Indirect Investing

 Alternative to direct investment in or ownership of securities

 Refers to buying and selling the shares of intermediaries that hold securities in portfolio

 Shares are ownership interest in portfolio entitled to portfolio income

 Shareholders also pay expenses

 Investment companies

 Financial intermediaries that collect funds form individual investors and invest those
funds in a potentially wide rande of securities or other asstes

 Polling of assets is the key idea behind investment comapnies

Investment Companies

 -Collecting funds from individuals

 -Investing in a big portfolio

 -How it works

 Investment company forms portfolio

 Sells investors shares in the portfolio

 investors have claim to the portfolio, proportional to their number of shares

These companies perform several important functions for investors:

 Administration & record keeping: capital gains, dividends and so on

 Diversification & divisibility:i.e. by pooling of assets

 Professional management: security analysts etc.

 Reduced transaction costs

Types of Investment Companies

 Investment Company Act 1940:

 Unit trusts

 Managed ivestment companies

 Unit Investment Trusts:

  pool of money invested in portfolio;

 its portfolio is fixed for the life,

 unmanaged.

-Brokerage firm buys and forms portfolio

-Sells shares in that trust called units or redeemable trust certificates

-Invest in relatively uniform types of assets:municipal bonds, corporate bonds

-All money from portfolio is distributed to share holders by trustee, i.e. company which manages
portfolio

e.g.

-Trust bought portfolio for $ 5 million

-Sells 5,000 shares at $1,030 per share

-3% premium per share obtained by trustee

trustee – bank or trust company

-Liquidate holdings

sell back to trustee for NAV

Sell enought securities from the asset portfolio toobtain the cash

Sell the shares to new investors

Decline in value

$105 billion in 1990

$50 billion 2007

• Managed Investment Companies; portfolio is managed

• Board of directors, elected by shareholders, hires management company for fee of 0.2 to 1.5% of
assets value

- Open-End (called mutual funds)

• shares redeemed or

• new shares issued at NAV;

• shares outstanding change when new shares are issued or old shares are
redeemed
 • Cash out shares – sell them back to fund

- Closed-End

Not redeemed, no new share issue

No change in shares outstanding

• Shares traded on organized exchanges and can be sold and bought at market price
(unlike open-end mutual funds shares)

• Cash out shares – sell to another investor

• May be priced at Premium or discount to NAV

Other Investment Organization

 Not organized or regulated as investment companies

 Functions similar

 Commingled Funds

 Real Estate Investment Trusts

 Hedge Funds

 Types of Invest. Companies Continued

-Commingled funds:

• Partnerships of investors that pool their funds

• Management firm that organizes the partnership (bank, insurance company) for fee

• Partners – retirement accounts, trusts

• Large portfolio but still can not be managed in separate basis

• units are issued (like shares).

• Like open-end, they're trades at NAV.

e.g. money market fund, bond fund, common stock fund often offered by Bank or insurance company

 Real estate investment trusts (REITs):

 Similar to closed-end fund

 Invest in real estate or loans secured bz real estate

  Beside issuing shares

 Raise capital by borrowing from banks and issuing bonds or mortgages

 Highly leveraged

 Debt ration of 70%

 Equity trust – directly in real estates

 Mortgages trust – mortgages and construction loans

 Established

 Banks, insurance companies, mortgage companies for fee

-Hedge funds

-Like mutual funds but private partnership

• pool assets to be invested by hedge manager

- under minimal SEC regulation

• For wealthy and institutional investors

• Lock-ups

• Allows: invest in illiquid assets

• Strategies

• Use of derivatives, short sales, leveraged

What is Unit Trust?

 A pooled investment plan where the capital contributions of investors are combined into a legally
formed trust fund

 Then invested by professional fund managers, acting on behalf of the investors, in a portfolio of
marketable securities

 “Trustee” is appointed to safeguard the rights and interests of the investors

 Investors receive “Units” (shares) in proportion to the amount of money they have contributed to
the fund

 Income derived from dividends, interests and capital gains are divided among the unit holders in
proportion to their investments.

 An indirect investment. It is also called investment companies.

  Unit Trust investment offers a reasonable amount of return with minimal risk. It is done by
professional management at minimal cost, minimizing, liquidity, and capital appreciation

 Investors money will be pooled together to be invested in a single diversified investment

portfolio which comprise stocks, bonds and others in accordance with the investment objective

 One important feature of unit trust is that professional fund managers are employed to manage the
funds. They are highly qualified and experienced in investments.

