        • Health care, precious metal, natural resources, and real estate equity”
      - “Funds in the equity category must invest a minimum of 90% of their non-cash assets in equity securities”
      - “The main investment objective of equity funds is long-term capital growth”
      - “Some equity funds are broadly diversified holdings of blue chip, income-yielding common shares. This type is classified at the conservative end of the equity fund scale.”
      - “These funds are therefore considered riskier than other fund types”
        
        “ investments in markets outside of Canada are subject to foreign exchange rate risk”
      - “other equity funds are more speculative; they aggressively seek capital gains at the sacrifice of safety and income.
        
        These funds invest in certain sectors of the market, such as precious metals, health care, and biotechnology, or in certain geographical locations, such as China, Latin America, and Japan.”
      - “Distributions are in the form of capital gains and dividends and are taxed accordingly.”
    - - “either invest in physical commodities or gain exposure to commodities through the use of derivatives”
      - “The exposure to commodities is primarily long and must not exceed 100% by way of leverage.”
    - - “concentrate their assets into one main area, such as a specific industry or region”
      - fund types
        
        “Retail venture capital
        
        • Alternative strategies
        
        • Miscellaneous, including”
        
        “Income and real property
        
        ◦ Leveraged
        
        ◦ Geographic
        
        ◦ Sector”
      - “Because of their narrower investment focus, these funds often carry substantial concentration risk.”
    - - two characteristics : 1. a target date; 2. a glide path
      - “The target date (i.e., the maturity date) is a date set by the investor to match a certain life goal. The date of retirement is a common target date.”
      - “The glide path refers to changes in the fund’s asset allocation mix over time. The fund pursues a growth strategy in its early years by holding more “risky assets.
        It then gradually moves towards less risky assets as the target date approaches. The fund manager adjusts the fund over time, without any action required from the fund holder”
      - “Upon maturity, they are moved out of the target-date group and included in the appropriate fixed-income or balanced fund category.”
    - - “Introduced as a category in 2019, funds in the Alternative Funds category employ alternative strategies such as short selling or other forms of leverage that the typical mutual fund is not permitted to use”
      - “may use speculative as well as hedging strategies”
      - “the Alternative Other category includes those funds that employ a unique strategy that does not fit into any of the other subcategories”
    - - “sets out to match the performance of a broad market index, such as the S&P/TSX Composite Index (for an equity index fund) or the FTSE Canada Universe Bond Index (for a bond index fund).”
      - e.g. ABC fund replicates the FTSE Canada Universe Bond Index; This fund is categorized as fixed-income fund- Canadian Fixed Income
      - “The index fund manager invests in the securities that make up the model index, in the same proportion that these securities are weighted in the index.”
        
        指数基金的投资理念是在证券市场上选定一部分符合条件的证券，这些证券可以通过客观标准（如：市值大小，现金分红偏好，行业，国别）选定，也可以通过主观标准（如成长性，被市场低估的程度）选定；被选定的证券共同构成一个指数，每一个证券都拥有一个确定的权重（即该证券在整个投资组合中所占的比例），指数基金经理按照这个指数购买证券，建立一个与指数完全相同或基本相同的投资组合，这样就创造了一支指数基金。
      - a low-cost way to pursue a passive investment strategy
        
        “the management fees associated with index funds are usually lower than those of other equity or bond funds”
      - “The investment objective of an equity index fund is to provide long-term growth of capital”
        Main risk: interest rate risk
      - “The distributions of an index fund depend on the type of index being matched”
        
        “For example, the income of a fund matching a bond index will be primarily interest, with some capital gains. An index fund matching an equity index, on the other hand, may have dividend and capital gains distributions.”
    - - Risk : Money market funds < fixed income< balanced < equity < specialty
      - Return : Money market funds < fixed income< balanced < equity < specialty
      - “There can be a large range of risk-return profiles within the same fund category”
        
        “For example, consider two typical equity funds: a Canadian dividend fund and an emerging markets equity fund. The risk profile of the dividend fund may be significantly lower than that of the emerging markets fund.”
- - - - “ lower management expense ratios ”
    - - “may involve individual company selection, over-weighting in favoured segments of industry sectors, or country selection for regional funds”
  - - - “does not replicate the market exactly, but sticks fairly closely to the market weightings by industry sector, by country or region, or by average market capitalization”
      - “some active managers are closet indexers. Their style can be determined by how closely their returns, volatility, and average market capitalization correspond to the index as a whole”
    - - “the funds simply buy the same stocks as the index. Because they do not need analysts for stock selection, management fees are lower than for actively managed funds.
        A final advantage is that indexing makes for low portfolio turnover, which is an advantage for taxable accounts.”
    - - “after the payment of fees and expenses, index mutual funds return somewhat less than the market benchmark in the long term”
      - “distributions in the form of derivative-based income are taxable as income rather than as capital gains.”
- - - - “Through the distribution of interest income, dividends, and capital gains realized by the fund
      - • Through any capital gains realized when the investor sells the fund”
    - - “When mutual funds are held outside a registered plan such as a registered retirement savings plan or a registered retirement income fund, the fund holder is sent “either a T3 form (for unitholders) or a T5 form (for shareholders)”
        
