Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 4-1 Chapter 4

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 4-2 Chapter Summary  Objective: To give an overview of institutional investing and institutions’ role in portfolio selection and management Institutional investors: objectives & constraints Mutual funds and investment policies Performance appraisal Taxation & tax sheltering

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 4-3 Institutional Investors Type of InvestorRisk Tolerance Individual and personal trusts Life cycle Mutual fundsVariable Pension fundsDepends on proximity of payouts Endowment fundsGenerally conservative Insurance companiesConservative BanksVariable

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 4-4 Constraints in Portfolio Management  Liquidity  Investment horizon  Regulatory constraints (institutional investors) The prudent person law Limits on foreign holdings Limits on individual firm holdings

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 4-5  Administration & record keeping  Diversification & divisibility  Professional management  Reduced transaction costs  Increased investment opportunities Services of Investment Companies

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 4-6 Types of Investment Companies  Mutual funds Closed-end Open-end Load funds  Commingled funds  Real estate funds Real estate limited partnerships Mortgage funds

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 4-7 Types of Mutual Funds (Investment Policies)  Money market funds  Equity funds (income, growth)  Fixed-income funds  Balanced and income funds  Asset allocation funds  Index funds  Specialized sector funds

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 4-8  Used as a basis for valuation of investment company shares Selling new shares Redeeming existing shares  Calculation: Net Asset Value

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 4-9 Shares Outstanding  Closed-end: no change unless new stock is offered  Open-end: changes when new shares are sold or old shares are redeemed Pricing  Open-end: Net Asset Value(NAV)  Closed-end: Premium or discount to NAV Open-End and Closed- End Funds: Key Differences

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 4-10 Summary Reminder  Objective: To give an overview of institutional investing and institutions’ role in portfolio selection and management Institutional investors: objectives & constraints Investment policies Performance appraisal Taxation & tax sheltering

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 4-11  Fee Structure Front-end load Back-end load  Operating expenses  Other charges (called ‘12b-1’ in US) Distribution costs paid by the fund Alternative to a load  Fees and performance Costs of Investing in Mutual Funds

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 4-12 Summary Reminder  Objective: To give an overview of institutional investing and institutions’ role in portfolio selection and management Institutional investors: objectives & constraints Investment policies Performance appraisal Taxation & tax sheltering

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 4-13 A First Look at Fund Performance  Benchmark: Wilshire 5000  Results Most funds underperform Not fair comparison because of costs  Adjusted Benchmark: Wilshire 5000 with passive management costs considered The majority of funds still underperform

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 4-14 Consistency of Fund Performance  Do some mutual funds consistently outperform?  Evidence suggests that some funds show consistent stronger performance Depends on measurement interval Depends on time period  Evidence shows consistent poor performance

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 4-15  Wiesenberger’s Investment Companies  Morningstar (PalTrak)  Investment Company Institute  Popular press  Investment services Sources of Information on Mutual Funds

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 4-16 Exchange-Traded Funds  Passive vs Active investing  Low fees  Exchange index funds  Specialized ETFs (bonds, sub-indices and sectors)  International index funds

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 4-17 Summary Reminder  Objective: To give an overview of institutional investing and institutions’ role in portfolio selection and management Institutional investors: objectives & constraints Investment policies Performance appraisal Taxation & tax sheltering

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 4-18 The Canadian Tax System  Interest income taxed as ordinary income  Favorable dividend income treatment  Only 50% of capital gains taxed Superficial loss rule Imputed interest taxed as income

Bodie Kane Marcus Perrakis RyanINVESTMENTS, Fourth Canadian Edition Copyright © McGraw-Hill Ryerson Limited, 2003 Slide 4-19 Tax Deferral and Shelters  Tax-deferral option for capital gains  Tax-deferred retirement plans  Deferred annuities Fixed annuities Variable annuities  Tax shelters