Who Are The Unit Trust Investors?

 Small or retail investors who neither have the time nor the know-how to hold portfolios through
direct investments.

 Many are highly inexperienced; as a result they turn to these unit trusts management companies
to act on their behalf.

How a Unit Trust Work?

 Trust deed

 An agreement that binds 3 parties (namely, Unit Trust Management Company, the trustee
and the unit trust fund’s investors – also called as unit holders) to the deed.

 The trust deed will have to be registered with the Securities Commission. A copy of the
trust deed can be bought at the management company.

 Trustee

 Can be the Public trustee of Malaysia or any independent trustee of Malaysia or any
independent trustee companies.

 A trustee is generally reputable financial institution appointed by a deed of Trust to look

after the interest of the unit holders.

 An independent Trustee is appointed to ensure compliance of the management company

with the requirements of the Trust Deed, Securities Commission’s guidelines on Unit
Trust Funds and Securities Commissioner Regulations 1996

 As the legal owner of the assets of the fund, the trustee is responsible to ensure that the
fund manager invests the funds according to the trust deed.

 Management Company

 The promoter of the fund to the public and provides investment expertise to manage the
fund and has the primary responsibility of investing the funds according to the objectives.

 The Management Company also acts as the Registrar of the fund maintaining the records
of the unit holders
  Investors or Unit holders 

 The providers of funds through purchase of unit trusts from the management company
would expect to receive benefits from the investment.

 If it is an Open-end Fund, the investors can buy units at anytime, as long as the fund
has not reached its maximum approved size.

 They can also sell the unit trusts back to the management company,.

 The Securities and Exchange Commission 

 Responsible to safe guarding the interests of the investors who make investments in unit
trusts.

 SEC formulates regulations for the operation of unit trusts and has the necessary power to
ensure the proper conduct of the business.

 It also has the power to license or suspend the licenses of Management Company to
operate unit trusts.

Types of Unit Trust

 Open-End Fund

 Investors buy and sell shares directly with the mutual fund company without a secondary
market

 Have an unlimited number of shares

 Purchase and selling price is determined by the Net Asset Value (NAV) of the fund

 All purchases and sales are completed at the end of the day after the stock markets have
closed

 Close-end fund

 Sell only the initial offering

 Subsequent trades are done in a secondary market, similar to the common stock
market

 Have a limited number of shares

 Investment advisor doesn’t have to worry about cash inflow or outflows

 Purchase and selling price is determined by supply

and demand
  Generally sell at premium or discount (usually discount)
to NAV

 How is close-end fund structured

 Has board of directors elected by the shareholders.

 The board of directors will appoint the fund manager for research, portfolio management
and the administration of the fund.

 The fund manager will make recommendation for investments.

 The investment committee will make decisions on investments.

 The public trustee will be responsible to disburse the fund for investment.

Unit Investment Trust

 Fixed pool of securities, normally bonds

 Not actively managed; securities in portfolio remain static

 Have shares that represent a proportionate share

of the trust

 A portfolio of shares is put together by the trust sponsor and these shares are held in safekeeping
under conditions set down in a trust agreement.

 Redeemable trust certificates will be sold to investors at NAV plus a small commission.

Real Estate Investment Trusts (REIT)

 Closed-end investment company that invests in mortgages and various types of real estate
investments

 Provide high dividends along with capital appreciation potential

 Types of REITs

 Property/equity REITs invest in shopping centers, hotels, apartments, office buildings

and other real estate

 Mortgage REITs invest in mortgages

 Hybrid REITS invest in both properties and mortgages

Types of Funds

 Equity Fund

 Primarily invest in the stock market.

  High level of risk and are expected to provide a high return in the long term.

 Growth Funds and Index Funds fall into this category of unit trusts

 Income funds

 It produces high level of current income- invest in high-grade shares that pay good
dividend.

 Established companies and generally viewed as low-risk.

 Invest in fixed income securities.

 Balanced funds

 Generates a balanced return of both current income and long-term capital gains

 Invest in blend of fixed-income securities and common stocks, with 30% to 40% in fixed
income

 Allocation between stocks and bonds typically remains constant or varies very little

 Emphasis between fixed-income and common stocks can be shifted as market conditions
change

 Less risky investments for relatively conservative investors looking for moderate growth

 Growth Fund

 The primary goal is capital gain and long-term growth.

