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Investment - Pooled Investments
Most ordinary investors choose to save through pooled investment vehicles administered by investment firms. The investment vehicles own securities and other assets, and, in turn, are held by their investors who share in the profits and losses in proportion to their ownership. Investors in an investment vehicle do not share ownership of the securities and assets owned by the investment vehicle; rather, they partake in the ownership of the investment vehicle itself. They are the beneficial owners of the investment vehicle’s securities and assets, but not their legal owners.
How Pooled Investment Vehicles Work
Banks, insurance companies, and investment management organizations organise most pooled investment instruments. The organiser is often termed the sponsor. Sponsors may construct investment vehicles like business trusts, limited partnerships, or limited liability companies. Depending on the form of the company, ownership shares are called as shares, units, or partnership interests. Large sponsors can establish hundreds of investment vehicles.
Pooled investment vehicles are governed by a board of directors, a board of trustees, a general partner, or a single trustee. The governance structure depends on the form of legal organisation. In some jurisdictions, directors must be independent of the sponsor, which means they are not allowed to work for the banks, insurance companies, or investment organizations that organise the investment vehicle. In other jurisdictions, employees or directors of the sponsor may also act as directors of its linked investment vehicles.
The directors pick a professional investment management firm, which is virtually often an affiliate of the sponsor. The investment manager works on a contractual basis in exchange for a management fee paid by the investment vehicle from its assets. The investment manager determines the securities and other assets owned by the investment vehicle.
The managers of pooled investment vehicles may use passive or aggressive investment methods.
Passive managers strive to equal the return and risk of a benchmark, whereas active managers try to surpass the benchmark.
All pooled investment vehicles describe their investment policies, their deposit and redemption procedures, their fees and expenses, and past performance information in an official offering document, the prospectus. Investors use this information to evaluate possible investments. Investment vehicles may provide extra information through other necessary regulatory filings, on their websites, or in marketing materials. The following are the three primary types of pooled investment vehicles
Open - end Mutual funds
Closed -end funds
Exchange-traded funds
Pooled investment vehicles may or may not be exchange-traded. Many closed-end funds and exchange-traded funds trade in organised secondary markets exactly like common equities. In contrast, open-end mutual funds are not exchange-traded.
Most ordinary investors choose to save through pooled investment vehicles administered by investment firms. The investment vehicles own securities and other assets, and, in turn, are held by their investors who share in the profits and losses in proportion to their ownership. Investors in an investment vehicle do not share ownership of the securities and assets owned by the investment vehicle; rather, they partake in the ownership of the investment vehicle itself. They are the beneficial owners of the investment vehicle’s securities and assets, but not their legal owners.
How Pooled Investment Vehicles Work
Banks, insurance companies, and investment management organizations organise most pooled investment instruments. The organiser is often termed the sponsor. Sponsors may construct investment vehicles like business trusts, limited partnerships, or limited liability companies. Depending on the form of the company, ownership shares are called as shares, units, or partnership interests. Large sponsors can establish hundreds of investment vehicles.
Pooled investment vehicles are governed by a board of directors, a board of trustees, a general partner, or a single trustee. The governance structure depends on the form of legal organisation. In some jurisdictions, directors must be independent of the sponsor, which means they are not allowed to work for the banks, insurance companies, or investment organizations that organise the investment vehicle. In other jurisdictions, employees or directors of the sponsor may also act as directors of its linked investment vehicles.
The directors pick a professional investment management firm, which is virtually often an affiliate of the sponsor. The investment manager works on a contractual basis in exchange for a management fee paid by the investment vehicle from its assets. The investment manager determines the securities and other assets owned by the investment vehicle.
The managers of pooled investment vehicles may use passive or aggressive investment methods.
Passive managers strive to equal the return and risk of a benchmark, whereas active managers try to surpass the benchmark.
All pooled investment vehicles describe their investment policies, their deposit and redemption procedures, their fees and expenses, and past performance information in an official offering document, the prospectus. Investors use this information to evaluate possible investments. Investment vehicles may provide extra information through other necessary regulatory filings, on their websites, or in marketing materials. The following are the three primary types of pooled investment vehicles
Open - end Mutual funds
Closed -end funds
Exchange-traded funds
Pooled investment vehicles may or may not be exchange-traded. Many closed-end funds and exchange-traded funds trade in organised secondary markets exactly like common equities. In contrast, open-end mutual funds are not exchange-traded.
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Investment - Direct and Indirect Investment
The enormous diversity of financial services and products available reflects the many varied requirements and issues clients encounter. Understanding the products and how they are organized supports an appreciation of how the investment sector delivers value for its clients. It also helps sharpen your awareness of how investment professionals may be assisted and how your contributions to the value creation process can be actualised.
Investment vehicles are any investment that can be made with the idea that by putting their money to work, the investor will enjoy some combination of a gain in the value of their money and a stream of cash flows. They may be formed with securities, such as shares, bonds, and warrants; real assets, such as gold, and real estate; or vehicles that combine wholly other investments.
Investors make direct investments when they acquire securities issued by firms and governments, and when they buy real, tangible assets, such as precious metals, art, real estate, or timber.
A typical approach to invest is through indirect investment vehicles. That is, investors send their money to investment firms, which subsequently invest the money in a variety of securities and assets on their behalf. Thus, investors make indirect investments when they acquire the securities of, or pay into, businesses, trusts, and partnerships that make direct investments. The following are instances of indirect investment vehicles:
Shares in mutual funds and exchange-traded funds
Limited partnership stakes in hedge funds
Asset-backed securities, such as mortgage-backed securities
Most indirect investment vehicles are pooled investments (also known as collective investment plans) in which participants pool their money together to enjoy the advantages of being part of a bigger group, with the pooling mediated by an investing professional. The associated economies of scale can greatly boost investment returns.
