Mutual Fund Portfolios

Let's take a somewhat detailed look at a mutual fund's balance sheet and income statement:

Series 7Help

What the heck is a Unit Investment Trust?

We're all familiar with open-end mutual funds because they've been marketed quite successfully by household names including Fidelity, Vanguard, Janus, and American Funds. With UITs or "Unit Investment Trusts," few people seem to be familiar. I like to think of it this way--eventually, I'm going to want to devote a serious percentage of my investment capital to fixed-income. I don't need the ultra-safety (and low yields) of US Treasuries, and since most of my investing is still done in a retirement account, I shun municipal bonds, as well. I need corporate bonds, but I can't buy the things outright without devoting say $100,000 per issue. And, I don't want to be exposed to just two or three issuers. So, I need a portfolio. I don't necessarily need an investment adviser trading that portfolio, however. If I don't want to pay management fees and don't necessarily believe that an actively managed portfolio of bonds will outperform an un-managed portfolio, I buy a unit investment trust as opposed to an open- or closed-end mutual fund. I figure the trustee will oversee/supervise the portfolio and only charge minimal fees to administer the trust. The rest of the income gets paid pro rata to us unit holders, and we can redeem our units for whatever they happen to be worth at the time. Many UITs are a portfolio of preferred stock, and that might be even more to my liking. Hold these in the taxable account and enjoy qualified dividends plus a well-diversified portfolio of fixed-income securities I'm too lazy to buy or manage myself. More Help

Open and Closed-End Funds

Wow. Didn't mean to neglect the Pass the 7 blog, but I haven't posted since flippin' February. Not accpetable. Let's start making up for it right now with a fun practice question . . .

Open- and closed-end funds share none of the following characteristics except that:
A. open-end funds must be "diversified" according to the 75/5/10 rule
B. closed-end funds must be "diversified" according to GAAP accounting rules
C. closed-end funds are non-redeemable investment company securities
D. open-end funds may issue preferred shares

EXPLANATION: once again, a mildly confusing topic can become massively confusing if the question is written a certain way. Oh well. Take a deep breath, look at the question from a different angle, and proceed to kick its butt. Do open-end funds have to be diversified? Heck no--it's just that if they want to call themselves "diversified," they have to follow the SEC rule. Closed-end funds don't have to be diversified, either, and even if they did "GAAP Accounting" is nonsense . . . so you can now eliminate the first two answer choices. Boom. See anything wrong with Choice C? Me neither, but let's not make our move too soon. What about D? Isn't it the CLOSED-end fund that might issue preferred shares to use leverage? Yes. D is false. The answer must be . . .


ANSWER: c

Net Asset Value

All of the following would cause NAV for an open-end fund to increase except

A. stocks in the portfolio increase in value

B. stocks in the portfolio pay a dividend

C. investors buy new shares in unexpectedly large quantities

D. bonds in the portfolio make interest payments

EXPLANATION: if you owned stocks and bonds in a brokerage account, the account value would rise whenever the value of the stocks and bonds went up, or whenever they put money into your account via dividend and interest payments. If you multiplied the size of your portfolio by a bazillion and cut it up into shares, the same thing would happen to the mutual owners of your mutual fund. So "A", "B", and "D", all do make the NAV rise. Choice C has nothing to do with NAV--supply and demand does not apply here. At 4 PM or so each day the fund is revalued based on what we just mentioned--THEN, they let buyers in based on that NAV, and they pay sellers out the NAV. But it's all proportional and all done at the same price.

ANSWER: c

Sales Charges and Operating Expenses

Sales charges and operating expenses are two different things . Sales charges are an extra fee added to the price of mutual fund shares when the investor purchases them. They go to the underwriter and the broker-dealers and agents in the distribution network. Sales charges cover the costs of printing the prospectus and other sales literature, sending it out in the mail, paying agents and broker-dealers to sell the shares, and doing all the advertising that we see in magazines and hear on the radio these days.
Do all funds have sales charges? No. The ones that do not impose sales charges are called "no load" funds. But, whether there is a "load" or not is one issue. The other issue is this: all mutual funds have operating expenses. Management fees cover the investment adviser who trades the portfolio. Accounting, legal, consulting, board of director and other expenses are usually lumped under "other expenses" in the prospectus. And, even though the fund calls itself "no load" it can still tack on another operating expense called a "12b-1 fee" that covers the costs of distributing/marketing the fund shares. The 12b-1 fee can not exceed .25% of the average net assets, but as long as it doesn't, the fund can call itself "no load."
So, not all funds have sales charges, but all funds impose operating expenses. Many people think they don't pay ongoing fees to hold their fund shares, but that' s because they don't get a bill. The fund just reaches into the big cash register and pulls out enough cash to cover the operating expenses mentioned above. Again, sales charges are not operating expenses. They are tacked onto the price of an A-share when the investor purchases or subtracted from the proceeds of a B-share when the investor sells. Either way, the fund takes out operating expenses along the way, including the management fee, the 12b-1 fee, and all "other expenses."