CHAPTER 21 1. The market value of Neptune's portfolio equals the combined value of its investment holdings: MVA (S50 000 x $10) + (20 000 x $7) + (35 000 x $30) + (10 000 x 100) $2 690 000 0 ‘The net asset value of an investment company equals: NAV = (MAV ~ LIAB)/NSO In this case: NAV (s2 690 000 - $30 000)/150 000 $17.60 2. It is true that the monthly rate of return on a mutual fund can be computed by calculating the percentage change in the net asset value from the beginning to the ‘end of the month. Assuming no distributions, the percentage change in the NAV represents the change over the month of one dollar invested in the fund at the beginning of the month. Note, however, that an investor who makes contributions 10 of withdrawals from his mutual fund during a given month will likely earn a different rate of return than that reported by the mutual fund for the month 3. a. The NAV of closed-end investment company is calculated in the same manner as the NAV for an open-end investment company. That is: NAV = (MAY - LIAB)/NSO In the case of the X fund: NAV ($300 000 000 - $2 000 000)/40 000 000 = $12.45 b. If the NAV is $12.45, thon an 8% discount implies thatthe fund's market price is Market price = (1 ~.08) x $1245 sis 0 199200 INVESTMENTS: CHAPTER 21 The primary difference between a closed-end investment company and an open- end investment company relates to their respective capitalizations A closed-end investment company does no! stand ready to repurchase shares from current shareholders, While a closed-end investment company has the optioito™ repurchase shares, it is under no obligation to do so. Furthermore. a closed-end investment company does not stand ready to sell new shares to existing shareholders or new investors. Again, a closed-end investment company may have the option (depending on the terms of its charter) to issue new shares, but this option is exercised infrequently Am open:end investment company does stand ready to repurchase existing shares from shareholders and sell new shares to investors. (The sale of new shares is made within the limit on total outstanding shares established in the company's charter.) ‘Because an open-end investment company will repurchase existing shares and sell new shares, its capitalization is referred to as variable. A closed-end investment company’s capitalization is referred to as fixed because it generally will not repurchase existing shares or sell new shares, Loads are most commonly charged by mutual funds whose sponsors are brokerage firms. The rationale for charging these loads is to pay for the cost of maintaining a large sales force and a group of client service representatives. Conversely, most no-load funds are sponsored by investment management firms who have limited marketing programs and whose client service is conducted over the phone and by mail. Thus the marketing expenses of most no-load funds are considerably lower than those of most load funds. There is also an element of charging what the market will bear in setting load charges. Mutual funds run by brokerage houses have been able to convert their reputations and nationwide presences into higher fees. In the same vein, some formerly no-load funds that in recent years have performed well and are in great ‘demand have started to charge loads in various forms. Many investors appear willing to pay the loads civarged by some mutual funds. These investors are often reluctant to do their investment business éver the phone or by mail, and instead prefer to deal in person with a representative of the mutual fund. Furthermore, some investors believe that certain funds that charge loads offer investment ‘expertise that justifies the additional costs. Due to the 8.5% load charge you would only be able to actually invest $91 in the mutual fund out of the initial $1000 that you had available to invest. Given the 1.10% annual operating expenses, to find the annual return that the fund must earn to match the accumulated dollars from a five-year investment in a 5% savings account, one must solve the following equation for X:sTMENTS: CHAPTER 21 $915.00 x (1+ X = O11) = $1000 x (1.05)* $915.00 x (989 + X)° = $1276.28 (989 + X)° = 13948 X = 080 = 80% A family of funds offers an investor the flexibility to structure an investment policy suited to his or her specific needs. The investor can place monies in @ number of funds with different objectives that can create a total investment portfolio perhaps quite different from that offered by any single “balanced” manager. Families of funds have also become popular because they permit zero or low-cost switching between funds. Some investors believe that they can forecast the performance of certain segments of the market. The various funds provide a means to invest in diversified portfolios within specific market segments, among which the investor can move back and forth. Probably the most important factor to consider in selecting an investment company is its investment policy. Specifically, what are the company's investment objectives and how much risk is it willing to take to achieve those objectives? This investment policy should be consistent with the role thatthe investor expects the investment company to play in his or her total portfoi Another important consideration is the amount of load charges (if any) levied by the investment company. Mutual funds can assess up to 8.5% of the amount invested as a front-end load charge, considerably reducing the amount of funds available for investment. A potential investor should also evaluate the ongoing expenses incurred by the investment company, primarily management fees and administrative charges. Management fees can range from .25% of assets under management to over 1%. Administrative charges average around .50% of assets under management. These costs are not trivial and, because they vary from fund to fund, they should be considered by a potential investor. Another expense that should be taken into account are transaction costs. These costs will largely depend upon the amount of turnover in an investment company's portfolio and the liquidity of the securities traded. Transaction costs are difficult to measure, but estimates in the 1%~5% range are not unusual for common stocks. Many investment companies’ portfolios experience turnover of over $0% annually. Thus transaction costs can be material. Past performance is another factor that is often considered in selecting an investment company. However, as discussed in the text, the correlation between past successful performance and future successful performance appears t0 be virwally zero.INVESTMENTS: CHAPTER 21 The return on a mutual fund paying a year-end distribution is given by f= [(NAV, - NAV,.) + D,J/NAY, In the case of the Saturn fund: ($16.90 - $1850) + $125/S18.50 =0.019 = -19% ‘The return on a mutual fund paying ycar-end distributions of income and realized capital gains is given by: t= [[NAV, - NAV,,) +1, + G,J/NAV,, In the ease of the Pluto Fund: 1 = ($1440 - $1389) + $0.29 + s012]/813.89 = 066 = 66% ($15.95 - $14.40) + $0.33 + $0.25]/$14.40 148 = 148% Fy = [$1520 - $15.95) + $0.36 + soos|/sis.95 ” 0021 = -21% ‘As a group, mutual fund managers have not demonstrated an ability to produce positive risk-adjusted returns afier accounting for management fees. This result should not be particularly surprising as mutual fund managers together control a large portion of the actively traded investment accounts. Because the market is an average of the performance of all investors, then mutual fund managers in total should find it difficult to beat the average performance of all investors, particularly if that performance is considered net of operating expenses. ‘The evidence indicates that past performance is of litle help in selecting a superior mutual fund. There is little statistical suppor for the notion that many mutual fund managers are capable of consistently outperforming the market on 2 risk-adjusted basis. Clearly, some managers will outperform the market in any given year, However, this superior performance appears to be more often coincidental, rather than a matter of skill. Asa result, it should not be expected ‘that a mutual fund manager who performed well last year will also perform well this year,