Both direct and indirect investments have advantages and disadvantages that investors need to assess. Direct investments have some advantages over indirect investments
Advantages of Direct Investments: -More control over decisions about investments -Manage to limit tax liabilities -Ability to select particular assets -High-quality guidance at a lesser cost for high-net-worth investors
Professionally managed -Small investors can use services of professional managers who they otherwise might be unable to afford -Share in the purchase and ownership of significant assets -Diversified portfolio -Less expensive to trade
Direct Investments
Investors exercise more control over direct investments than over indirect investments. Investors who hold indirect assets normally must accept all decisions made by the investment managers, and they can rarely have influence into such decisions.
Investors select when to buy or sell their direct investments to limit their tax responsibilities. In contrast, although the managers of indirect investments generally aim to limit the collective tax liabilities of their investors, they cannot simultaneously effectively serve all investors when their investors confront various tax circumstances.
Investors can choose not to invest directly in particular securities – for example, in stocks of companies that sell tobacco or alcohol. In contrast, indirect investors worried about such risks must choose investments with investment rules that include these limits.
Investors who are wealthy can typically acquire high-quality financial advice at a lesser cost when investing directly rather than indirectly.
Indirect Investments
Indirect investments are professionally managed. Professional management is particularly vital when direct investments are hard to find.
Indirect investments allow small investors to employ the services of expert managers, whom they otherwise could not afford to pay.
Indirect investments allow investors to join in the acquisition and ownership of major assets, such as skyscrapers. This benefit is especially crucial to small investors who cannot afford to buy huge assets directly.
Indirect investments allow investors to hold diversified pools of risks and so receive more reliable, but not necessarily greater, investment returns. Many indirect investment vehicles indicate ownership in many different assets, each of which normally is exposed to specific risks not shared by the others.
For example, a risk of investing in home mortgages is that the homeowners may default on their debts. Defaults on individual mortgages are highly unexpected, which makes keeping an individual mortgage quite dangerous. In comparison, the average default rate among a large sample of mortgages is significantly more predictable. Investing an amount in shares in a large mortgage pool is substantially less hazardous than investing the same amount in a single mortgage.
Indirect investments are often much less expensive to trade than the underlying assets. This cost benefit is especially significant for publicly traded investment vehicles that own very illiquid assets (i.e., cannot be acquired or sold fast without a considerable compromise in price).
Liquidity is one of the benefits of real estate investment trusts compared with real estate limited partnerships or real estate equity funds.Although the assets in which traded investment vehicles invest may be difficult to buy and sell, ownership shares in these vehicles can trade in liquid markets.
Is direct or indirect investment more profitable for investors?
It depends. Each investor and each investing firm must decide on the appropriate method given their individual demands and circumstances.
Investment Control Problems
Although the majority of investment managers strive faithfully to serve their clients, some are not always careful, attentive, or honest, which can lead to investment losses from inadequate research, lost opportunities, self-serving advice, or blatant fraud.
Insufficient Due Diligence
Investment managers who do not undertake sufficient research or due diligence may advise improper investments. Consider the scenario of a manager who buys a stock for a client portfolio purely based on the recommendation of a friend. It would be unacceptable for the manager to buy the stock without first completing full study and due diligence on the company.
Churning
Investment managers that receive commissions on trades that they recommend may conduct too many trades. Some managers have been known to sell and replace their whole portfolios once or more over the course of a year. Practitioners term this practice churning.
Self-Serving Managers
Investment managers may privilege themselves or their preferred clients above other clients when allocating trades that have been, or are likely to be, successful. For instance, a management might issue shares in an initial public offering that is projected to do well solely to preferred clients.
To successfully use the services of professional investment managers, investors must anticipate such challenges. Investors who do not wish to deal with these concerns sometimes prefer indirect investment vehicles, such as public mutual funds, for which a board of directors (or trustees) has main responsibility for monitoring the performance of the managers.
Although board members normally work honestly on behalf of their shareholders, some may be more devoted to the management they monitor than to the owners that they represent. Regardless, mutual fund managers often work hard for their investors. They are normally paid in proportion to the value of assets under management. Good performance draws further investors and serves to enhance their fees.
In contrast, large institutional investors are frequently direct investors who hire and oversee investment managers. These institutional investors can typically commit large resources to monitoring and appraising their managers.
The enormous diversity of financial services and products available reflects the many varied requirements and issues clients encounter. Understanding the products and how they are organized supports an appreciation of how the investment sector delivers value for its clients. It also helps sharpen your awareness of how investment professionals may be assisted and how your contributions to the value creation process can be actualised.
Investment vehicles are any investment that can be made with the idea that by putting their money to work, the investor will enjoy some combination of a gain in the value of their money and a stream of cash flows. They may be formed with securities, such as shares, bonds, and warrants; real assets, such as gold, and real estate; or vehicles that combine wholly other investments.
Investors make direct investments when they acquire securities issued by firms and governments, and when they buy real, tangible assets, such as precious metals, art, real estate, or timber.
A typical approach to invest is through indirect investment vehicles. That is, investors send their money to investment firms, which subsequently invest the money in a variety of securities and assets on their behalf. Thus, investors make indirect investments when they acquire the securities of, or pay into, businesses, trusts, and partnerships that make direct investments. The following are instances of indirect investment vehicles:
Shares in mutual funds and exchange-traded funds
Limited partnership stakes in hedge funds
Asset-backed securities, such as mortgage-backed securities
Most indirect investment vehicles are pooled investments (also known as collective investment plans) in which participants pool their money together to enjoy the advantages of being part of a bigger group, with the pooling mediated by an investing professional. The associated economies of scale can greatly boost investment returns.
