Question

a. Describe the following: front-end load, back-end load, level load, 12b-1 fee, management fee. b. Why do mutual funds have different classes of shares? c. What are the advantages of an ETF relative to open-end and closed-end investment companies?

Answer 1

A.) Front-End Load - A front-end load is a commission or sales charge applied at the time of the initial purchase of an investment. The term most often applies to mutual fund investments, but may also apply to insurance policies or annuities. The front-end load is deducted from the initial deposit, or purchase funds and, as a result, lowers the amount of money actually going into the investment product.

Back-End Load - A back-end load is a fee paid by investors when selling mutual fund shares, and it is expressed as a percentage of the value of the fund's shares. A back-end load can be a flat fee or gradually decrease over time, usually within five to ten years. In the latter case, the percentage is highest in the first year and falls until it drops to zero.

Level Load - The level load is a charge imposed by mutual funds on investors. The fee is collected by intermediaries towards the distribution and marketing costs of a mutual fund.The level load is an annual charge for owning mutual fund units. The load reduces an investors profit from the mutual fund investment. The load is calculated as a percentage of the mutual fund holding.

12b-1 Fees - A 12b-1 fee is an annual marketing or distribution fee on a mutual fund. The 12b-1 fee is considered to be an operational expense and, as such, is included in a fund's expense ratio. It is generally between 0.25% and 0.75% (the maximum allowed) of a fund's net assets. The fee gets its name from a section of the Investment Company Act of 1940.

Management Fees - A management fee is a charge levied by an investment manager for managing an investment fund. The management fee is intended to compensate the managers for their time and expertise for selecting stocks and managing the portfolio. It can also include other items such as investor relations (IR) expenses and the administration costs of the fund.

B.) Some Mutual funds have different classes of shares because :

But each class has different shareholder services and/or distribution arrangements with different fees and expenses. Because of the different fees and expenses, each class will likely have different performance results. A multi-class structure offers investors the ability to select a fee and expense structure that is most appropriate for their investment goals (including the time that they expect to remain invested in the fund).

Here are some key characteristics of the most common mutual fund share classes offered to individual investors:

Class A shares typically charge a front-end sales load, but they tend to have a lower 12b-1 fee and lower annual expenses than other mutual fund share classes. Some mutual funds reduce the front-end load as the size of the investment increases. These discounts are called breakpoints

Class B shares typically do not have a front-end sales load. Instead, they may charge a back-end sales load and a 12b-1 fee (along with other annual expenses). The most common type of back-end sales load is the “contingent deferred sales load,” also referred to as a “CDSC” or “CDSL.” Typically the amount of the contingent deferred sale load decreases the longer an investor holds the shares.Class B shares also might convert automatically to a class with a lower 12b-1 fee and no contingent deferred sales load if the investor holds the shares long enough.

Class C shares might have a 12b-1 fee, other annual expenses, and either a front-end or back-end sales load. But the front-end or back-end load for Class C shares tends to be lower than for Class A or Class B shares, respectively. Unlike Class B shares, Class C shares generally do not convert to another class; as a result, the back-end load will not decrease over time. Class C shares tend to have higher annual expenses than either Class A or Class B shares.

C.) Advantages of an ETF relative to open-end and closed-end investment companies :

There are numerous advantages to ETFs, especially when compared to their mutual fund cousins like open ended or close ended investment companies .

1. Diversification

One ETF can give exposure to a group of equities, market segments, or styles. An ETF can track a broader range of stocks, or even attempt to mimic the returns of a country or a group of countries.

2. Trades Like a Stock

Although the ETF might give the holder the benefits of diversification, it has the trading liquidity of equity. In particular:

• ETFs can be purchased on margin and sold short.
• ETFs trade at a price that is updated throughout the day. An open-ended mutual fund, on the other hand, is priced at the end of the day at the net asset value.
• ETFs also allow you to manage risk by trading futures and options just like a stock.

Because ETFs trade like a stock, you can quickly look up the approximate daily price change using its ticker symbol and compare it to its indexed sector or commodity. Many stock websites also have better interfaces for manipulating charts than commodity websites, and even provide applications for your mobile devices.

3. Lower Fees

ETFs, which are passively managed, have much lower expense ratios compared to actively managed funds, which mutual funds tend to be. What drives up a mutual fund's expense ratio? Costs such as a management fee, shareholder accounting expenses at the fund level, service fees like marketing, paying a board of directors, and load fees for sale and distribution.

4. Immediately Reinvested Dividends

The dividends of the companies in an open-ended ETF are reinvested immediately, whereas the exact timing for reinvestment can vary for index mutual funds. (One exception: Dividends in unit investment trust ETFs are not automatically reinvested, thus creating a dividend drag.)

5. Limited Capital Gains Tax

ETFs can be more tax-efficient than mutual funds. As passively managed portfolios, ETFs (and index funds) tend to realize fewer capital gains than actively managed mutual funds. Also, when an ETF buys or sells shares, it's considered an in-kind redemption and does not result in a tax charge.

Mutual funds, on the other hand, are required to distribute capital gains to shareholders if the manager sells securities for a profit. This distribution amount is made according to the proportion of the holders' investment and is taxable. If other mutual fund holders sell before the date of record, the remaining holders divide up the capital gain and thus pay taxes even if the fund overall went down in value.

6. Lower Discount or Premium in Price

There is a lower chance of ETF share prices being higher or lower than their actual value. ETFs trade throughout the day at a price close to the price of the underlying securities, so if the price is significantly higher or lower than the net asset value, arbitrage will bring the price back in line. Unlike closed-end index funds, ETFs trade based on supply and demand and market makers will capture price discrepancy profits.