You expect a tax-free municipal bond portfolio to provide a rate of return of 4%

Question

You expect a tax-free municipal bond portfolio to provide a rate of return of 4%. Management

fees of the fund are .6%. What fraction of portfolio income is given up to fees?

If the management fees for an equity fund also are .6%, but you expect a portfolio return

of 12%, what fraction of portfolio income is given up to fees? Why might management

fees be a bigger factor in your investment decision for bond funds than for stock funds?

Can your conclusion help explain why unmanaged unit investment trusts tend to focus

on the fixed-income market?

Explanation / Answer

1.    For the bond fund, the fraction of portfolio income given up to fees is:

    (0.6% / 4.0%) = 0.150 = 15.0%

For the equity fund, the fraction of investment earnings given up to fees is:
  

     (0.6% / 12.0%) = 0.050 = 5.0%

     Fees are a much higher fraction of expected earnings for the bond fund, and therefore may be a more important factor

in selecting the bond fund.

This may help to explain why unmanaged unit investment trusts are concentrated in the fixed income market. The advantages of unit investment trusts are low turnover and low trading costs and management fees. This is a more important concern to bond-market investors......

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