Both direct and indirect investments have advantages and disadvantages that investors need to assess. Direct investments have some advantages over indirect investments
Advantages of Direct Investments: -More control over decisions about investments -Manage to limit tax liabilities -Ability to select particular assets -High-quality guidance at a lesser cost for high-net-worth investors
Professionally managed -Small investors can use services of professional managers who they otherwise might be unable to afford -Share in the purchase and ownership of significant assets -Diversified portfolio -Less expensive to trade
Direct Investments
Investors exercise more control over direct investments than over indirect investments. Investors who hold indirect assets normally must accept all decisions made by the investment managers, and they can rarely have influence into such decisions.
Investors select when to buy or sell their direct investments to limit their tax responsibilities. In contrast, although the managers of indirect investments generally aim to limit the collective tax liabilities of their investors, they cannot simultaneously effectively serve all investors when their investors confront various tax circumstances.
Investors can choose not to invest directly in particular securities – for example, in stocks of companies that sell tobacco or alcohol. In contrast, indirect investors worried about such risks must choose investments with investment rules that include these limits.
Investors who are wealthy can typically acquire high-quality financial advice at a lesser cost when investing directly rather than indirectly.
Indirect Investments
Indirect investments are professionally managed. Professional management is particularly vital when direct investments are hard to find.
Indirect investments allow small investors to employ the services of expert managers, whom they otherwise could not afford to pay.
Indirect investments allow investors to join in the acquisition and ownership of major assets, such as skyscrapers. This benefit is especially crucial to small investors who cannot afford to buy huge assets directly.
Indirect investments allow investors to hold diversified pools of risks and so receive more reliable, but not necessarily greater, investment returns. Many indirect investment vehicles indicate ownership in many different assets, each of which normally is exposed to specific risks not shared by the others.
For example, a risk of investing in home mortgages is that the homeowners may default on their debts. Defaults on individual mortgages are highly unexpected, which makes keeping an individual mortgage quite dangerous. In comparison, the average default rate among a large sample of mortgages is significantly more predictable. Investing an amount in shares in a large mortgage pool is substantially less hazardous than investing the same amount in a single mortgage.
Indirect investments are often much less expensive to trade than the underlying assets. This cost benefit is especially significant for publicly traded investment vehicles that own very illiquid assets (i.e., cannot be acquired or sold fast without a considerable compromise in price).
Liquidity is one of the benefits of real estate investment trusts compared with real estate limited partnerships or real estate equity funds.Although the assets in which traded investment vehicles invest may be difficult to buy and sell, ownership shares in these vehicles can trade in liquid markets.
Is direct or indirect investment more profitable for investors?
It depends. Each investor and each investing firm must decide on the appropriate method given their individual demands and circumstances.
Investment Control Problems
Although the majority of investment managers strive faithfully to serve their clients, some are not always careful, attentive, or honest, which can lead to investment losses from inadequate research, lost opportunities, self-serving advice, or blatant fraud.
Insufficient Due Diligence
Investment managers who do not undertake sufficient research or due diligence may advise improper investments. Consider the scenario of a manager who buys a stock for a client portfolio purely based on the recommendation of a friend. It would be unacceptable for the manager to buy the stock without first completing full study and due diligence on the company.
Churning
Investment managers that receive commissions on trades that they recommend may conduct too many trades. Some managers have been known to sell and replace their whole portfolios once or more over the course of a year. Practitioners term this practice churning.
Self-Serving Managers
Investment managers may privilege themselves or their preferred clients above other clients when allocating trades that have been, or are likely to be, successful. For instance, a management might issue shares in an initial public offering that is projected to do well solely to preferred clients.
To successfully use the services of professional investment managers, investors must anticipate such challenges. Investors who do not wish to deal with these concerns sometimes prefer indirect investment vehicles, such as public mutual funds, for which a board of directors (or trustees) has main responsibility for monitoring the performance of the managers.
Although board members normally work honestly on behalf of their shareholders, some may be more devoted to the management they monitor than to the owners that they represent. Regardless, mutual fund managers often work hard for their investors. They are normally paid in proportion to the value of assets under management. Good performance draws further investors and serves to enhance their fees.
In contrast, large institutional investors are frequently direct investors who hire and oversee investment managers. These institutional investors can typically commit large resources to monitoring and appraising their managers.
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Investment - Security Market Indices
It is more practical to use a single metric that is indicative of the performance of the whole stock market rather than analyzing the performance of each and every security listed on the market to evaluate how the stock market did this week. The S&P 500 Index, the FTSE 100 (which is sometimes pronounced as "footsie"), the CAC 40, and the Korea Composite Stock Price Index (KOSPI) are a few examples.
An asset class, market segment, or security market is represented by an index of securities called a security market index. The aforementioned securities market indices are commonly available stock market indices. Many more indexes have also been developed by practitioners.
The Universe Index
To assess the values of practically every market, asset class, nation, and industry now in existence, the investment industry has developed indices.
Widespread Market Indices
Broad market indices often span a single nation or region and encompass an entire asset class, such as stocks or bonds.
Multiple-Market Indexes
Multi-market indices encompass a class of assets across numerous nations or areas.
Industry Indices
Single industries are covered by industry indexes.
Sector Indices
Sector indices encompass broad economic sectors, which are essentially groups of industries connected by shared goods or clients, such energy, transportation, or healthcare.
Style Indices
Style indices offer standards for popular investment management philosophies. Value or growth stock indices, small-, mid-, and large-capitalization stock indices, and combinations of these classifications, like small-cap growth, are a few examples of equity-style indices.
Fixed Income Indices
Debt securities are covered by fixed-income indices, which differ based on the issuers' and underlying securities' attributes. Bonds issued by corporations and governments, for instance, as well as short-, mid-, and long-term bonds, investment-grade and high-yield bonds, inflation-protected and convertible bonds, and asset-backed securities are all included in different indices.
Other Indices
Hedge funds, real estate investment trusts (REITs), and commodities are examples of alternative investments whose performance is tracked by other indices.
How to Determine an Indice's Value
The values of the securities that make up an index are used to calculate the index's value.
