Browse Analysis of Managed and Structured Products

17.3.3 Mutual Fund Structured As Trust

Learn about the structure and advantages of mutual funds structured as trusts, focusing on their tax benefits, roles and responsibilities, and investor rights.

Overview of Mutual Fund Structures

While mutual funds can be structured as either trusts or corporations, the unincorporated open-end trust is the most common setup. This structure not only simplifies administrative processes but also leverages favorable taxation rules, as the fund itself avoids paying taxes. Here, we dive deep into the characteristics, components, and advantages of mutual funds structured as trusts.

Key Characteristics

Mutual funds structured as trusts pass income directly to unitholders. This income consists of interest, dividends, and capital gains after accounting for fees and expenses. Each type of income maintains its nature for tax purposes, creating certain efficiencies.

Taxation

The unique advantage is that the income generated by the fund is not taxed at the fund level. Instead, the taxation responsibility falls on the unitholder based on the type of income generated.

Essential Components of Trust Deed

The trust deed, an essential instrument for mutual funds structured as trusts, outlines the following:

  • Principal Investment Objectives: Defines the primary goals of fund investments.
  • Investment Policy: Details guidelines and strategies for choosing specific investments.
  • Restrictions on Investments: Specifies limitations on types of investments or sectors in which the fund may invest.
  • Roles & Responsibilities: Identifies the roles of fund’s manager, distributor, and custodian.

Investor Rights

Investors of open-end mutual funds are allotted units which are redeemable. Key points include:

  • Redemption Rights: Unitholders can redeem their units at a price close to the current Net Asset Value Per Share (NAVPS).
  • Voting Rights: Depending on the trust deed, investors may or may not have voting rights. It’s crucial to consult the fund prospectus for specific rights and responsibilities.

Governing Policies

Common policy mandates include the requirement to hold security holder meetings to review and approve key changes, such as:

  • Alterations to the fundamental investment objectives.
  • Changes in the fund’s auditor or management structure.
  • Changes in the frequency of NAVPS calculation.

Investors should carefully review the mutual fund prospectus for a thorough understanding of these policies.

Frequently Asked Questions (FAQ)

Q: What is the primary advantage of a mutual fund structured as a trust?

A: The primary advantage lies in tax efficiencies, as income is taxed in the hands of unitholders rather than at the fund level.

Q: What is NAVPS?

A: NAVPS stands for Net Asset Value Per Share, an indicator of the fund’s current value per unit, which reflects the fund’s total assets minus liabilities divided by the number of outstanding units.

Q: What should I look for in a mutual fund prospectus?

A: Prospective investors should look for detailed information about investment objectives, policies, fees, redemption rights, and governance structures.

Key Terms & Definitions

  • Unitholder: An investor who owns units in a mutual fund structured as a trust.
  • NAVPS: Net Asset Value Per Share; the value per unit of the fund’s assets minus liabilities.
  • Prospectus: A formal legal document required by and filed with the regulatory authority that provides details about an investment offering to the public.
  • Trust Deed: The legal document that establishes the open-end trust, outlining authoritative guidelines and roles.
  • Custodian: An institution that holds and safeguards a mutual fund’s assets.

Key Takeaways

  • Most mutual funds are structured as trusts to benefit from tax efficiencies.
  • Income from the fund is taxed in the hands of unitholders rather than at the fund level, based on income type (interest, dividends, capital gains).
  • Understanding the trust deed and prospectus are crucial for any investor considering a mutual fund structured as a trust.
  • Frequent security holder meetings ensure investor involvement in significant fund management decisions.

Investing in mutual funds structured as trusts can offer tax efficiencies and clear governance, but it’s essential for potential investors to thoroughly research and understand their rights and obligations.


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## What is one of the most common structures for mutual funds in Canada? - [ ] Incorporated closed-end trust - [ ] Unincorporated closed-end trust - [x] Unincorporated open-end trust - [ ] Incorporated open-end trust > **Explanation:** Most mutual funds in Canada are structured as unincorporated open-end trusts. This structure enables the fund to avoid taxation by allowing income to flow directly to unitholders. ## How is income from a mutual fund structured as a trust taxed? - [ ] Income is taxed in the hands of the fund - [ ] Income is not taxed at all - [x] Income is taxed in the hands of the unitholder - [ ] Income is taxed as if it were corporate income > **Explanation:** The income generated by the mutual fund, net of fees and expenses, flows through directly to the unitholders and is taxed based on the type of income it generates. ## What document establishes the fund’s principal investment objectives and other key components in an unincorporated open-end mutual fund? - [ ] Prospectus - [x] Trust deed - [ ] Articles of Incorporation - [ ] Investment Policy Statement > **Explanation:** The trust deed for an unincorporated open-end mutual fund covers the fund’s principal investment objectives, investment policy, and other crucial elements, including the appointment of the fund’s manager, distributor, and custodian. ## What do investors receive when they invest in an open-end mutual fund? - [ ] Share certificates - [ ] Bonds - [ ] Options - [x] Units > **Explanation:** Investors in an open-end mutual fund receive units, which represent their share of ownership in the fund. ## What rights might investors in an open-end mutual fund have? - [ ] The right to redeem units at a price significantly higher than NAVPS - [x] The right to redeem units at a price close to NAVPS - [ ] Guaranteed voting rights - [ ] No rights at all > **Explanation:** Investors in an open-end mutual fund have the right to redeem their units at a price that is the same as, or close to, the fund’s current Net Asset Value per Share (NAVPS). They may or may not have voting rights depending on the trust agreement. ## When should investors consult a mutual fund’s prospectus? - [ ] Only after purchasing units - [ ] When calculating the fund’s NAVPS - [ ] When transferring units - [x] Before purchasing units > **Explanation:** Investors should consult the mutual fund’s prospectus before purchasing units to understand their rights and the fund’s investment objectives and policies. ## What is one of the roles established by the trust deed of an open-end mutual fund? - [ ] Chief compliance officer - [ ] Marketing director - [x] Custodian - [ ] Head trader > **Explanation:** The trust deed establishes the custodian, among other roles such as the fund’s manager and distributor. ## Under what circumstances are mutual fund security holders typically required to convene a meeting? - [x] To approve a change in the fund’s fundamental investment objectives - [ ] To discuss quarterly earnings - [ ] To set initial unit prices - [ ] To review the trust deed > **Explanation:** Security holders must convene a meeting to approve significant issues such as changing the fund’s fundamental investment objectives, changing auditors, or changing the fund manager. ## If a mutual fund needs to change its fund manager, what procedure must be followed? - [ ] Inform the custodian only - [x] Convene a meeting of security holders for approval - [ ] Submit the changes to the tax authorities - [ ] File an amendment with the provincial securities regulator > **Explanation:** The fund typically must convene a meeting of security holders to consider and approve changes such as appointing a new fund manager. ## What does NAVPS stand for? - [x] Net Asset Value per Share - [ ] Net Annual Volatility Percentage - [ ] Net Allocation Value per Share - [ ] New Average Value per Share > **Explanation:** NAVPS stands for Net Asset Value per Share, which represents the value of one share/unit of the fund based on the total value of the fund’s assets minus liabilities.

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Tuesday, July 23, 2024