Characteristics, Uses and Taxation of Investments - Pooled and Managed Investments

E. Pooled and Managed Investments: broadly defined, these are funds that pool investors' contributions to them. Professional investment managers invest the funds according to a particular strategy with certain objectives.

  1. Exchange Traded Funds (ETFs): [Noteworthy is that these are not to be confused with exchange funds, a vehicle used to unwind or monetize large concentrated stock positions. "Exchange funds allow investors a tax-free means to diversify a low-cost-basis and/or restricted stock position. Exchange funds allow investors to pool their low-cost-basis stocks in a fund. In exchange for contributing their stock to the fund, each investor owns a pro-rata share of the fund. After a set period of time - generally seven years - investors can redeem their interest in the fund. They will receive a non-taxable, distribution of a diversified pool of stock from the fund's portfolio. The value of this distribution is equal to the net asset value of their pro-rata interest in the fund at the time of the distribution. The stock distributed from the fund will retain in the aggregate the low cost basis of the stock originally contributed to the fund. There is always the possibility that the U.S. tax code could change, disallowing the favorable tax treatment of exchange funds. These changes could be retroactive, although this is believed to be unlikely." The reader will find a more detailed discussion of strategies used to diversify concentrated stock positions in Chapter Nine of the Investment Planning section of the study guide entitled "Asset Allocation and Portfolio Diversification".]: these are publicly traded, passively managed funds which track the performance of an index, sector or region. They may be purchased on margin and sold short without being subject to the uptick rule. Because these are index type funds, their expense ratio is quite low. Additionally, because of their passive nature, turnover is quite low resulting is fewer taxable distributions than most mutual funds. A form of closed end fund, redemption is accomplished through sale on an exchange rather than from tendering units to a mutual fund company. Because they throw off little income, exchange-traded funds may be more suitable for taxable accounts, though the tax decision is but one consideration of an investor's policy considerations.
  2. Unit Investment Trusts: these are registered investment companies that are liquidate themselves, are passively managed and may invest in equities, fixed income or other securities. The units generate dividend and interest income and principal as fixed income securities mature. Securities selected for inclusion in the trust are held to maturity.
  3. Mutual Funds: a mutual fund is an investment company that pools money from shareholders and invests in a diversified portfolio of securities [Pozen, Robert C. The Mutual Fund Business, The MIT Press 1998 p.16]. A type of management investment company, mutual funds manage the portfolio either actively through the selection of securities according to a specified discipline or passively by tracking an index of securities.
    1. Mutual fund essentials
      1. Mutual funds are one of three types of investment company.
        1. Unit Investment Trust
        2. Closed-End
        3. Open-End (mutual fund)
      2. Investment companies are non-taxable, conceptually similar to partnerships and subchapter S corporations in terms of their tax treatment in that they pass through interest income, dividends and capital gains to the shareholders in the fund. Qualifications for the investment company to meet to maintain favorable tax treatment include
        1. The investment company needs to earn at least 90% of its income from interest, dividends and capital gains on the securities in which it invests.
        2. The investment company must distribute at least 90% of its taxable income to its shareholders.
        3. Not more than 25% of the value of the fund's total assets may be invested in the securities of one issuer.
Mutual Fund Expenses
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