The value of an index is influenced by two significant factors:
The stocks that are part of the index
The weight that each index security is given
A limited number of stocks from a single sector or national market are included in certain indices.
For instance, the Dow Jones Utility Average (DJUA) only has 15 significant US company stocks from the utility sector, while the Dow Jones Industrial Average (DJIA) only contains 30 large US firm stocks.
Some indices incorporate hundreds or thousands of stocks from around the globe in an effort to take a bigger chunk of the securities market. For instance, the 1,508 equities from twenty-three developed markets make up the Morgan Stanley Capital International (MSCI) World Index as of December 2022. Be aware that an index's list of incorporated securities is subject to periodic revision. Index reconstitution is the process of adding and removing securities from the index.
An index's constituent stocks can be given weights using one of three methods: price, capitalization, or equal weighting.
A price-weighted index is one in which the price of each security is divided by the total of all the security prices to determine the weight allocated to each security.
Consequently, higher-priced equities are given more weighting and have a bigger impact on the index's value than lower-priced firms. Price-weighted indexes include the Nikkei 225 in Japan and the DJIA in the United States.
A large number of indexes are capitalization-weighted, sometimes referred to as market-weighted, value-weighted, or cap-weighted indices. The market capitalization of each securities determines the weight given to it. The market capitalization of a security is determined by multiplying its market price by the total number of outstanding shares of the asset. A stock has a market capitalization of USD5 billion if it trades for $50 per share and there are 100 million outstanding shares.
Larger corporations' securities carry a higher weight. Capitalization-weighted indices include the S&P 500 in the United States, the FTSE 100 in the United Kingdom, and the Hang Seng in Hong Kong.
Equal-weighted indices display the returns that would result from investing the same amount of money in each of the index's securities. These securities' prices fluctuate on a regular basis.
Therefore, periodic index rebalancing is required to preserve the equal weights among the equities.
Even when they concentrate on the same national market or sector, the differences in indices' value fluctuations can be explained by the fact that different indices include different securities and employ different methods to assign weights to the securities. For those who use an index, it is crucial to understand which securities are included in it and how much weight is given to each.
The index return is the percentage change in an index's value over a given period of time. Because index values are arbitrary, analysts place greater emphasis on index returns than on index values. For instance, on January 3, 1984, when the London Stock Exchange and the Financial Times launched the index, the FTSE 100's value was arbitrarily set at 1,000. Analysts are therefore more interested in the index's percentage movement than in its level at any given moment.
It is more practical to use a single metric that is indicative of the performance of the whole stock market rather than analyzing the performance of each and every security listed on the market to evaluate how the stock market did this week. The S&P 500 Index, the FTSE 100 (which is sometimes pronounced as "footsie"), the CAC 40, and the Korea Composite Stock Price Index (KOSPI) are a few examples.
An asset class, market segment, or security market is represented by an index of securities called a security market index. The aforementioned securities market indices are commonly available stock market indices. Many more indexes have also been developed by practitioners.
The Universe Index
To assess the values of practically every market, asset class, nation, and industry now in existence, the investment industry has developed indices.
Widespread Market Indices
Broad market indices often span a single nation or region and encompass an entire asset class, such as stocks or bonds.
Multiple-Market Indexes
Multi-market indices encompass a class of assets across numerous nations or areas.
Industry Indices
Single industries are covered by industry indexes.
Sector Indices
Sector indices encompass broad economic sectors, which are essentially groups of industries connected by shared goods or clients, such energy, transportation, or healthcare.
Style Indices
Style indices offer standards for popular investment management philosophies. Value or growth stock indices, small-, mid-, and large-capitalization stock indices, and combinations of these classifications, like small-cap growth, are a few examples of equity-style indices.
Fixed Income Indices
Debt securities are covered by fixed-income indices, which differ based on the issuers' and underlying securities' attributes. Bonds issued by corporations and governments, for instance, as well as short-, mid-, and long-term bonds, investment-grade and high-yield bonds, inflation-protected and convertible bonds, and asset-backed securities are all included in different indices.
Other Indices
Hedge funds, real estate investment trusts (REITs), and commodities are examples of alternative investments whose performance is tracked by other indices.
How to Determine an Indice's Value
The values of the securities that make up an index are used to calculate the index's value.
The value of an index is influenced by two significant factors:
The stocks that are part of the index
The weight that each index security is given
A limited number of stocks from a single sector or national market are included in certain indices.
For instance, the Dow Jones Utility Average (DJUA) only has 15 significant US company stocks from the utility sector, while the Dow Jones Industrial Average (DJIA) only contains 30 large US firm stocks.
Some indices incorporate hundreds or thousands of stocks from around the globe in an effort to take a bigger chunk of the securities market. For instance, the 1,508 equities from twenty-three developed markets make up the Morgan Stanley Capital International (MSCI) World Index as of December 2022. Be aware that an index's list of incorporated securities is subject to periodic revision. Index reconstitution is the process of adding and removing securities from the index.
An index's constituent stocks can be given weights using one of three methods: price, capitalization, or equal weighting.
A price-weighted index is one in which the price of each security is divided by the total of all the security prices to determine the weight allocated to each security.
Consequently, higher-priced equities are given more weighting and have a bigger impact on the index's value than lower-priced firms. Price-weighted indexes include the Nikkei 225 in Japan and the DJIA in the United States.
A large number of indexes are capitalization-weighted, sometimes referred to as market-weighted, value-weighted, or cap-weighted indices. The market capitalization of each securities determines the weight given to it. The market capitalization of a security is determined by multiplying its market price by the total number of outstanding shares of the asset. A stock has a market capitalization of USD5 billion if it trades for $50 per share and there are 100 million outstanding shares.
Larger corporations' securities carry a higher weight. Capitalization-weighted indices include the S&P 500 in the United States, the FTSE 100 in the United Kingdom, and the Hang Seng in Hong Kong.
