Mutual Funds and ETFs

Investment Strategies and Portfolio Management

Overview of Investment Approaches

• Investors manage pools of investments, known as portfolios, to achieve specific objectives.

• Limited Partnerships (LPs) are used for pooling funds managed by specialized investment managers, typically available only to accredited investors with limited liquidity.

• Mutual funds serve individual investors and are managed by investment companies that handle subscriptions and redemptions daily.

Exchange-Traded Funds (ETFs)

• ETFs are similar to mutual funds but trade on stock markets; they can be actively managed or designed to emulate an index.

• Active management involves selecting stocks with the aim of outperforming benchmarks, while passive strategies invest in the market without active management.

Investment Strategy Categories

• Rule-based management combines elements of active and passive strategies using predetermined rules for asset selection.

• The Fidelity Fund is highlighted as an example of an actively managed equity fund focused on long-term growth.

Performance Evaluation

• The Fidelity Fund has outperformed its benchmark, the S&P 500 Total Return Index, over five years but may underperform in shorter time frames.

• Studies indicate that 70% to 80% of active managers fail to beat their benchmarks over a decade, making manager selection critical.

Emergence of Index Funds

• Vanguard pioneered the first index mutual fund, leading to the development of ETFs that behave like mutual funds but trade on exchanges.

• The largest ETF globally is based on the S&P 500 Index (the Spider), which has a low expense ratio compared to actively managed funds.

Hybrid Strategies in ETFs

• An example is the iShares Russell 1000 Value ETF from BlackRock, which tracks lower growth and valuation multiples within the Russell 1000 index.

Advantages of ETFs

• ETFs offer low costs due to minimal management fees; for instance, the Russell 1000 ETF has an expense ratio significantly lower than traditional funds.

How Do ETFs Achieve Market Liquidity?

Understanding ETF Market Dynamics

• ETFs (Exchange-Traded Funds) provide liquidity for investors, allowing units to be traded at any time. They are designed to maintain a value that reflects the underlying shares in the index.

• To ensure liquidity, ETF managers appoint market makers who facilitate the buying and selling of ETF units. When demand increases, market makers acquire stocks representing the index and supply equivalent ETF units back to the market.

• The high liquidity of underlying shares simplifies this process, ensuring that the fund's market value closely aligns with its index value. Conversely, if many investors sell their units, shares are sold off to maintain balance.