        “Both tax forms report the types of income distributed that year: foreign income and Canadian interest, capital gains, and dividends, including dividends that have been reinvested”
      - E.g.
        
        “Lewis purchases an equity mutual fund for $11 per share. In each of the next five years, he receives $1 in annual distributions per share, composed of $0.50 in dividends and $0.50 in distributed capital gains. Each year, Lewis receives a T5 from the fund indicating that he must report to the Canada Revenue Agency an additional $1 per share in income. The T5 may indicate offsetting dividend tax credits (from dividends earned from taxable Canadian corporations).”
      - why they have to declare capital gains when they have not sold any of their funds
        
        “the fund manager buys and sells stocks throughout the year for the fund. If the manager sells a stock for more than it was bought, the capital gain that results is passed on to the fund holder. Capital losses, however, cannot be passed on. Instead, they are held in the fund and may be used to offset capital gains in subsequent years.”
    - - “Only 50% of net capital gains is added to the investor’s income and taxed at their marginal rate.”
      - e.g.
        
        “Suppose a mutual fund shareholder buys shares in a fund at a NAVPS of $11 and later sells them at a NAVPS of $16. The sale generates a capital gain of “$5 per share. The investor must therefore report an additional $2.50 per share in income for the year (calculated as 50% × $5 capital gain). This capital gain is not shown on the fund’s T5 form because the sale was not a fund transaction.”
    - - “If the distribution of capital gains is carried out only at year end, it can pose a problem for investors who purchase a fund close to the end of the year.”
      - example book18.11
    - - “The adjusted cost base refers to the total cost of purchase plus commission expenses. ”
      - “A problem may arise when an investor chooses to reinvest fund income automatically in additional, non-registered fund units.”
        “ When the fund is sold, the capital gain must be calculated on the difference between the original purchase price and the sale price”
      - e.g. $8000 capital gain, including 2 parts: a capital gain and the reinvestment of income (already paid tax)
        
        “To arrive at the adjusted cost base, the portion of the increase from reinvestment must be added to the original investment of $10,000.
        The capital gain is calculated on this adjusted cost base. Suppose, for example, that Maryam had received a total of $3,500 in reinvested dividends over the course of the holding period.
        The adjusted cost base would then be “ing period. The adjusted cost base would then be $13,500 (the original $10,000 plus the $3,500 in dividends that have already been taxed). The capital gain is then $4,500, rather than $8,000.”
      - Original Cost + Reinvested Dividends = Adjusted Cost Base
        
        ACB= original cost + interest+ capital gains + dividends
      - Proceeds on the Sale (total growth) - distribution = Capital Gain
  - - - “A mutual fund’s shareholders have a continual right to withdraw their investment in the fund simply by making the request to the fund itself. In return, they receive the dollar amount of their net asset value”
    - - “the investor instructs the fund to pay out part of the capital invested, plus distributions, over time. Withdrawals may be arranged monthly or quarterly, or at other predetermined intervals”
    - - “the investor receives an annual income from the fund by redeeming a specified percentage of fund holdings each year.”
      - “The percentage chosen for redemption usually falls between 4% and 10% per year, depending on the amount of income the investor requires.”
      - example book 18.14
    - - “ the fund holder chooses a specified dollar amount to be withdrawn on a monthly or quarterly basis”
      - “Funds offering this type of plan often require that withdrawals be in round amounts (e.g., $50 or $100).”
      - “If the investor’s fixed withdrawals are greater than the growth of the fund, the withdrawals will encroach upon the principal”
    - - “a specified amount is withdrawn over a pre-determined period with the intent that all capital will be exhausted when the plan ends.”
    - - “A life expectancy-adjusted withdrawal plan is a variation of a fixed-period withdrawal plan”
      - “A life expectancy-adjusted withdrawal plan is a variation of a fixed-period withdrawal plan”
      - “the amounts withdrawn vary in relation to the amount of capital remaining in the plan and the plan holder’s revised life expectancy”
- - - - “under automatic reinvestment plans, the distributions are used to purchase additional shares. Therefore, your clients are just as well off as they were before the distribution decreased the NAVPS”
  - - - “Performance is measured by calculating the return realized by a portfolio manager over a specified time interval”
    - - “measures the actual rate of return earned by the portfolio manager”
      - calculated by averaging the return for each sub-period in which a cash flow occurs to create a return for the reporting period
      - daily valuation method
        