Equal-weighted indices display the returns that would result from investing the same amount of money in each of the index's securities. These securities' prices fluctuate on a regular basis.
Therefore, periodic index rebalancing is required to preserve the equal weights among the equities.
Even when they concentrate on the same national market or sector, the differences in indices' value fluctuations can be explained by the fact that different indices include different securities and employ different methods to assign weights to the securities. For those who use an index, it is crucial to understand which securities are included in it and how much weight is given to each.
The index return is the percentage change in an index's value over a given period of time. Because index values are arbitrary, analysts place greater emphasis on index returns than on index values. For instance, on January 3, 1984, when the London Stock Exchange and the Financial Times launched the index, the FTSE 100's value was arbitrarily set at 1,000. Analysts are therefore more interested in the index's percentage movement than in its level at any given moment.
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Investment - Comparison of Pooled Investment Vehicles
We already mentioned that two major variations between pooled investment vehicles are whether they are exchange-traded and whether they are passively or actively managed. Other distinctions involve risks, management accountability, costs, and taxes.
All pooled investment vehicles are dangerous, although the risks associated with each investment vehicle mostly rely on the securities and other assets that it owns in its portfolio. These risks vary far more by the investment method than by how the investment vehicle is formed. In general, passively managed funds are less hazardous than actively managed funds that invest in the same asset class since investors in actively managed funds bear the risk that their managers may underperform the market for that asset class.
Closed-end funds generally are riskier than similar open-end mutual funds because the discounts and occasional premiums at which closed-end funds trade compared to their NAVs vary over time. Variation of these discounts and premiums raises the risk of holding closed-end funds. ETFs also sometimes trade at discounts and premiums to their NAVs, but these differences tend to be minor.
Management Accountability
Investors in indirect investment vehicles cannot choose who will manage their money, but they can choose the funds in which they invest. Investors aim to invest in funds run by managers that they trust, and to sell funds run by managers in whom they have lost confidence.
Management accountability is just a small concern for ETFs and for open-end mutual funds that use passive investing strategies because their managers have limited influence on portfolio performance.
Investors are more concerned about the responsibility of managers of actively managed open-end mutual funds and ETFs. Investors will remove their money from these funds if they are unsatisfied with the management, thus lowering the manager’s assets under management and the fee paid to the manager.
In contrast, managers of closed-end funds are largely protected from their shareholders. Shareholders can sell their shares to new investors, but the assets under management stay the same.
Costs The costs incurred by pooled investment vehicles are subtracted from their assets, decreasing their investment performance.
The major expenditures are those associated with management, distribution, and account maintenance. The level of management fees depends mostly on the style of asset management and the type of assets managed. Investors in passively managed funds normally pay lower management fees, whereas management fees for actively managed funds are usually higher.
Another form of cost is related with trade. Investors can trade most listed closed-end funds or ETFs at any moment they can find a counterparty ready to accept the other side of their trade. In contrast, investors in open-end mutual funds can trade only at the end of the day. They can place their orders at any time, but settlement occurs after the markets shut after the NAV has been calculated.
Investors who trade listed closed-end funds and exchange-traded funds often know the prices at which their trades can take place because market prices are known. They frequently utilize brokers to organize their trades and must pay commissions to them.
Tax Implications of Cash Distributions
Pooled investment vehicles normally disperse the income, primarily interest and dividends, that they get from holding securities as cash dividends to their investors. Capital gains are the upside that arise from selling a securities at a higher price than it was purchased at, and these vehicles also distribute any short- and long-term capital gains on their security trades as cash dividends.
Distributions provided on a per-share basis are the same for all investors, regardless of how long the shares have been held. Investors may choose, if the investment vehicle allows it, to reinvest these distributions rather than receive them. Investors should be mindful of the tax effect of these cash distributions because this can alter the return on their investment.
We already mentioned that two major variations between pooled investment vehicles are whether they are exchange-traded and whether they are passively or actively managed. Other distinctions involve risks, management accountability, costs, and taxes.
All pooled investment vehicles are dangerous, although the risks associated with each investment vehicle mostly rely on the securities and other assets that it owns in its portfolio. These risks vary far more by the investment method than by how the investment vehicle is formed. In general, passively managed funds are less hazardous than actively managed funds that invest in the same asset class since investors in actively managed funds bear the risk that their managers may underperform the market for that asset class.
Closed-end funds generally are riskier than similar open-end mutual funds because the discounts and occasional premiums at which closed-end funds trade compared to their NAVs vary over time. Variation of these discounts and premiums raises the risk of holding closed-end funds. ETFs also sometimes trade at discounts and premiums to their NAVs, but these differences tend to be minor.
Management Accountability
Investors in indirect investment vehicles cannot choose who will manage their money, but they can choose the funds in which they invest. Investors aim to invest in funds run by managers that they trust, and to sell funds run by managers in whom they have lost confidence.
Management accountability is just a small concern for ETFs and for open-end mutual funds that use passive investing strategies because their managers have limited influence on portfolio performance.
Investors are more concerned about the responsibility of managers of actively managed open-end mutual funds and ETFs. Investors will remove their money from these funds if they are unsatisfied with the management, thus lowering the manager’s assets under management and the fee paid to the manager.
In contrast, managers of closed-end funds are largely protected from their shareholders. Shareholders can sell their shares to new investors, but the assets under management stay the same.
Costs The costs incurred by pooled investment vehicles are subtracted from their assets, decreasing their investment performance.
The major expenditures are those associated with management, distribution, and account maintenance. The level of management fees depends mostly on the style of asset management and the type of assets managed. Investors in passively managed funds normally pay lower management fees, whereas management fees for actively managed funds are usually higher.
Another form of cost is related with trade. Investors can trade most listed closed-end funds or ETFs at any moment they can find a counterparty ready to accept the other side of their trade. In contrast, investors in open-end mutual funds can trade only at the end of the day. They can place their orders at any time, but settlement occurs after the markets shut after the NAV has been calculated.
