Question

1. Identify 3 of the 5 advantages of using investment funds over making an investment in an individual security.
2. Explain briefly why the returns earned by investors in index funds has typically been higher than the returns earned by investors in traditional mutual funds.
3. In February of 2019, you bought 800 units in an actively managed mutual fund for $24.66 each. As a result of your purchase, the number of units outstanding was 1,240,768. Over the last 12 months, the fund earned a 42% return, increased asset under management by 288%, and incurred $0.88 per unit in management fees (paid at the end of the period). What is the fund’s current NAV?
4. What is the main difference between a mutual fund and an ETF? (1 mark)
5. Why did ETFs not exist in the 1950s? (1 mark)

Answer 1

a) 1. Investment fund house charges a small management fees when you invest in the fund. This Fees is used to hire a professional portfolio manager who would manage the fund's portfolio, investing the assets defined in the mandate. As the fund has multiple investors, this fees gets divided among all the investors, making it very small for each investor. So this is affordable and can be invested with minimum investment skills

2) Diversification - Funds invest in numerous securities and/or sectors depending on the type of fund (Large cap, Energy sector). Investing in one security is very risky. (Dont put all your eggs in one basket). Few funds also invest in stocks, bonds and other asset classes, reducing the overall risk by diverisfication.

3) Funds are easy to buy and understand. The minimum investment is kept at a very low amount which make sin affordable to many people. They are also liquid, can be bought and sold any day.

b) Index funds invests in securities which are present in the index which it tracks Eg. S&P 500. It provides a broad market exposure as the index composition consists of securities across various sectors. This strategy is a passive investment strategy which doesnt involve a portfolio manager to research on which security to invest in (Like traditional mutual funds where the manager needs to decide which security to invest im). Thus the cost of expenses is less in index fund compared to traditional mutual funds.

c) Current NAV = $34.14 per unit

	Beginning period	End of period	Change
NAV	24.66	35.0172	42%
No of units	1240768	4814180	288
Expense per unit		0.88
Current NAV (NAV - expense)	24.66	34.14

d) Mutual funds are usually actively managed funds which attempts to over perform the index (Benchmark) and provide a profit to the investors. Its bought/sold between investors and fund houses and NAV is determined at the end of the day. ETFs are passively managed which tracks broad market/specific sectors and they can be bought and sold like stocks thoughout the day.

e) ETF were invented only after 1990 hence not avialable to investment in 1950s