Indirect Investing Lec1-Investment Managment And Portfolio-Lecture Notes, Study notes of Investment Management and Portfolio Theory

Download Indirect Investing Lec1-Investment Managment And Portfolio-Lecture Notes and more Study notes Investment Management and Portfolio Theory in PDF only on Docsity! y g ( ) Lesson # 20 INDIRECT INVESTING Investing Indirectly: Indirect investing in this discussion usually refers to the buying and selling of the shares of investment companies' that, in turn, hold portfolios of securities. Most of our attention is focused on investment-companies, arid mutual funds in particular, because of their importance to investors. However, we will conclude the chapter with a discussion of Exchange-Traded Funds (ETFs), which represent a bridge between direct and indirect in vesting. Investors buy ETFs like any other stock, but many ETFs can be compared to index mutual funds. The decision of whether to invest directly or indirectly is an important one that all investors should think about carefully. Because-each alternative has possible advantages arid disadvantages, it is not necessarily easy to choose one over the other. Investors can be, active investors, investing directly, or passive investors, investing indirectly. Of course, they can do both at the same time, and many individuals do exactly that! An investment company such as a mutual fund is a clear alternative for an investor seeking to own-stocks and bonds. Rather .than purchase securities and manage a portfolio, investors' can, in effect, indirectly invest by turning their money over to an investment company which will do all the work and make all the decisions (for a fee,-of course). Investors who purchase shares of a particular portfolio managed by an investment company The primary difference is that the investment company stands between the investors and the portfolio of securities, Although technical qualifications exist, the point about indirect investing is that investors gain and lose through the investment company's activities in the same manner that they would gain and lose from holding a portfolio directly. The differences are the, costs (any sales charges plus the management fee) and the benefits which consist of additional services gained from the investment company, such as recordkeeping and check-writing privileges. The line between direct and indirect investing is becoming blurred. For example, investors can invest indirectly by investing directly— 'that is, they can buy various mutual funds through their brokerage accounts. This is explained at the end of the chapter when we discuss fund "supermarkets." And, as noted above, ETFs have characteristics of both direct and indirect investing. What Is An Investment Company? An investment company is a financial service organization that sells shares in it to the public and uses the funds it raises to invest in a portfolio of securities such as money market instruments or stocks and bonds. By pooling the funds of thousands of investors, a widely diversified portfolio of financial assets can be purchased and the investment company can offer its owners (shareholders) a variety of services. . A regulated investment company can elect to pay no federal taxes on any distribution of dividends, interest, and realized capital gains to its shareholders. The investment company acts as a conduit, "flowing through" these distributions to stockholders who pay their own marginal tax, rates on them. In effect, fund shareholders are treated as if they held the docsity.com y g ( ) securities in the fund's portfolio. Shareholders pay the same taxes they would pay if they owned the shares directly. Fund taxation is unique with income taxed only once when it is received by its shareholders. A funds short-term gains and other earnings are taxed to shareholders as ordinary income, whereas its long-term capital gains are taxed to shareholders as" long-term, capital gains. Tax-exempt income received by a fund is generally tax exempt to the shareholder. Investment companies are required by the Investment Company Act of 1940 to register with the Securities and Exchange Commission (SEC). This detailed regulatory statute contains numerous provisions designed to protect shareholders. Both federal and state laws require appropriate disclosures to investors. It is important to note that investment companies are not insured or guaranteed by any government agency or by any financial institution from which an investor may obtain shares. These are risky investments, losses to, investors can and do occur (just think 2000 to 2002), and investment companies' promotional materials state this clearly. Types of Investment Companies: All investment companies begin by selling shares in themselves to the public. The proceeds are then used to buy a portfolio of securities. Most investment companies are managed companies, offering professional management of the portfolio as one of the benefits. One less well-known type of Investment Company is unmanaged. We begin here with the unmanaged type and then discuss the two types of managed investment companies. After we consider each of the three types, we focus on mutual funds, the most popular type of investment company by far for the typical' individual investor. Unit Investment Trusts: An alternative form of. Investment Company that deviates from the normal managed type is the unit -investment trust, (OIT), which typically is an unmanaged, fixed-income security portfolio put together by a sponsor and handled by an independent trustee. Redeemable trust certificates representing claims against the assets, of the trust are sold to investors at net asset value plus a small commission. All interest (or dividends) and principal repayments are distributed to the holders of the certificates. Most unit investment trusts hold either equities or tax-exempt securities. The assets are almost always kept unchanged, and the trust ceases to exist when the bonds mature, although it is possible to redeem units of the trust. In general, unit investment trusts are designed to be bought and held, with capital preservation as a major objective. They enable 'investors to gain diversification, provide professional, management that takes care of all the details, permit the purchase of securities by (he trust at a cheaper; price than, if purchased individually, and ensure minimum operating costs.. If conditions change, however, investors lose the ability to make rapid, inexpensive, or costless changes in their positions. Closed-End Investment Companies: One of the two types of managed investment companies, the closed-end investment company, usually sells no additional shares of its own stock after the initial public offering. Therefore, their capitalizations are fixed, unless a new public offering is made. The shares of a closed-end fund trade in the secondary markets (e.g., on the-exchanges) exactly like any other stock.10 To buy and sell, investors use their brokers, paying docsity.com