Investors who trade listed closed-end funds and exchange-traded funds often know the prices at which their trades can take place because market prices are known. They frequently utilize brokers to organize their trades and must pay commissions to them.
Tax Implications of Cash Distributions
Pooled investment vehicles normally disperse the income, primarily interest and dividends, that they get from holding securities as cash dividends to their investors. Capital gains are the upside that arise from selling a securities at a higher price than it was purchased at, and these vehicles also distribute any short- and long-term capital gains on their security trades as cash dividends.
Distributions provided on a per-share basis are the same for all investors, regardless of how long the shares have been held. Investors may choose, if the investment vehicle allows it, to reinvest these distributions rather than receive them. Investors should be mindful of the tax effect of these cash distributions because this can alter the return on their investment.
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Investment - Exchange-Traded Funds
Exchange-traded funds (ETFs) are pooled investment vehicles that are normally passively managed to track a particular index or sector, but a rising number of ETFs are actively managed. ETFs are often managed by investment professionals who provide investing, managerial, and administrative services. The fees for these services and trading costs are cheap, particularly for ETFs that are passively managed.
Exchange-traded funds (ETFs) are pooled investment vehicles that are normally passively managed to track a particular index or sector, but a rising number of ETFs are actively managed. ETFs are often managed by investment professionals who provide investing, managerial, and administrative services. The fees for these services and trading costs are cheap, particularly for ETFs that are passively managed.
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Investment - Closed-End Funds
Closed-end funds do not issue or redeem shares on demand; in contrast to open-end funds, they have a fixed number of shares. These occurrences are rare, although they could repurchase shares or issue more shares through rights issues or secondary offerings. As a result, most closed-end funds rarely have a change in the total number of outstanding shares.
In initial public offers (IPOs), closed-end funds registered on exchanges sell shares to the general public in a manner akin to that of a company's stock sale. After that, they buy securities and other assets with the IPO proceeds. Investors use exchanges and dealers to buy or sell listed closed-end funds after the initial public offering (IPO). All that the closed-end fund does in these transactions is register the resulting changes in ownership. In the secondary market, investors purchase and sell shares at any price they can get.
Listed closed-end funds typically trade at prices that deviate from their net asset value (NAV) and are actively managed. If the trading price of a fund is less than its net asset value (NAV) or more than its NAV, the fund is said to trade at a premium. Because many closed-end fund investment managers have not been able to contribute more value to their funds than they lose due to various operating costs, discounts are more typical than premiums. The biggest of these expenses is usually the investment management fee. Accounting and other administrative service fees, as well as transaction costs for portfolios, are additional expenses.
Closed-end funds do not issue or redeem shares on demand; in contrast to open-end funds, they have a fixed number of shares. These occurrences are rare, although they could repurchase shares or issue more shares through rights issues or secondary offerings. As a result, most closed-end funds rarely have a change in the total number of outstanding shares.
In initial public offers (IPOs), closed-end funds registered on exchanges sell shares to the general public in a manner akin to that of a company's stock sale. After that, they buy securities and other assets with the IPO proceeds. Investors use exchanges and dealers to buy or sell listed closed-end funds after the initial public offering (IPO). All that the closed-end fund does in these transactions is register the resulting changes in ownership. In the secondary market, investors purchase and sell shares at any price they can get.
Listed closed-end funds typically trade at prices that deviate from their net asset value (NAV) and are actively managed. If the trading price of a fund is less than its net asset value (NAV) or more than its NAV, the fund is said to trade at a premium. Because many closed-end fund investment managers have not been able to contribute more value to their funds than they lose due to various operating costs, discounts are more typical than premiums. The biggest of these expenses is usually the investment management fee. Accounting and other administrative service fees, as well as transaction costs for portfolios, are additional expenses.
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Investment - Open End Mutual Funds
Many individual and institutional investors choose pooled investment vehicles like open-end mutual funds. Because the shares that comprise the fund can be issued or redeemed (repurchased) upon demand, these are known as open-end funds.
The fund issues new shares in exchange for the cash that investors deposit when they wish to make an investment. The fund redeems the investors' shares and gives them cash when current investors wish to take their money out. Purchases and sales by investors are viewed by the fund as deposits and redemptions, respectively.
The pricing at which deposits and redemptions take place in an open-end mutual fund are set by the manager. The price for deposits and redemptions on any given day is determined by the same formula for no-load funds, which do not impose deposit or redemption fees. This figure represents the fund's net asset value.
A fund's net asset value (NAV) is determined by dividing its entire net value—which is the sum of its assets less its liabilities—by the total number of outstanding units.
Every day after the regular close of exchange market trading, managers calculate the fund's net asset value (NAV). They evaluate the portfolio securities using the most recent recorded trading prices, and they typically release the NAVs a few hours after the market closes. Shares of mutual funds are only purchased or sold by investors after the NAV is determined at the end of the day.
The fund distributor, who sells the fund, may require sales loads from investors at the time of purchase, redemption, or over time. When purchasing shares in a fund, investors may be required to pay fees known as front-end sales loads. When investors sell shares in a fund that they have held for less than a predetermined amount of time, usually a year or more, they may be required to pay fees known as back-end sales charges. A proportion of the sales price is used to compute sales loads. Though it can go as high as 9%, the rate is typically about 3%. Generally, the fund distributor gets the fee and, unless they are prohibited by law from doing so, pays a portion of it to the investment manager and a portion to anyone who assisted in setting up the transaction.
Purchase or redemption fees are also assessed by certain funds. Rather than paying front-end or back-end sales loads, investors pay these costs to the fund. When other shareholders buy and sell the fund's shares, purchase and redemption fees cover the costs incurred by the fund for the existing shareholders. These expenses result from trading portfolio securities when purchasing securities with investor funds or when liquidating securities to generate funds for redemptions.