        “the incremental change in value from day to day is expressed as an index from which the return can be calculated”
        
        “The main drawback is the need to value the portfolio every day. It can be difficult to price the daily market value of such assets as real estate, mortgage-backed securities, and illiquid issues”
      - modified dietz method
        
        “It assumes a constant rate of return through the period”
        
        “weights each cash flow by the length of time it is held in the portfolio.”
    - - “Canadian regulators have instituted standard performance data that specify the minimum return measures that mutual fund companies must include, and how they are to be calculated”
      - mutual fund: 1, 3, 5 and 10 years “ as well as the total period since inception of the fund”
      - Money market funds: “the standard performance data include the current yield and the effective yield”
      - “In the role of a mutual fund advisor, you should look at periods of three to five years or more, as well as individual years. Nevertheless, it is reasonable to ask questions if the fund is significantly different from the average in its category.”
      - “There is no single appropriate time horizon for rating risks and returns, and the practices of industry analysts vary considerably.
        
        For long-term funds, a three-year period is generally regarded as a bare minimum. More weight can be attached to longer periods of five to 10 years, or at least two market cycles.”
    - - return data does not indicate whether the fund was performing well or poorly
      - to determine the quality of fund performance, must compare return against some standard
      - 2 general standards of comparison: “the return on a fund’s benchmark index and the average return on the fund’s peer group of funds”
    - - S&P/ TSX Composite Index for broad-based Canadian equity funds
      - FTSE Canada Universe Bond Index for bond funds
      - “If a fund reports a return that is higher than the return on the index, we can say that the fund has outperformed its benchmark. If it reports a “return that was lower than the return on the index, it has underperformed its benchmark”
      - “Morningstar Canada has developed a series of mutual fund benchmarks that summarize average rates of return for Canadian bond, Canadian equity, U.S. equity, global bond, and international equity funds.”
    - - “To measure the performance of a fund, its return is compared to the average return of the peer group.”
      - e.g.
        
        “f a fund posted a one-year return of 12% while the average return of its peer group over the same period was 9%, we can say that the fund outperformed its peer group over the evaluation period.”
  - - - “e.g., a fixed-income fund versus a growth equity fund) or comparing funds that have differing investment objectives or degrees of risk acceptance.”
    - - “for example, that funds classified as Canadian equity funds may at times have significant portions of their assets invested in equities other than Canadian stocks.”
      - “This discrepancy between a fund’s formal classification and its actual asset composition can impair attempts to create a portfolio. ”
        
        “For example, an investor who wished to allocate 10% of a portfolio to gold stocks might be surprised to find that, at some points, gold mutual funds are holding 50% of their assets in cash.”
      - “Any assessment of fund performance should consider the volatility of a fund’s returns”
        
        the following measures are used to quantify mutual fund volatility
        
        “The standard deviation of the fund’s returns, which, if high, might indicate future volatility
        
        • Beta, which relates the change in the price of a security to the change of the market as a whole
        
        • The number of calendar years it has lost money
        
        • The fund’s best and worst 12-month periods
        
        • The fund’s worst annual, quarterly, or monthly losses”
      - “Other methods, which look at different time periods, can be used to calculate best-case and worst-case scenarios. ”
      - “When dealing with mutual funds in the role of an advisor, you should be aware of a fund’s performance relative to the stock market cycle.”
        
        “The beta, available on most fund performance software, measures the extent to which a fund is more or less volatile than the underlying market in which it invests.”
        
        “Software products that permit advisors to review performance and sort funds according to various criteria include Globe HySales and Morningstar PALTrak.”
    - - “Past performance is not indicative of future performance”
        
        (“mutual fund advisors often scrutinize the past in an attempt to predict future performances”)
      - “Historical performance may be especially irrelevant when there has been a change in portfolio manager. ”
        (some abservers argue that the performance is a reflection of the skill of the portfolio manager)
      - “Although average returns for a peer group of funds are useful measures, they can reflect survivorship bias.
        This term describes a tendency for poorly performing funds to be discontinued or merged.
        Therefore, average returns of surviving funds may be artificially high because they do not fully reflect past performance of the entire spectrum of funds.”
      - “Mutual fund performance evaluations should consider both the type of fund and its investment objectives. ”
      - “beware of selective reporting of performance periods, especially when there are no comparable numbers for the performance of a market benchmark or a peer group of competing funds.”