LEARNING MODULE #4

INVESTMENT AND PORTFOLIO MANAGEMENT

MUTUAL FUNDS
When a small investor cannot decide as to what kind of equity and debt securities to
invest in, he would prefer to invest in an optimum combination thereof. However, with his
limited funds and lack of expertise in, or time for investment management, he would prefer to
combine his resources with those of other investors and delegate the task of investing and
managing the investment to one of them who may be qualified to do so. This practice gave rise
to the existence of investment companies some of which are classified as mutual funds.

Investment Company Defined

An investment company is defined in the Investment Company Act or ICA as “any issuer
which is or holds itself out as being engaged primarily or proposes to engage primarily, in the
business of investing, reinvesting or trading in securities”. It may therefore be defined also as a
stock corporation that pools money from numerous investors by issuing its shares and investing
the pooled funds in accordance with its objectives and policies.

Classifications of Investment Companies

1. Open-end company or mutual fund- it is an investment company that continuously
issues its redeemable shares and stands ready to redeem them back at net asset
value per share (NAVPS) should investors decide to pull out their investments.

Example: a mutual fund has 20,000 shares outstanding and its portfolio securities
are commercial papers, bonds, stocks and treasury bills. An investor, Lucio
Tamparan owns 200 shares. This implies that Lucio Tamparan’s shares represent
200/20,000 ownership in all the portfolio securities of the fund. Should Lucio decide
to pull out his investment, his 200 shares shall be paid for at the prevailing net asset
value for the day minus any exit (or redemption) fee.

Right of redemption. Right of redemption is unique on the part of investors in a

mutual fund because the latter stands ready to pay for any share returned by its
shareholders. The fund is required by law to pay for redeemed shares within seven
banking days from date of redemption request.

Waiver of Pre-emptive right. Pre-emptive right refers to a stockholder’s right to

subscribe to new issuance of the shares of stock of an investee corporation.
 2. Closed-end companies- it is an investment company that issues a limited number of
non-redeemable shares so that they are listed in the stock exchange to provide
liquidity to its shareholders.

Net Asset Value per share of Mutual Funds

When investing in mutual funds, the price paid per share is equal to its net asset value
plus fee. Net asset value refers to the excess of assets at current value over liabilities.

Net Asset Value per share=Assets – Total Liabilities

No. of shares outstanding

Investor’s Transaction Costs

A mutual fund charges fees to investors and they are classified as follows:

A. Sales fee (or front-end load)- this is a charge made based on NAVPS of shares issued
to investors. It has the effect of increasing purchase cost per share.

B. Redemption or exit fee – this is charged to the investor upon redemption of his
shareholdings. It reduces net proceed from redemption on the part of the investor.

C. Reinvestment fee – this charged to the investor upon reinvestment of his earnings
from the mutual fund. In most cases, this is not charged anymore by the fund.

D. Value Added Tax (VAT) – this is computed based on the new train law. It is generally
included in the fee percentage when the latter is based on the public offering price

A mutual fund that charges fees on transactions with investors is called a load fund
while a fund that does not make these charges is called a no-load fund. All mutual funds in
the Philippines are load fund

Classifications of Mutual Funds

Mutual funds may be classified as follows:

A. Based on Charging of fees:

1. Load funds – they charge fees to investors upon sale and redemption of shares.
 2. No-loads funds – they do not charge fees to investors upon sale or redemption of
shares. This implies that charges that are directly related to sales and redemptions
such as broker’s commissions are treated as part of the fund expenses.

B. Based 0n securities invested in:

1. Equity or Stock funds - they invest primarily in shares of stock.
a. Equity income funds – they are after current income so that they invest
primarily in stocks that regularly declare relative high dividends.

b. Growth funds – they invest in growth stocks or those which have sale,
earnings and market share growing rates higher than the average company
or the economy.

c. Aggressive growth funds – they invest primarily in smaller and younger

companies wherein there is more potential for growth but which are subject
to greater volatility in prices therefore can result I bigger profit but entail
greater risk.

d. Index funds – they invest in stocks that are included in the market index.

e. Global stock funds – they invest in stocks in different countries.

2. Bond funds – their investment is primarily in bonds.

a. Government bond fund – their primary investment is in government bonds.

b. Commercial bond funds – they invest primarily I bonds issued by private

corporations.