Money Market
Investors see money market funds, a particular kind of open-end mutual fund, as interest-bearing bank accounts without insurance. In contrast to other open-end mutual funds, money market funds are allowed by authorities to take deposits and fulfill redemptions at a fixed price per share, usually equal to one unit of the local currency (a euro per share in the eurozone, for example), provided that they fulfill specific requirements. They are only allowed to own money market securities, which are often relatively short-term, low-risk debt instruments issued by companies with excellent credit ratings. Money market funds are permitted by regulators to deliver their monthly income distributions to shareholders on a daily basis. These agreements guarantee that money market funds' NAVs stay very close to their fixed redemption price.
Funds for money markets are susceptible to an asset run. Investors may rush to redeem their shares before the NAV drops, especially if they anticipate that the value of their money market funds will drop soon. Because they compel funds to sell portfolio securities while the market is declining, these activities have the potential to produce instability.
Many individual and institutional investors choose pooled investment vehicles like open-end mutual funds. Because the shares that comprise the fund can be issued or redeemed (repurchased) upon demand, these are known as open-end funds.
The fund issues new shares in exchange for the cash that investors deposit when they wish to make an investment. The fund redeems the investors' shares and gives them cash when current investors wish to take their money out. Purchases and sales by investors are viewed by the fund as deposits and redemptions, respectively.
The pricing at which deposits and redemptions take place in an open-end mutual fund are set by the manager. The price for deposits and redemptions on any given day is determined by the same formula for no-load funds, which do not impose deposit or redemption fees. This figure represents the fund's net asset value.
A fund's net asset value (NAV) is determined by dividing its entire net value—which is the sum of its assets less its liabilities—by the total number of outstanding units.
Every day after the regular close of exchange market trading, managers calculate the fund's net asset value (NAV). They evaluate the portfolio securities using the most recent recorded trading prices, and they typically release the NAVs a few hours after the market closes. Shares of mutual funds are only purchased or sold by investors after the NAV is determined at the end of the day.
The fund distributor, who sells the fund, may require sales loads from investors at the time of purchase, redemption, or over time. When purchasing shares in a fund, investors may be required to pay fees known as front-end sales loads. When investors sell shares in a fund that they have held for less than a predetermined amount of time, usually a year or more, they may be required to pay fees known as back-end sales charges. A proportion of the sales price is used to compute sales loads. Though it can go as high as 9%, the rate is typically about 3%. Generally, the fund distributor gets the fee and, unless they are prohibited by law from doing so, pays a portion of it to the investment manager and a portion to anyone who assisted in setting up the transaction.
Purchase or redemption fees are also assessed by certain funds. Rather than paying front-end or back-end sales loads, investors pay these costs to the fund. When other shareholders buy and sell the fund's shares, purchase and redemption fees cover the costs incurred by the fund for the existing shareholders. These expenses result from trading portfolio securities when purchasing securities with investor funds or when liquidating securities to generate funds for redemptions.
Money Market
Investors see money market funds, a particular kind of open-end mutual fund, as interest-bearing bank accounts without insurance. In contrast to other open-end mutual funds, money market funds are allowed by authorities to take deposits and fulfill redemptions at a fixed price per share, usually equal to one unit of the local currency (a euro per share in the eurozone, for example), provided that they fulfill specific requirements. They are only allowed to own money market securities, which are often relatively short-term, low-risk debt instruments issued by companies with excellent credit ratings. Money market funds are permitted by regulators to deliver their monthly income distributions to shareholders on a daily basis. These agreements guarantee that money market funds' NAVs stay very close to their fixed redemption price.
Funds for money markets are susceptible to an asset run. Investors may rush to redeem their shares before the NAV drops, especially if they anticipate that the value of their money market funds will drop soon. Because they compel funds to sell portfolio securities while the market is declining, these activities have the potential to produce instability.
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Investment - Long and Short Positions
Purchasing stock is what we call "taking a position" as an investor. However, investors have other options as well. They can pledge to purchase a stock at a later time and pay the seller money for it. With the majority of assets and securities, one can adopt either a buying or an owing position. The amount of a security or asset that an individual or organization owns or owes is referred to as their position. Typically, a portfolio of investments consists of numerous positions.
When an investor owns securities or assets, they are considered to be in a long position. Belonging to real assets, bonds, currencies, commodities, shares, and commodities are examples of long positions. The value of long holdings rises as prices climb. On the other hand, positions that appreciate in value as prices decline are referred to as short positions. Investors who wish to take short positions must sell securities or other assets they do not own by borrowing them, selling them, and then buying them back to give the owner.
To profit from a decline in the securities' price, short sellers build holdings in the securities. Initially, they take securities from long-position investors. Security lenders are investors who lend their securities. The borrowed securities are subsequently sold to other traders by short sellers. By repurchasing the securities and giving them back to the security lenders, they close, or exit, their holdings.
The short seller makes money if the price of the securities has dropped since they can now buy the securities for less than they were originally sold for. But short sellers will lose money if the price of securities increases. Short sellers are said to cover their positions when they buy back the securities.
In general, a long position has theoretically infinite gains. Successful businesses might see multiple increases in their share values. But unless the position is backed by borrowings (debt), the maximum losses in a long position are limited to 100%, or the total loss of the initial investment.
Potential gains and losses in a long position are mirrored in a short position's potential losses and gains. Put differently, the possible profits from a short position are restricted to 100%, for example, in the event that the share price drops to zero, but the possible losses, on the other hand, are unbounded when the share price rises. Short positions can be extremely dangerous due to their limitless potential losses.
For the duration of the loan, security lenders do not actually own the securities they lend, despite their perception to the contrary. Rather, the pledges to return the securities offered by the short sellers belong to the security lenders. Security lending agreements contain records of these commitments. According to these agreements, the security lenders will receive all dividends and interest that the short sellers would have received if they hadn't borrowed the securities. We refer to these payments as "payments in lieu of interest" or "payments in lieu of dividends."
