This page of our SIE Study Guide covers packaged products such as mutual funds, exchange traded funds, and variable life insurance.
When the term packaged is used in the securities industry, it’s best to think of these investments as a collection of stocks and/or bonds, more often referred to as a portfolio of securities. Investment companies will package a portfolio of stocks and/or bonds and then offer shares of that portfolio for purchase by the investing public. The basic types of investment companies are described below.
Most mutual funds are open-ended, meaning any investor can invest as much as they would like into shares of the portfolio/the fund. The price of the fund (the net asset value or NAV) is calculated as the total value of the fund’s securities divided by its number of outstanding shares and can fluctuate on a daily basis. Note that investors own shares of the fund itself rather than the actual underlying securities.
Many mutual funds are actively managed, meaning one or more portfolio managers (typically investment firms) make the decisions to buy or sell specific securities. They are assisted in these decisions by a team of research analysts.
Some mutual funds offer different share classes which have the same objectives and invest in the same securities but charge different fees and expenses depending on when the investor would prefer to pay them. The four main share classes are Class A, Class B, Class C, and Class D. Class A shares, for example, typically require a front-end fee at the time of purchase while Class B shares typically require a back-end fee at the time of sale.
There is often a purchase minimum for buying into mutual funds. This minimum can range from $500 to $5,000 for retail funds, though such is commonly waived for mutual funds purchased through retirement accounts like IRAs or 401(k)s.
There are several expenses associated with mutual funds. These can be found in the fund’s prospectus and may include sales loads, redemption fees, account fees, management fees, and more. Total annual fund operating expenses will be listed as a percentage of the fund’s assets under management. On average, actively managed equity mutual funds charge between 0.5% and 1.0%.
A prospectus is a pamphlet that provides information about a fund. Investment companies are required to deliver a prospectus to investors prior to accepting investments into the funds. Key information contained in a prospectus will include the fund’s objectives, managers, securities held, minimum investment amounts, fees, and more.
For traditional mutual funds, orders are executed after market close each day, typically 4:00 PM Eastern Standard Time (EST), at a purchase price based upon the NAV. Those who wish to buy or sell fund shares must therefore place their orders prior to 4:00 PM EST.
A principal of a FINRA member firm must approve all mutual fund advertisements prior to their distribution and, in the event the firm has been a member for less than a year, the advertisement must be filed with FINRA ten days before it may be used.
Mutual funds, and other regulated investment companies, have certain disclosure requirements. On a quarterly basis they must report the complete lists of their holdings using SEC Forms N-Q and N-CSR, no later than 60 days after the fiscal quarter ends. Mutual funds may also decide to disclose their assets under management, performance, net asset value, or other information.
There are many different types of mutual funds though most will belong to one of the following four categories: money market funds, bond funds, stock funds, and target date funds. Each category comes with its own objectives, strategies, and risks.
- Money market funds are required by law to invest only in specific high-quality, short-term debt investments issued by governments, banks, or corporations, and as such are considered one of the safest investments.
- Bond funds are considered riskier than money market funds but safer than stock funds. They invest in a portfolio of government and/or corporate debt securities with the goal of generating monthly income (returns) for investors through interest payments.
- Stock funds (also known as equity funds) invest in corporate stocks and, while they have a greater potential for growth, they are also riskier by nature. There are several different types of stock funds that have different goals. Growth funds, for example, aim to invest in stocks believed to bring greater returns. Industry funds focus on corporate stocks in a specific industry such as agriculture or energy.
- Target date funds are designed for investors who are saving for retirement with a certain date in mind. They invest in a mix of equity, debt, and other investments that rebalances to become much more conservative as the target date approaches.
Index funds are similar to mutual funds in that they both invest in a portfolio of securities and then offer shares of those portfolios for sale to investors. Mutual funds, however, are actively managed whereas index funds are passively managed and thus typically have lower expenses. For this reason, index funds may be popular with newer investors looking to diversify.
The objective of an index fund is to replicate the performance of a particular stock market index (which is referred to as the benchmark), such as the S&P 500 or Dow Jones, by purchasing all the securities that the index tracks. Advantages of index funds include passive management, lower costs, and lower taxes compared to traditional mutual funds since fewer trades lead to fewer capital distributions. Index funds have grown significantly in popularity, but they don’t come without risks which may include low investment flexibility, inaccurate index tracking, and volatility.
Closed-End Funds (CEFs)
CEFs issue a finite—or limited—number of available fund shares. Closed-end funds are actively managed and they often concentrate on a single sector or industry. They are different in that a CEF raises capital through an IPO and then trades on a stock exchange. Following the IPO, the fund will not issue any new shares nor buy back any existing shares from investors.
