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Investment Companies:: Mutual Funds Closed-End Funds Uits

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Investment Companies:

Generally, an "investment company" is a company (corporation, business trust, partnership,


or Limited Liability Company) that issues securities and is primarily engaged in the business
of investing in securities.

An investment company invests the money it receives from investors on a collective basis,
and each investor shares in the profits and losses in proportion to the investor's interest in the
investment company. The performance of the investment company will be based on (but it
won't be identical to) the performance of the securities and other assets that the investment
company owns.

Benefits:

1. Professionally managed funds

2. Portfolio management

3. Yield

4. Diversified investment

5. Liquidity

Types of Investment Company:

The investment companies are three basic types:

 Mutual funds (legally known as open-end companies);


 Closed-end funds (legally known as closed-end companies);
 UITs (legally known as unit investment trusts)/Unit Fund.

Mutual Funds

A mutual fund is a professionally-managed trust that pools the savings of many investors and
invests them in securities like stocks, bonds, short-term money market instruments and
commodities such as precious metals. Investors in a mutual fund have a common financial
goal and their money is invested in different asset classes in accordance with the fund’s
investment objective. Investments in mutual funds entail comparatively small amounts,
giving retail investors the advantage of having finance professionals control their money even
if it is a few thousand rupees.

Mutual funds are pooled investment vehicles actively managed either by professional fund
managers or passively tracked by an index or industry. The funds are generally well
diversified to offset potential losses. They offer an attractive way for savings to be managed
in a passive manner without paying high fees or requiring constant attention from individual
investors. Mutual funds present an option for investors who lack the time or knowledge to
make traditional and complex investment decisions. By putting your money in a mutual fund,
you permit the portfolio manager to make those essential decisions for you.
How is mutual Fund set up?

A mutual fund is set up in the form of a trust that has a Sponsor, Trustees, Asset Management
Company (AMC). The trust is established by a sponsor(s) who is like a promoter of a
company and the said Trust is registered with Securities and Exchange Commission (SEC) of
Bangladesh as a Mutual Fund. The Trustees of the mutual fund hold its property for the
benefit of unit holders. An Asset Management Company (AMC) approved by SEC manages
the fund by making investments in various types of securities.

The trustees are vested with the power of superintendence and direction over the AMC. They
monitor the performance and compliance of SECB regulations by the mutual fund. The
trustees are vested with the general power of superintendence and direction over AMC. They
manage the performance and compliance of SECB Regulations by the mutual fund.

How does mutual operate?

A mutual fund company collects money from several investors, and invests it in various
options like stocks, bonds, etc. This fund is managed by professionals who understand the
market well, and try to accomplish growth by making strategic investments. Investors get
units of the mutual fund according to the amount they have invested. The Asset Management
Company is responsible for managing the investments for the various schemes operated by
the mutual fund. It also undertakes activities such like advisory services, financial consulting,
customer services, accounting, marketing and sales functions for the schemes of the mutual
fund.

What are the different types of mutual fund schemes?

A. Based on the maturity period

Open-ended Fund:

An open-ended fund is a fund that is available for subscription and can be redeemed on a
continuous basis. It is available for subscription throughout the year and investors can buy
and sell units at NAV related prices. These funds do not have a fixed maturity date. The key
feature of an open-ended fund is liquidity.

Close-ended Fund:

A close-ended fund is a fund that has a defined maturity period, e.g. 3-6 years. These funds
are open for subscription for a specified period at the time of initial launch. These funds are
listed on a recognized stock exchange.

Interval Funds :

Interval funds combine the features of open-ended and close-ended funds. These funds may
trade on stock exchanges and are open for sale or redemption at predetermined intervals on
the prevailing NAV.
Based on investment objectives

Equity/Growth Funds:

Equity/Growth funds invest a major part of its corpus in stocks and the investment objective
of these funds is long-term capital growth. When you buy shares of an equity mutual fund,
you effectively become a part owner of each of the securities in your fund’s portfolio. Equity
funds invest minimum 65% of its corpus in equity and equity related securities. These funds
may invest in a wide range of industries or focus on one or more industry sectors. These types
of funds are suitable for investors with a long-term outlook and higher risk appetite.

Debt/Income Funds:

Debt/ Income funds generally invest in securities such as bonds, corporate debentures,
government securities (gilts) and money market instruments. These funds invest minimum
65% of its corpus in fixed income securities. By investing in debt instruments, these funds
provide low risk and stable income to investors with preservation of capital. These funds tend
to be less volatile than equity funds and produce regular income. These funds are suitable for
investors whose main objective is safety of capital with moderate growth.

Balanced Funds:

Balanced funds invest in both equities and fixed income instruments in line with the pre-
determined investment objective of the scheme. These funds provide both stability of returns
and capital appreciation to investors. These funds with equal allocation to equities and fixed
income securities are ideal for investors looking for a combination of income and moderate
growth. They generally have an investment pattern of investing around 60% in Equity and
40% in Debt instruments.