Counterparty risk is the possibility that one of the parties to a contract won't fulfill their end of the bargain. This risk affects security lending. Security lenders bear the risk that short sellers won't return the securities if their price increases, so in order to reduce counterparty risk, they require short sellers to deposit the short sale proceeds with them as collateral for the loan. When the price of the securities increases, short sellers will need to produce more collateral to secure the loan. Collateral is defined as assets that a borrower commits to the lender. On the other hand, if the price of the securities drops, short sellers bear the risk that the security lenders won't return the collateral; on the other hand, if the price of the securities drops, the security lenders are required to repay some of the collateral.
Purchasing stock is what we call "taking a position" as an investor. However, investors have other options as well. They can pledge to purchase a stock at a later time and pay the seller money for it. With the majority of assets and securities, one can adopt either a buying or an owing position. The amount of a security or asset that an individual or organization owns or owes is referred to as their position. Typically, a portfolio of investments consists of numerous positions.
When an investor owns securities or assets, they are considered to be in a long position. Belonging to real assets, bonds, currencies, commodities, shares, and commodities are examples of long positions. The value of long holdings rises as prices climb. On the other hand, positions that appreciate in value as prices decline are referred to as short positions. Investors who wish to take short positions must sell securities or other assets they do not own by borrowing them, selling them, and then buying them back to give the owner.
To profit from a decline in the securities' price, short sellers build holdings in the securities. Initially, they take securities from long-position investors. Security lenders are investors who lend their securities. The borrowed securities are subsequently sold to other traders by short sellers. By repurchasing the securities and giving them back to the security lenders, they close, or exit, their holdings.
The short seller makes money if the price of the securities has dropped since they can now buy the securities for less than they were originally sold for. But short sellers will lose money if the price of securities increases. Short sellers are said to cover their positions when they buy back the securities.
In general, a long position has theoretically infinite gains. Successful businesses might see multiple increases in their share values. But unless the position is backed by borrowings (debt), the maximum losses in a long position are limited to 100%, or the total loss of the initial investment.
Potential gains and losses in a long position are mirrored in a short position's potential losses and gains. Put differently, the possible profits from a short position are restricted to 100%, for example, in the event that the share price drops to zero, but the possible losses, on the other hand, are unbounded when the share price rises. Short positions can be extremely dangerous due to their limitless potential losses.
For the duration of the loan, security lenders do not actually own the securities they lend, despite their perception to the contrary. Rather, the pledges to return the securities offered by the short sellers belong to the security lenders. Security lending agreements contain records of these commitments. According to these agreements, the security lenders will receive all dividends and interest that the short sellers would have received if they hadn't borrowed the securities. We refer to these payments as "payments in lieu of interest" or "payments in lieu of dividends."
Counterparty risk is the possibility that one of the parties to a contract won't fulfill their end of the bargain. This risk affects security lending. Security lenders bear the risk that short sellers won't return the securities if their price increases, so in order to reduce counterparty risk, they require short sellers to deposit the short sale proceeds with them as collateral for the loan. When the price of the securities increases, short sellers will need to produce more collateral to secure the loan. Collateral is defined as assets that a borrower commits to the lender. On the other hand, if the price of the securities drops, short sellers bear the risk that the security lenders won't return the collateral; on the other hand, if the price of the securities drops, the security lenders are required to repay some of the collateral.
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Investment - Market Structures - Order Driven Markets
Order Matching: Order-driven markets use rules to match buy and sell orders in order to arrange deals. Usually, the orders include the quantity that the traders wish to purchase or sell, as well as possible price details like the highest amount the buyer is willing to pay or the lowest amount the seller will take.
Algorithms are now largely used by computers to conduct the matching.
Trades are frequently made between strangers because rules match buyers and sellers. Order-driven markets, meanwhile, are dependent on settlement mechanisms to guarantee that buyers and sellers fulfill their trading obligations and complete their security deals.
Otherwise, if a shift in the market made settlement unprofitable, dishonest traders would not fulfill their obligations.
Order Matching: Order-driven markets use rules to match buy and sell orders in order to arrange deals. Usually, the orders include the quantity that the traders wish to purchase or sell, as well as possible price details like the highest amount the buyer is willing to pay or the lowest amount the seller will take.
Algorithms are now largely used by computers to conduct the matching.
Trades are frequently made between strangers because rules match buyers and sellers. Order-driven markets, meanwhile, are dependent on settlement mechanisms to guarantee that buyers and sellers fulfill their trading obligations and complete their security deals.
Otherwise, if a shift in the market made settlement unprofitable, dishonest traders would not fulfill their obligations.
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Investment - Market Structure - Quote-Driven Markets
Investors trade with dealers in quote-driven marketplaces, also known as dealer markets or price-driven markets. The fact that investors transact with dealers at the prices such dealers quote gives these markets their name. The majority of spot commodities—commodities whose trades provide for instant delivery—as well as almost all bonds and currencies trade in quote-driven marketplaces.
Because securities were once physically exchanged over a counter in the dealer's office, quote-driven markets are also referred to as over-the-counter (OTC) markets. In today's OTC markets, the majority of deals are made over the phone, online, or through instant messaging apps.
Investors trade with dealers in quote-driven marketplaces, also known as dealer markets or price-driven markets. The fact that investors transact with dealers at the prices such dealers quote gives these markets their name. The majority of spot commodities—commodities whose trades provide for instant delivery—as well as almost all bonds and currencies trade in quote-driven marketplaces.
Because securities were once physically exchanged over a counter in the dealer's office, quote-driven markets are also referred to as over-the-counter (OTC) markets. In today's OTC markets, the majority of deals are made over the phone, online, or through instant messaging apps.