Mutual funds

1

• Mutual funds
• (see Ch. 24 Reilly and Brown)

2
Investment Companies
An investment company invests a pool of funds
belonging to many individuals in a portfolio of
individual investments such as stocks and
bonds Benefits

• Diversification
• Professional management
• Low capital requirement
• Reduced transaction costs
• Access to illiquid markets
• Access to non-traditional trading strategies

3
Mutual Funds

• An investment company that issues its portfolio
  shares to investors.
• Money from shareholders are pooled and invested
  in a wide range of stocks, bonds, or money market
  securities.
• Managed by professional managers
• Each investor shares proportionately in the
  income and investment gains and losses, as well
  as the brokerage expenses and management fees.
• Open end fund of shares issued solely depends
  on investor demand
• Bought and sold directly through the investment
  company (not an exchange)

4
Net Asset Value

• Used as a basis for valuation of mutual funds.
• Selling new shares
• Redeeming existing shares
• Calculation
• Market Value of Assets Fund Expenses -
  Liabilities
• Shares Outstanding
• A mutual fund has 100 mil in assets and 3 mil
  in short term liabilities. 10.765 mil shares
  outstanding. What is the NAV?
• Solution
• (100 mil - 3 mil) / 10.765 mil 9.0107
  per share

5
Sources of Information

• Lipper Inc. leading provider of data and
  analysis on the investment company business (
  www.lipperweb.com )
• Morningstar.com provide unbiased data and
  analysis and candid editorial commentary
  (www.morningstar.com)
• Vanguard Group providing competitive investment
  performance and lowest operating expenses (
  www.vanguard.com )

6
Mutual Funds Investment Policies

• Money Market
• Fixed Income
• Equity
• Balance Income
• Asset Allocation
• Indexed
• Specialized Sector

7
Mutual Fund Organization

• Mutual fund shareholders own mutual funds, elect
  the board of directors
• Majority of the directors must be independent
  directors
• Investment advisor manages the day-to-day
  operations
• Principal underwriter, administrator, transfer
  agent, custodian, and independent public
  accountant

8
Types of Investment Organizations

• Mutual funds
• Open-End
• Closed-End
• (Stock trades on secondary market Net
  asset value (NAV) is determined daily, but market
  price determined by supply and demand)
• - ETFs (Exchange Traded Funds)
• Hedge Funds
• Private equity/venture capital funds

9
Costs of Investing in Mutual Funds

• Fee Structure
• Front-end load
• Back-end load
• Operating expenses
• 12 b-1 charges
• distribution costs paid by the fund
• Alternative to a load
• Fees and performance

10
Mutual funds Performance

• Its not conclusive
• Most of the studies suggest that the average MF
  underperforms its benchmark
• There is some evidence of short-term performance
  persistence
• The evidence show that its not easy to find
  funds that outperform
• for a long period of time
• Nonetheless, hot funds receive a
  disproportionately amount of
• new money

11
Closed-End Funds

• Issues a fixed number of shares at a given point
  in time
• Collect money from investors through and IPO and
  use this money to invest in securities.
• of securities are fixed at the time of IPO.
• When the market price exceeds its NAV, selling at
  a premium, otherwise, selling at a discount
  (closed-end funds typically sell at a discount)
• Suited to specialized investing in small or
  illiquid markets

12
Exchange Traded Funds

• Are similar to closed-end funds traded
  securities entails commission costs
• Each ETF is a claim on a trust that holds a
  specified pool of assets (e.g. SP500 index
  components)
• ExamplesSPDRS,ishares,HOLDERS
• Advantages
• Liquidity
• Taxes
• Can be purchased on margin or sell short
• ETF are appropriate for short-term investors and
  the ones who buy in large lots

13
Alpha

• Alpha mutual fund return benchmark return
• Higher the Alpha better the fund performance

14
Morningstar rating

• Created in 1984 to provide comprehensive
  assessment of mutual funds
• The star system was not meant to predict future
  performance
• 5 - the top 20 of the funds 1 the bottom
  20

15
Hedge Funds

• Considerable confusion exists concerning hedge
  funds
• what they are (and are not) and how they work
• Hedge funds are privately organized, pooled
  investment vehicle with no restrictions in terms
  of investment strategies, asset classes and use
  of leverage
• Many of them registered off-shore for tax and
  regulatory reasons
• Cant have more than 100 accredited investors
  or 500 super-accredited investors
• Accredited investor net worth gt 1 million or
  income of 200,000 in each of the past two years
• Super-Accredited investor net worth gt 5 million

16
Hedge Funds

• Are not allowed to advertise broadly and engage
  in
• general solicitation to the investing public
• Charge 1-2 of assets under management and
  20-25 of profits
• First hedge fund on record, Jones Hedge Fund,
  was established in 1949
• He hedged the US equity market risk and focused
  on stock selection
• By 2001, more than 5,000 funds in existence
  world-wide
• Common features
• - shorting
• - leverage
• - concentration
• Do they all hedge?

17
Hedge Fund Strategies

• Long-short equity
• Equity market neutral
• Fixed-income arbitrage
• Convertible arbitrage
• Merger arbitrage
• Global macro
• Special situations
• In 2010, more than 9,000 hedge funds managing
  around 1.7 trillion
• Hedge Funds performance significant
  risk-adjusted performance

18
Private Equity

• I. Venture Capital
• Seed
• Early stage
• Later stage
• II. LBO (Buyouts)

19
Learning objectives

• Discuss the advantages and disadvantages of
  mutual funds
• Know how to calculate NAV
• Define and Discuss the differences between open
  end, closed end and ETFs
• Briefly discuss the costs, loads and fees of
  investing in mutual funds
• Morningstar and Style boxes
• Discuss what the hedge funds are, and how do they
  differ from traditional professionally managed
  investment products
• Hedge Funds Strategies hedge funds performance
• Private equity venture capital, seed, early
  stage, later stage buyouts