Money Market/ Liquid Funds:

Money market/ Liquid funds invest in safer short-term instruments such as Treasury Bills,
Certificates of Deposit and Commercial Paper for a period of less than 91 days. The aim of
Money Market /Liquid Funds is to provide easy liquidity, preservation of capital and
moderate income. These funds are ideal for corporate and individual investors looking for
moderate returns on their surplus funds.

Gilt Funds
Gilt funds invest exclusively in government securities. Although these funds carry no credit
risk, they are associated with interest rate risk. These funds are safer as they invest in
government securities.

Other Schemes

Tax-Saving (Equity linked Savings Schemes) Funds

Tax-saving schemes offer tax rebates to investors under specific provisions of the Income
Tax Act, 1961. These are growth-oriented schemes and invest primarily in equities. Like an
equity scheme, they largely suit investors having a higher risk appetite and aim to generate
capital appreciation over medium to long term.

Index Funds

Index schemes replicate the performance of a particular index such as the BSE Sensex or the
S&P CNX Nifty. The portfolio of these schemes consist of only those stocks that represent
the index and the weightage assigned to each stock is aligned to the stock’s weightage in the
index. Hence, the returns from these funds are more or less similar to those generated by the
Index.

Sector-specific Funds:

Sector-specific funds invest in the securities of only those sectors or industries as specified in
the Scheme Information Document. The returns in these funds are dependent on the
performance of the respective sector/industries for example FMCG, Pharma, IT, etc. The
funds enable investors to diversify holdings among many companies within an industry.
Sector funds are riskier as their performance is dependent on particular sectors although this
also results in higher returns generated by these funds.
Benefits of investing in mutual funds:

Professional Management:

When you invest in a mutual fund, your money is managed by finance professionals.
Investors who do not have the time or skill to manage their own portfolio can invest in
mutual funds. By investing in mutual funds, you can gain the services of professional fund
managers, which would otherwise be costly for an individual investor.

Diversification
Mutual funds provide the benefit of diversification across different sectors and companies.
Mutual funds widen investments across various industries and asset classes. Thus, by
investing in a mutual fund, you can gain from the benefits of diversification and asset
allocation, without investing a large amount of money that would be required to build an
individual portfolio.

Liquidity
Mutual funds are usually very liquid investments. Unless they have a pre-specified lock-in
period, your money is available to you anytime you want subject to exit load, if any.
Normally funds take a couple of days for returning your money to you. Since they are well
integrated with the banking system, most funds can transfer the money directly to your bank
account.

Flexibility
Investors can benefit from the convenience and flexibility offered by mutual funds to invest
in a wide range of schemes. The option of systematic (at regular intervals) investment and
withdrawal is also offered to investors in most open-ended schemes. Depending on one’s
inclinations and convenience one can invest or withdraw funds.

Low transaction cost


Due to economies of scale, mutual funds pay lower transaction costs. The benefits are passed
on to mutual fund investors, which may not be enjoyed by an individual who enters the
market directly.

Transparency
Funds provide investors with updated information pertaining to the markets and schemes
through factsheets, offer documents, annual reports etc.

Well regulated

Mutual funds in India are regulated and monitored by the Securities and Exchange Board of
India (SEBI), which endeavors to protect the interests of investors. All funds are registered
with SEBI and complete transparency is enforced. Mutual funds are required to provide
investors with standard information about their investments, in addition to other disclosures
like specific investments made by the scheme and the quantity of investment in each asset
class.
Risk Involved

Mutual funds invest in different securities like stocks or fixed income securities, depending
upon the fund’s objectives. As a result, different schemes have different risks depending on
the underlying portfolio. The value of an investment may decline over a period of time
because of economic alterations or other events that affect the overall market. Also, the
government may come up with new regulations, which may affect a particular industry or
class of industries. All these factors influence the performance of Mutual Funds.

Risk and Reward: The diversification that mutual funds provide can help ease risk by
offsetting losses from some securities with gains in other securities. On the other hand, this
could limit the upside potential that is provided by holding a single security.

Lack of Control: Investors cannot determine the exact composition of a fund’s portfolio at
any given time, nor can they directly influence which securities the fund manager buys.

Closed-end funds (legally known as closed-end companies);

A "closed-end fund," legally known as a "closed-end company," is one of three basic types of
investment company. The two other basic types of investment companies are mutual funds
and unit investments trusts (UITs).

Here are some of the traditional and distinguishing characteristics of closed-end funds:

 Closed-end funds generally do not continuously offer their shares for sale. Rather,
they sell a fixed number of shares at one time (in an initial public offering), after
which the shares typically trade on a secondary market, such as the New York Stock
Exchange or the Nasdaq Stock Market.
 
 The price of closed-end fund shares that trade on a secondary market after their initial
public offering is determined by the market and may be greater or less than the
shares’ net asset value (NAV).
 
 Closed-end fund shares generally are not redeemable. That is, a closed-end fund is not
required to buy its shares back from investors upon request. Some closed-end funds,
commonly referred to as interval funds, offer to repurchase their shares at specified
intervals.
 
 The investment portfolios of closed-end funds generally are managed by separate
entities known as "investment advisers" that are registered with the SEC.
 