3. Balanced (or hybrid) funds – their investments are primarily in stocks and bonds.

4. Money market fund – their primary investment is in short-term money market

instrument such as treasury bills, commercial papers, banker’s acceptances, and
negotiable certificate of deposit.

Advantages in Investing in Mutual Funds

1. Professional Management – mutual fund hire full-time investment managers,
strategists, analysts who are better qualified in choosing and managing investments.
very few direct investors can match their skill and experience.
 2. Diversification of investments – a mutual fund invests in different kind of securities.
Even if one’s investable cash is not significant in amount, he can still be assured of
having proportionate ownership in different classes of securities which he cannot
afford to buy alone.

3. Smaller investable cash requirement – direct investment in different securities

require significant amount of investment. In mutual funds, there is minimal amount
investment requirement that can give an investor interest in different securities on a
proportionate basis.

4. Liquidity of investment – investment in mutual funds can be readily converted into

cash because of the redemption right of the shareholders.

5. Relative safety of investment - mutual funds are closely regulated by the SEC in
enforcing the Investment Company Act and its implementing rules.

6. Lower purchase cost – mutual fund investment entail lower acquisition cost due to
its greater purchasing power and the brokers’ tiered basis of charging commissions.

7. Convenience – mutual fund shares can be bought directly from a fund or through a
broker, bank or agent, by mail, over the phone and over the internet. Most of them
provide 24 hour phone or computer access to fund and account information.

Safety Features of Mutual Funds

The Investment Company Act or ICA and the implementing rules adopted by the SEC
provide for safety features for the protection of the investing public. Among these are given
below.
a. Required capitalization – investment companies are required to have atleast
50M subscribed and paid-in capital. The significant amount of capital required
provides the fund greater purchasing power, liquidity and ability to survive
economic crisis.

b. Common stock with voting rights only – only common shares with voting rights
can be issued by mutual funds. This implies that fund shares of stock participate
in the fund earnings equal basis and that all shareholders have a voice on
matters that must be presented to them from approval.
 c. Required liquidity – The SEC requires that at least 10% of the fund should be
invested in liquid/semi liquid assets in the form of short term government
securities (such as treasury bills and certificate of indebtedness issued by the
BSP)

d. Unallowed investment – an investment company is not allowed to sell securities

short or invest in margin purchase of securities, commodity futures contracts,
precious metals, and unlimited liability investment.

e. Bonded employees – any officer or employee having access to securities or

funds is required to be bonded by a reputable fidelity insurance company against
larceny and embezzlement.

Risk in Mutual Fund investments

As in any kind of investment, there is no assurance that an investment in a mutual fund
will always result in an increase in its value. Sometimes, redemption price may even lower than
purchase cost. This may be due to changes in market conditions, general or political situations,
and changes in performance of investee corporations. However, on a long term basis,
investment in mutual fund funds may be more profitable depending on the ability of the fund
manager in selecting securities and in shifting investment emphasis.

Fund Aspects to be Looked into

an investor should look into some aspects of mutual funds as given below to be better
assured of relative safety and profitability of his investments.

A. Level of transactions cost and mutual fund operating expenses. Both transaction
costs (sales, redemption and reinvestment fees) and mutual fund expenses should
be as low as possible.

B. Tract record of mutual fund – investment in mutual funds is a long term with
advisable holding period of three to ten years so that an investor should look into
their track records rather than give undue emphasis on short term achievements.
How do they perform in bearish markets? Oftentimes, funds that overperform
others in time of bullish markets incur significant losses at other times thereby
wiping out all previous gains.
C. Tract record of fund managers – an investor in a fund buys not only its shares per se
but also the expertise of the fund manager who may be an individual or team.
Although a fund manager is qualified with so many academic degrees and so many
years of experience, how good is he or she at picking securities? What investing style
or analysis does he or she apply in evaluating and making selection? How is his or
her track record in times of bearish market in comparison with the others?

D. Periodic performance of mutual funds – an investor should periodically determine

how his investee mutual fund is performing relative to the market and other funds.
This may be done by keeping track of the NAVPS as published daily in the
newspapers and by reading the fund’s periodic reports.