- CEF shares trade between investors on the secondary market throughout regular trading hours, just like any other stock, and their price is set by the market. Because of this, the price will fluctuate and will normally be higher or lower than the shares’ NAV. Selling at a price higher than the NAV indicates a premium and selling at a price lower than the NAV indicates a discount.
- CEFs can be equity funds or bonds funds. The investment company itself is registered as an investment company under the 1940 Act and the securities offering gets registered (prior to going public) under the Securities Act of 1933.
- Unlike traditional mutual funds, CEFs are allowed to issue debt and/or preferred shares to leverage their net assets. That leverage can increase distributions to investors, but also increases the volatility of the fund’s NAV.
- Distributions are typically paid on a monthly or quarterly basis in the form of dividends, capital gains, interest income, or repayment of principal.
Unit Investment Trusts (UITs)
UITs maintain long-term fixed portfolios of securities in order to meet a particular investment objective. The trust sponsor will typically raise capital from investors through a one-time public offering of a fixed portfolio of securities, like a closed-end fund, and can buy back their units from investors at the estimated NAV, like a mutual fund. Many UITs will also allow for their units to be traded between investors in the secondary market.
- Unlike other investment companies, UITs are not actively managed. They purchase a specific number of securities—fifteen stocks, for example—and will then hold them for the life of the UIT with little to no changes. Prospective investors can see which securities will be held within the portfolio by reviewing the UIT’s prospectus. This prospectus will also contain information on the trust’s termination date, dividends, fee schedules, among other provisions.
- UITs have mandatory termination dates which are determined at the time the trusts are created. Once they terminate, the remaining securities in the portfolio are sold off and the proceeds from these sales are paid out to the investors.
- The UIT itself along with its securities offering are both registered with and regulated by the SEC.
Other Investment Companies
Variable Life Insurance: A type of permanent life insurance policy issued by an insurance company that pays out a specified death benefit to the policyholder’s beneficiaries upon their death. The cash value of the policy is invested into a particular set of securities, like a mutual fund, giving it greater “upside potential” than traditional life insurance policies.
- Permanent life insurance means the policy coverage will remain in place indefinitely (lifetime) for as long as the premiums get paid.
- Variable life policies will offer a guaranteed minimum death benefit and must be registered with the SEC. However, this guaranteed minimum will be lower than that of a traditional life insurance policy and will come with higher premiums. Therefore, if the variable investments underperform, then a variable life policy could end up being more expensive than a traditional life policy.
Separate Accounts of Variable Annuities: Portfolios maintained by insurance companies into which variable annuity investors have their money invested, typically for long-term tax-deferred purposes.
Municipal Fund Securities — 529 College Savings Plans: Many families take advantage of 529 college savings plans to save up for qualified postsecondary educational expenses like college tuition, textbooks, and more. These plans are technically referred to as municipal securities by the SEC since they are created and sponsored by each state.
Packaged Products Terminology
Investment Objective: Every fund will have a stated purpose or objective, such as: growth of invested capital, income from stock and bond investments, or preservation of capital, among many others.
Surrender Charge: The penalty an investor might have to pay when selling—withdrawing—funds from an insurance policy, annuity, or mutual fund too early, during a predetermined number of years known as the surrender period. The charge is meant to dissuade investors from treating these certain types of products as short-term investments.
Load Funds: Mutual funds that charge a commission fee, known as a sales charge or load. FINRA caps these loads at 8.5% of the purchase or sale.
- Front-end funds charge the fee at the time of an investor’s purchase whereas back-end funds charge the fee at the time of an investor’s sale.
- No-load funds do not charge a fee at the time of purchase nor the time of sale, but they often find other ways of collecting fees. Funds are allowed to market themselves as no-load if their fees are below the FINRA-designated 12-1b charges, a maximum of 0.75% of the fund’s net assets.
Breakpoint: The dollar level at which an investor in a mutual fund will receive a discount on their sales charge. Breakpoint eligibility requirements are outlined in the fund’s prospectus and a few common provisions are described below. Not all mutual funds will have these provisions.
- Lumpsum: Lumpsum investing refers to making a single purchase of mutual fund shares that is large enough to qualify the investor for breakpoint sales charge discounts. Institutional investors are typically the ones who can make such investments, due to their size.
- Letter of Intent (LOI): Mutual fund investors can sign a letter of intent stating their commitment to purchase a number of the fund’s shares over a period of time, typically 13 months, thereby granting them breakpoint discounts on the smaller payments. By splitting the lumpsum into these smaller payments, investors with fewer assets than institutional investors – retail investors for example – are able to take advantage of immediate breakpoint discounts.
- Rights of Accumulation: Under rights of accumulation, mutual fund investors are entitled to bulk sales charge discounts once their accumulated investments in the fund reach or exceed certain breakpoint thresholds, which can sometimes take a number of years. Common breakpoint thresholds are $25,000, $50,000, and $100,000.