 Closed-end funds are permitted to invest in a greater amount of "illiquid" securities
than are mutual funds. (An "illiquid" security generally is considered to be a security
that cannot be sold within seven days at the approximate price used by the fund in
determining NAV.) Because of this feature, funds that seek to invest in markets where
the securities tend to be more illiquid are typically organized as closed-end funds.
Closed-end funds come in many varieties. They can have different investment objectives,
strategies, and investment portfolios. They also can be subject to different risks, volatility,
and fees and expenses.

Keep in mind that just because a fund had excellent performance last year does not
necessarily mean that it will duplicate that performance. For example, market conditions can
change and this year’s winning fund could be next year’s loser. To understand the factors you
should consider before investing in a mutual fund, read Mutual Fund Investing: Look at More
Than a Mutual Fund's Past Performance. In addition, you should carefully read all of a fund’s
available information, including its prospectus and most recent shareholder report before
purchasing mutual fund shares.

Closed-end funds are subject to SEC registration and regulation, which subjects them to
numerous requirements imposed for the protection of investors. Closed-end funds are
regulated primarily under the Investment Company Act of 1940 and the rules adopted under
that Act. Closed-end funds are also subject to the Securities Act of 1933 and the Securities
Exchange Act of 1934. You can find the definition of "closed-end company" in Section 5 of
the Investment Company Act.

Unit Investment Trusts (UITs)/Unit Fund

A"unit investment trust," commonly referred to as a "UIT," is one of three basic types of
investment company. The other two types are mutual funds and closed-end funds.

Here are some of the traditional and distinguishing characteristics of UITs:

 A UIT typically issues redeemable securities (or "units"), like a mutual fund, which
means that the UIT will buy back an investor’s "units," at the investor’s request, at
their approximate net asset value (or NAV) . Some exchange-traded funds (ETFs) are
structured as UITs. Under SEC exemptive orders, shares of ETFs are only redeemable
in very large blocks (blocks of 50,000 shares, for example) and are traded on a
secondary market.
 

 A UIT typically will make a one-time "public offering" of only a specific, fixed
number of units (like closed-end funds). Many UIT sponsors, however, will maintain
a secondary market, which allows owners of UIT units to sell them back to the
sponsors and allows other investors to buy UIT units from the sponsors.
 
 A UIT will have a termination date (a date when the UIT will terminate and dissolve)
that is established when the UIT is created (although some may terminate more than
fifty years after they are created). In the case of a UIT investing in bonds, for
example, the termination date may be determined by the maturity date of the bond
investments. When a UIT terminates, any remaining investment portfolio securities
are sold and the proceeds are paid to the investors.
 
 A UIT does not actively trade its investment portfolio. That is, a UIT buys a relatively
fixed portfolio of securities (for example, five, ten, or twenty specific stocks or
bonds), and holds them with little or no change for the life of the UIT. Because the
investment portfolio of a UIT generally is fixed, investors know more or less what
they are investing in for the duration of their investment. Investors will find the
portfolio securities held by the UIT listed in its prospectus.
 
 A UIT does not have a board of directors, corporate officers, or an investment adviser
to render advice during the life of the trust.

Net Asset Value (NAV)


Net Asset Value (NAV) is the total asset value (net of expenses) per unit of the fund and is
calculated by the AMC at the end of every business day. In order to calculate the NAV of a
mutual fund, you need to take the current market value of the fund's assets minus the
liabilities, if any and divide it by the number of shares outstanding. NAV is calculated as
follows:

For example, if the market value of securities of a Mutual Fund scheme is 500 lakh and the
Mutual Fund has issued 10 lakh units of 10 each to investors, then the NAV per unit of the
fund is 50.

Problems:

Tafida Mutual Fund has Tk.10,000,000.00 capital fund divided in to 1,000,000 shares.
The portfolio of the fund by using total fund is as follows:

SL Name of the company No. of shares Market value per


shares on 31.12.19
01 GP 10,000 350
02 BEXIMCO PHARMA 20,000 150
03 Summa Cement 40,000 100
04 Prime Bank Ltd 10,000 35
05 Lankabangla Finance 10,000 30

The Liability of the fund comes to Tk.500,000 as on 31.12.2015.

Required:

i) Calculate Net Asset Value (NAV)

ii) Whether the performance of money manager is good?


iii) Whether the performance of money manager is good, if the risk free rate of
return is 8%?

Solution: (i)

SL Name of the company No. of Market value per Total Market Value
shares shares on
31.12.19
1 GP 10,000 350 3,500,000.00
2 BEXIMCO PHARMA 20,000 150
3,000,000.00
3 Summa Cement 40,000 100 4,000,000.00
4 Prime Bank 10,000 35 350,000.00
5 Lankabangla Finance 10,000 30
300,000.00
       Total 0.00

11,150,000.00 - 500,000
NAV= ------------------------- = Tk.10.65 per share
1,000,000

(ii) It is observed that the money manager has created positive value i,e NAV is
increased by 6.5% ( 0.65/10 X 100). So the money manager’s performance is good.

(iii) Then money manager’s performance is not satisfactory because the risk free rate of
return is 8% whereas the manger has registered 6.5% return with risky environment .

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