 Normally offer little dividends or current income. Because of uncertain long-term

perspective, it can be quite risky.

 Aggressive Growth Fund

 highly speculative mutual fund that seeks large profits from capital gains

 Invest in small, unseasoned companies with high price/earnings ratios

 Often look for turnaround situations

 Prices are often highly volatile

 High risk investments for very aggressive investors

 Islamic Fund

 Fund will invest in shares which complies with syariah Principles.

  The Syariah Principles distinguishes between ‘halal’ and ‘non halal’ type of business
activities.

 The returns received would depend on whether investment objective is for growth,
current income or a combination of growth and current.

 Bond Funds

 Invests in various kinds and grades of bonds, with income as primary objective

 Advantages of bond funds over individual bonds:

 More liquid

 Offer high diversification

 Bond funds automatically reinvest interest

 Lower risk investments for investors who are looking for steady income

 Some price volatility occurs with changing

interest rates

 Property trust funds 

 Special type of close-end fund where it invests mainly in real property rather than in
shares or bonds. Because of the nature of the investment, the returns are highly
speculative.

Advantages of Unit Trust

 Diversification

 Many investors lack sufficient resources to establish an adequate diversification on their

own.

 Funds with variety of objectives

 Different types of funds are created for different investment objectives. So investors
should have no problem finding funds that meet their objectives in terms of return and
risk

 Record keeping services.

 The management company maintains and administers the records of shareholder’s

activity for a given year. This is a great convenience for the investors.
 

 Professional management

 Fund managers who are knowledgeable about investment and they have good track
records of performance, high integrity, etc.

 High liquidity

 Unit trust can be bought and sold easily. Thus they do not suffer from liquidity risk.

 Affordability

 Only a small amount of money is needed to participate in a portfolio of investment which

enjoys the same benefits as in direct investment which requires large amount capital.

 Disadvantages of Unit Trust

 Load fee

 This is sales charge added to the fund’s NAV when unit trust is sold. It is as high as
10%.   

 High annual expense

 The operating expenses like accounting, legal, postage, management fees have to be
borne by the investors.

 Transaction costs.

 Management companies must also pay transaction costs to buy and sell securities even
though they trade in large blocks..

Determine the Price of Unit Trust

 Determined by Net Asset Value (NAV) of the funds managing the portfolio excluding any
liabilities incurred and the number of units in circulation.

 NAV represents the underlying value of a unit share of stock in a particular unit trust.

 NAV is found by taking the total market value of all securities held by the fund, less any
liabilities and divided by the number of units on issue.

NAV = Value of Assets - liabilities

No. of units outstanding

What is a Mutual Fund?

 A mutual fund is a pool of money managed by a professional money manager.

 The objective and the risk level are outlined in a document called a prospectus. The prospectus
provides detailed guidelines for the types of investments the manager can purchase.

 A mutual fund is also known as an open-ended investment fund, which means the fund sells units
(of this pool on money) upon request.

What are the benefits of purchasing a mutual fund?

1 Professional Management: The fund company hires talented money managers who have many
resources behind them (including a team of people dedicated to researching, tracking,
determining trends, and doing thorough analysis), and who work full time on your behalf.

2 Diversification: Lowers the risk because, regardless of the size of your investment, each unit
purchased is made up of many different investments.

3 Liquidity: Mutual funds can be sold anytime, and easily

4 Flexibility: Mutual funds allow you to purchase as much or as little as you want, and offer a
variety of purchase plans.

What are the fees?

Mutual funds can either be purchased through a:

1 Front-end load: An investor pays a fee upfront (usually, a percentage of the total investment).

2 Back-end load: An investor doesn't pay an initial fee, but they are locked into the fund family for
a predetermined period of time (outlined in the prospectus). If the investor holds the fund to
"maturity"of the "contract," they will never pay a fee. But, if they choose to redeem early, they
will have to pay a redemption fee, which decreases on a percentage basis every year the fund is
held.

What types of funds can I buy?

Major Asset Classes:

1 Money Market Funds

2 Bond Funds

3 Balanced Funds

4 Dividend

5 Equity Funds

6 Specialty Funds
What is a Money Market Fund?

 This type of fund's main objective is to hold investment instruments that are liquid and secure.
This type of fund is usually held on a short-term basis and invests in money market securities.
Examples: Treasury bills, banker's acceptances, and short term notes.

 One thing an investor should be aware of is that these funds are NOT guaranteed like a Fixed
deposit, and hold NO fixed return, but are of low risk.

