Investor satisfaction across bond, stock, and annuity funds

Investor Satisfaction Case

A Business Report

INVESTOR SATISFACTION REPORT

As requested, here are my findings on the investor satisfaction report as collated by our analysis department. Our investment brokerage firm is advised to follow up on the results to improve brokerage performance based on type of investment product purchased.

100 clients were randomly selected and asked a series of questions, the criteria being they must have purchased shares in any one of the funds. Investment counselors personally ask the client to rate their level of satisfaction with the product as high medium or low.

30% of our investors have invested in bond fund, 30% in the stock fund and 40% have invested in the tax-deferred annuity. We can deduce from the total population data that 40% of all clients displayed high satisfaction, 40% displayed medium satisfaction and 20% displayed low satisfaction (Table 2.17).

Stock fund clients report high satisfaction generally across our tabulation results, bond fund investors seem to have high to medium satisfaction while out tax-deferred clients seem to be relatively less satisfied.

While analyzing row percentages and column percentages we can deduce that 50% of bond fund investors reported high satisfaction with our company's performance while 40% of these same investors reported medium satisfaction, and only 10% reported low satisfaction (Table 2.18). A collective look at the entire range of row percentages brings us to the conclusion that stock fund investors are highly satisfied, that bond fund investors are quite satisfied (but somewhat less than stock fund investors) and that tax-deferred annuity purchasers are less satisfied than both stock fund or bond fund investors (Collins & . Mack, 2007).

Regardless of whether a mutual fund is passively or actively managed, most funds have only one class of stock that shares equally in all the investment income and capital gains of the fund. However, some mutual funds have several classes of stockholders. For instance, dual funds have one class of shareholders with a claim on the fund's investment income (dividends and interest payments) while another class of shareholders has a claim on the capital gains of the fund.

More recently, a new type of mutual fund has been developed whereby one class of preferred shareholders has a prior claim on the interest income of the fund up to a specified amount that varies with a specified money market interest rate, while the common shareholders of the mutual fund have a claim on all remaining investment income and capital gains (Deliva & Olson, 2008). This latter capital structure is especially useful for municipal bond funds, as it gives the preferred shareholders a fairly secure money market interest rate that exceeds high-grade municipal money market rates, while allowing the common shareholders of the fund to obtain a leveraged investment in municipal bonds by essentially "borrowing" (Blake, 2005) at a low tax-advantaged rate (because municipal securities are exempt from federal tax, they tend to have negative Oj terms with yields below the risk-free Treasury rate).

There has been a great deal of discussion about the optimal size of a mutual fund. Although larger mutual funds tend to have lower administrative expenses due to economies of scale, they also often have higher trading costs because of the need to buy so much of a security to obtain a meaningful position (Deliva & Olson, 2008). In addition, larger funds find it especially difficult to take significant positions on smaller companies without substantial trading costs. Overall, although it is nearly impossible to start a mutual with less than $1 million in assets, and administrative costs tend to be extremely high for funds with even $10 million in assets, there are many fund managers who believe that it is so counterproductive to be too large that they close their funds to new investors once they reach several billion dollars in assets (Clements, 2004).

There also exists a type of fund called a fund of funds that pools investors' money for purpose of investing into other mutual funds. Many of these types of funds are offered by the administrator of a family of mutual funds to invest only into a portfolio of mutual funds in that family. Many funds of funds generally add an extra layer of annual expense (often called a wrap fee) for the service of determining for investors the mutual funds into which they are to invest (as little as 0.08% per year for Fidelity but closer to 2% for others, which is in addition to the annual expenses charged to the funds themselves into which the money is invested). However, some fund administrators (such as Vanguard, Scudder, and T. Rowe Price) do not charge for this service. There was $29 billion invested through such funds of funds in 2008.

Recommendations

Our board members are advised to take the following recommendations into consideration win the next meeting to improve client satisfaction of our Tax-Deferred Annuity investors. While it is established that some mutual funds are sold as a package with some form of life insurance policy. Investments in such package contracts are often called variable-rate deferred annuities. Investments in these contracts can be made in one lump sum or periodically as the investor wishes.

Upon the death of the individual specified in the contract, the life insurance portion of the investment generally guarantees the right to a payment at least equal to the full amount invested in the package. In other words, the life insurance portion of the contract represents a European put option with an exercise price equal to the cost of the summed total investments in the contract and with the expiration date at the death of the individual specified in the contract. However, some of the annuities offer more valuable life insurance in the package than others, with a few variable annuities having the exercise price of the conditional put option rise by a few percent each year. In any case, although the annual fee paid for this put option death benefit is generally less than 1% of the money invested, the present value of those annual expenses is generally many times the value of the death put (which usually turns out to be worthless).

The package of a mutual fund and a death put is called a deferred annuity because it permits investors to defer payouts on their mutual fund investment until the earlier of either the retirement or the death of the individual (or individuals) specified in the contract. Then, at retirement or death, payments can be made as an annuity for the remaining life of an investor. Nevertheless, despite the name of this packaged financial product, investors may choose, instead, to receive their payout from the deferred annuity in one lump sum and may choose to receive their payout earlier than at retirement or death.

Deferred annuities that are invested in a selection of mutual funds offered by the insurance company sponsor are called variable-rate deferred annuities because the return on the investment varies with the performance of the mutual funds. Variable-rate annuities are similar to fixed-rate annuities, except that a fixed-rate annuity promises a fixed rate of return to be paid directly from the life insurance company (as opposed to a variable rate being paid through the performance of a mutual fund).

Generally, investors in variable-rate deferred annuities can transfer money between mutual funds offered by the life insurance company without charge (as with open-end mutual funds). However, penalties of 7% or so are usually levied on an early cash-out from the deferred annuity contract (i.e., for a cash redemption before retirement or death), with the fee sometimes being scaled downward (to 0% after 7 years) when the money has been invested into the contract for a longer period of time (such scaled charges essentially represent a conditional back-end load).

By 1996 there was over $300 billion invested in this type of mutual fund account, with much of the investment motivated for tax reasons. In particular, returns on investments that are combined with some form of life insurance, as in a tax-deferred annuity, are tax-deferred until the money is explicitly withdrawn. It is even possible to withdraw money out of such investments without being subject to tax as long as one repays the money to one's own account within 5 years. Variable-rate deferred annuities are available not only from major life insurance companies but also through insurance subsidiaries set up by mutual fund administrators so that individuals can invest into their funds tax-deferred.

The Wall Street Journal quarterly publishes a special section indicating the expenses and loads associated with these contracts. Vanguard and Scudder have the lowest annual fees of about 1% per year, while the remaining annuities charge around 2% or more annually.