Financial markets homework help. TASK BRIEF • The assignment consists of 2 questions

 
 PART 1

1. Mutual funds are investment portfolios that are managed by professional money managers, the concept of this type of fund is to pool money from many investors in order to invest it on many different securities such as stocks (equity fund), bonds (fixed income fund), mix of stocks and bond (balanced fund). Some mutual funds are also specialized on specialized mandates such as commodities, real estate or socially responsible investing. Those different types of securities are hold into
   Mutual funds portfolios have different objectives regarding their investments and what they have promised to their clients but their main goal at the end of the day is to generate capital gains or income for the investors.
   On the other hand an ETF (exchange traded fund) is an investment fund involving a basket of securities mostly composed of stocks , bonds or commodities that you can trade through the stock exchange or via a brokerage firm.
   Those two funds share the  similarity of being a smart option for investor to diversify their portfolios and prevent risk because both funds consist on baskets composed different assets.
   They also share the similarity of having different types within a mutual fund or ETF’S, for example we have 2 types of mutual funds which are open-ended funds and closed-end funds. Within the EPF’S we have 3 different types which are exchange traded open index mutual fund, exchange traded unit investment trust and exchange traded grantor trust.
   However , there is a difference in the way those funds are managed as mutual funds can be purchased when a trading day is about to end based on a fix calculated price which means that they can be either sold or bought only one time per day and on top of that they are managed by professional money managers (active managing).
   ETF’s way of management is different as they are passive and depend on a specific market index and in addition to that, ETF’s are traded in the stock exchange.
   This management style difference lead to different fees , we tend to have higher fees and expense ratios for mutual funds and the minimum investment required is higher than the one required for ETF’S but this of course depends on the company and the fund type.
   The last difference we can state is that mutual funds transactions occur directly between investors and the fund while for ETF’s , shares are traded between investors.
   b) Among the many advantages we have In investing in mutual funds we can state the following ones :

 

• High Flexibility: There is a possibility to switch between portfolios according to your objectives and the market conditions and for a very little fee. This is allowed because mutual funds companies are responsible for the managing of many different types of funds which allows you to switch when you feel the need.
• Liquidity: The fact that units and shares within a mutual fund have this particularity to be traded during any day of the week (business days of course), this allows to investors to have a fast and easier access to their investments.
• Managed Professionally: One of the main advantages is that mutual funds are managed by professionals which means that once investors have put their money, they do not have to worry anymore about finding new opportunities and investments. Everything will be done for them.
• Affordable for anyone: Depending on the mutual funds and the type of units and shares you want to buy; you can start with a small amount of money.
• High Diversification: Mutual funds are not that risky as they can manage safely different types of securities coming from many investors which means that this decrease the risk of facing a loss or losing all your capital thanks to their portfolio diversification.

 
Mutual funds have many advantages but we also have a few disadvantages , for example it’s not worth it to withdraw your investment in a short term window period because you will be losing more with the sales commissions and the fees due to your investment redemption than if you were letting your investment evolve in the long-term = No short term redemption advantage.
Another disadvantage is that fees are higher for mutual funds because of the services and management provided no matter if the fund make gains or not … and this can decrease your return on investment .
The last disadvantage is that all mutual funds are not providing what they promise and actually only a very few mutual fund professionals are able to provide capital gains in the long term which means that you placed your investment capital in the hand of someone and you can never be sure of the outcome.
 
On another hand, the ETF advantages are :
 

• Costs are lower than mutual funds: As ETF’s are managed in a passive way (unlike mutual funds), they have lower fees such as lower expense ratios.
• Immediate dividends reinvestment : The dividend made by a company in an ETF are used to reinvest them instantly which gives you a potential higher growth in the long-term.
• Tax-efficient: Unlike mutual funds, ETF’s capital gains are not being tax charged as they not have high capital gains.
• High Liquidity: ETF’s are trades in the stock exchange market which means that they can be traded at any time of the day as long as the stock market is still open and during that period of the day , the market Is highly volatile and give many opportunities to investors.
• ETF’s value can’t be under or overvalued: if the price is higher than the net asset value, an automatic arbitrage drives down or up the price to its most adequate value.

 
 
Among the disadvantages we can count the following ones such as:
 

• Lack of diversification: ETF’s are appropriate for the US market but it’s more difficult for foreign investments as they are limited to large-cap stocks.
• Low volatility and volume: This doesn’t apply for all the ETF’s , some have are volatile and have high volume as they are traded In the stock market but some ETF’s do have low volatility and volume for the same reason. Depending on the trader’s objectives and trading style, low volatility could be considered as an advantage or a disadvantage.
• Risky: If an investor don’t take the time to research about an ETF and analyze it carefully, he can end up buying a risky asset made of risky securities.
• Cost presence: ETF fees are considered as an advantage compared to mutual funds costs but if we compare ETF’s cost with the investment of a specific stock, we’ll be having higher costs.
• Low dividend yields: ETF’s investments are less risky than mutual funds but the dividend yield is lower and even lower than if you were investing on a group of high yielding stock…
• The bottom line : ETF’s are facing limitations concerning diversification and dividends as they’re based on an index.

 
 

1. The difference between an active and a passive management is that an active one such as mutual funds for example are managed by a professional manager or a management team which are responsible of decision making regarding how they’re going to invest the money that investors pooled into the fund. They’re work is based on buying and selling securities and stocks with the objective of outperforming an index in order to make high returns and capital gains for the investors.
   A mutual fund success which is actively managed depend on the portfolio manager skills and knowledge of the market and a fee has to be paid by investors for the service provided.
   Passive management such as ETF’s for example is different as they’re not managed in a proactive manner as they follow a specific index such as the S&P 500 for instance and the return on investment will depend on how this index is performing. This explain the lower fees charged for ETF’s compared to mutual funds.

 
 
 
PART 2
 

1. The Morningstar Style Box (MSB) is composed of a 9 square grid which provides to investors information about the investment style (risk preference, value orientations, growth…) of different mutual funds and stocks.
   The MBS helps investors and analysts to have a better knowledge and make better investments decisions as they have access thanks to that tool to an exact classification of securities that are made according to certain factors.
   It gives securities classification such as stocks and stock funds that can be seen through a vertical axis which is a classification based on market capitalization and an horizontal axis which is based on growth and value factors.
   The main objective is to provide a visual representation of stock and funds in an accessible manner that can be understood by investors, analysts and advisors in order for them to have useful information to build their portfolios or their client’s portfolios.

 

5. Each mutual fund passes through a clear rating system in which they receive a star ranking based on the fund’s previous performances going on a scale from 1 to 5.
   The rating is based on a comparison of the funds with their peers and the returns are evaluated according to the risk level that mutual fund managers have to face to generate those return on investment.
   The ratings go in a sort of curve system where the top 10% funds collect a 5 star rating, the following 22,5% collect 4 stars, the 35% in the middle 3 stars , then the next 22.5 % collect 2 stars and the last 10% which are the less performing funds receive a 1 star rating.
   None of the ratings received by a mutual fund is based on random statistics or facts but they are all carefully examined and risk-adjusted. There is a relativity on those ratings because each fund rating is compared to its peer and rated according to this comparison and the past performances of the peer funds as we mentioned before.
   Logically, the top 10% funds are the less risky ones and have a lower return than the last 10% funds which are the most risky ones and provide a higher return.

 
 
c)

Financial markets homework help