What is a Bond Fund?

 This type of fund's main objective is to provide a steady stream of income, and holds bonds
issued by either governments or corporations.

 The risk level of this type of fund will be determined by the guidelines in the prospectus, which
will, in turn, determine what type of "rating" and term (years to maturity) of bond the manager is
allowed to purchase.

What is a Balanced Fund?

 This type of fund's main objective is to hold an optimal mix of investments among cash, equities,
and income-producing securities.

 This type of fund usually has several managers who specialize in a specific area.

 This type of investment is ideal for someone who wants a better return than a fixed income, but
also wants less risk than equity.

What is an Equity Fund?

 This type of fund's main objective is to provide long-term growth through equity/stock
investments.

Different types of equity funds:

1 Diversified Equity Funds

2. Sector specific Funds

3. Index Funds

4. Middle Capitalization Funds

5. International Equity Funds

6. Others

What is a Specialty Fund?

 This type of fund's main objective is to concentrate its holdings in one particular sector,
geographic region, or in one capital market.
  Examples: telecommunications, health care, technology, financial services, European markets or
Japan.

* As you specialize, you minimize diversification, and that results in increased risk.

What are the three different investment styles for equity investing?

 Fund managers have different styles of investing. Their style affects the type of stocks they will
purchase, and the price they are willing to pay. This, in turn, affects your future returns.

1 Value: A manager purchases stocks that offer value at a time when the price of the stock is low,
relative to the actual book value. In other words, the company is selling for less than it is worth.
* Note: This is the most conservative approach.

1 Growth: A manager purchases stocks that are deemed to have growth potential, which, in turn,
could generate above average returns in the future.
* Note: Growth investments are usually small- to medium-sized companies, thereby increasing
the risk exposure.

1 Momentum/Sector rotation: A manager purchases sectors that are, or that they think will soon be,
"hot." The choices are determined by the manager's anticipation of where the greatest potential
rests.
* Note: This is a high-risk way of investing.

Other investments with structures similar to a mutual fund include clone funds, and
segregated funds.

Mutual Funds – Organisation

Sponsors:

The sponsors initiate the idea to set up a mutual fund. It could be a registered company, scheduled bank or
financial institution. A sponsor has to satisfy certain conditions, such as capital, record (at least five years’
operation in financial services), de-fault free dealings and general reputation of fairness. The sponsors
appoint the Trustee, AMC and Custodian. Once the AMC is formed, the sponsor is just a stakeholder.

Trust/ Board of Trustees:

Trustees hold a fiduciary responsibility towards unit holders by protecting their interests. Trustees float
and market schemes, and secure necessary approvals. They check if the AMC’s investments are within
well-defined limits, whether the fund’s assets are protected, and also ensure that unit holders get their due
returns. They also review any due diligence by the AMC. For major decisions concerning the fund, they
have to take the unit holders consent. They submit reports every six months to SEBI; investors get an
annual report. Trustees are paid annually out of the fund’s assets – 0.5 percent of the weekly net asset
value.

Fund Managers/ AMC: They are the ones who manage money of the investors. An AMC takes
decisions, compensates investors through dividends, maintains proper accounting and information for
pricing of units, calculates the NAV, and provides information on listed schemes. It also exercises due
diligence on investments, and submits quarterly reports to the trustees. A fund’s AMC can neither act for
any other fund nor undertake any business other than asset management. Its net worth should not fall
below Rs. 10 crore. And, its fee should not exceed 1.25 percent if collections are below Rs. 100 crore and
1 percent if collections are above Rs. 100 crore. SEBI can pull up an AMC if it deviates from its
prescribed role.

Custodian: Often an independent organisation, it takes custody of securities and other assets of mutual
fund. Its responsibilities include receipt and delivery of securities, collecting income-distributing
dividends, safekeeping of the units and segregating assets and settlements between schemes. Their
charges range between 0.15-0.2 percent of the net value of the holding. Custodians can service more than
one fund.

Advantages of Mutual Funds

 Professional portfolio management

 Diversification (risk reduction)

 Convenience

 Record keeping

 Other factors

 Examples: liquidity, minimal investment requirements, regulation

Disadvantages of Mutual Funds

 Management fees, expenses, and loads for load funds reduce their returns.

 Large investors, such as mutual funds, sometimes adversely affect the market when they trade.

 Institutions usually restrict their analysis to a small percentage of traded stocks (i.e., the larger
ones).