Indirect Investment

Introduction

• In Direct Investment, investors have control over the buying and selling of securities.

• In Indirect Investment, investors handed-over their investment to third party; thus losing their direct control of the securities.

• Mutual fund is one of the best alternative of indirect investment.

• Difference between direct investment and indirect investment [Jones,....Figure 3.1, p. 51,]

Introduction

• Direct Investment: Investor owns portfolio of financial assets and receive dividend or capital gains.

• Indirect Investment: Investor owns share in an ‘investment company’ fund’ which invest in portfolio of financial assets and receive dividend and capital gains; out of these inflow, shareholders receive their shares.

Investment Company?

• “A company engaged in investing in, and managing, a portfolio of securities”.

• There are three types of investment companies.1. Closed-End investment companies (Managed

Firm)2. Exchange-Traded Funds (ETFs) [Un-Managed

Firm]3. Mutual Funds (Managed Firm)

Managed Vs Unmanaged Firms

• Managed Fund (Active Management or Active Investing) – the investment strategy where the managers try to earn beyond the investment benchmark index.

• Un-managed Fund (Passive Investing): Investment strategies which do not entail any forcasting in order to minimize investing fees. The objective is not to outperform the benchmark index.

1. Closed-End Investment Companies

• An investment company with a fixed capitalisation (the number of fund share outstanding) whose share trade on exchanges.

• Investors buy and sell through brokerage houses.

• The oldest form of investment company

2. Exchange-Traded Funds (ETFs)• Unmanaged funds• Passive strategy investment• Investment fund traded on the stock exchange

like shares.• It posses the features of both closed and open-

ended funds. Like closed-end, it is traded on the stock exchange; and like open-end, ETFs shares are created and extinguished in response to demand for them.

• The newest form of the three major types.

3. Mutual Funds (Open-Ended Investment Companies)

• Investment company selecting and managing a portfolio of securities.

• An investment company whose capitalization constantly changes as new share are sold and outstanding shares are redeemed.

• Unlike closed-end funds and ETFs, mutual funds do not trade on stock exchanges.

• Investors buy mutual funds shares from investment companies and sell their share back to the companies.

• Mutual Fund Association of Pakistan (http://www.mufap.com.pk/)

Types of Mutual Funds• There are four types of mutual funds

1. Money Market mutual funs2. Equity (stock) funds3. Bond Funds4. Hybrid or Balanced Funds (Combination of Bond and

Stock)On the basis of risk, it is categorised as:

Money Market Funds (MMFs)

• Open-end investment companies whose portfolios consist of money market securities.

• Interest is credited on daily basis.• Investors can earn interest alongwith

securities diversification and great liquidity.• Not insured

1. Equity Fund

• Fund where investments are in the form of equity (Shares).• Having two categories:– Value Fund (Income Fund): Shares having a constant flow

of income; may be evaluated on the basis of standard fundamental analysis such as earnings, book value and dividend yield. Usually such investment in the form of large cap. companies

– Growth Fund: The companies are expected to show rapid growth in earnings, even if current earnings are poor. Such investment is usually in small cap. firms.

2. Bond Funds

• Investment in the form of bonds.• Usually fixed income securities...• There are many categories such as corporate

bond, government bonds etc.• Having different maturities bonds...

3. Hybrid Fund

• Investment in the form of both shares and bonds.

• Also called balanced fund.• Having objective of preserving investment

alongwith earning return.• A bit risky than equity investment

4. Index Fund

• “Mutual Fund holding a bond or stock portfolio designed to match a particular market index.”

• It is unmanaged portfolio investment.• First it was created by John Bogle 1976 in his

undergraduate research; he was the CEO of Vanguard Company as well.

• It was also known as Vanguard’ 500 Index Fund.

ETF Vs Index Fund

• ETFs can be purchased and sold anytime during the trading day at the current price; while mutual funds (index fund) are priced once a day.

The Net Asset Value (NAVs) Per Share

• NAV is the per share value of the securities in the fund’s portfolio.

• Market value of a fund’ securities = the product of each security’s current market price multiplied by the number of shares of that security owned by the fund.

• The NAV Of a fund is calculated each day.• NAV is the price an investor pays to buy a mutual fund on a

given day or the price an investor receive when selling shares back to the investment company.

• NAV = Market Value of a Fund’ Securities – LiabilitiesNumber of Investor Shares Outstanding

NAV Calculation

• A portfolio consists of 10 shares of OGDCL @ 100 each; 5 shares of PTCL @ 50 each; and 1 bond of PTC @ 20 each. The liabilites of the fund is Rs. 70 and number of shares held by the fund is 100. what is NAV– Market Value of the Portfolio = – 10 @ 100 = 1000– 5 @ 50 = 250– 1 @ 20 = 20 Sum = 1270

• NAV = 1270 – 70/ 100 = 12At Rs. 12, a buyer and seller will be ready to purchase (sell) the fund.

The Mechanics of Investing Indirectly

Closed-Ended Fund• The price of close-ended funds are

determined on the basis of supply and demand of the fund not on its NAVs.

• May be sold at discount if market price is less than NAV

• May be sold at premium if the market price is more than NAV.

The Mechanics of Investing Indirectly

Mutual Fund – mutual fund can be purchased in two ways1. Directly, from a fund company....2. Indirectly, from a sales agent including securities firms, banks,

life insurance etc.• May take the services of underwriter...• The owners of fund shares can sell them back to the fund

company at time at the NAV minus any sales charges (purchase) and redemption fee (for sales)

• Service charges may be in the form of fees and expense

Fees Vs. Expense

• Mutual fund fees are paid directly by an investor; it includes– Sales charges (load) either front-end (at the time

of purchase) or back-end (at the time of sales)– Redemption fee – fee at the time of redemption– Exchange fee – transfer of funds within same fund

family– Annual account maintenance fees – may be

charged on low balance accounts

Expense

• These show the operating expenses and not directly charged to investors.

• The expenses are charged form the fund’ income such as dividends, interest and capital gains.

• These are indirect expenses; it includes:– Management fees– Distribution fees– Other expnses

Load Funds Vs. No-load Funds

• Load Funds– Funds that charge investors a sales fee for costs of

selling the fund to the investors is load funds.– NAV + front-end load = selling price of fund

• No-Load Funds– No-load funds are purchased at the NAV directly

from the fund itself.

Fund Supermarkets

• A mechanism through which investors can buy, own, and sell the funds of various mutual fund families through one source (brokerage firm).