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Perspectives on Global Asset Management: Beyond mutual funds

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Title: Perspectives on Global Asset Management: Beyond mutual funds


1
Perspectives on Global Asset ManagementBeyond
mutual funds?
  • Professor Massimo Massa
  • BNP-PARIBAS

2
The Vanguard ApproachMain Features
  • What type of approach? Main Characteristic?

Mutualistic. Customer focus, not product or
performance. The goal is to serve shareholders.
  • What is the market?

Wholesale.
  • What type of service?
  • Low cost, no load, low fee pricing.
  • Plain vanilla products, which attempt to offer
    dependable return.
  • They have cornered the market on the low fee game
    huge barriers to entry before someone else
    could try to compete with them.
  • Economies of scales means lower average fees in
    future.

3
The Vanguard ApproachMain Features
  • How is demand related to performance and fees?
  • Does it depend on star/dog strategies?

No
  • Does it depend on load/fee based strategies?

No
  • Is there a scope for tunneling?

Scarce
  • Is there a scope for incubation?

No
4
The Vanguard ApproachMain Features
  • Is there a conglomerate strategy?

Well it depends on size. But then liquidity
effects.
  • What is the role of advertising?
  • Relies on Free Press
  • Little paid advertising or promotion.
  • Focus on candor
  • Is there a branding role of managers?
  • Well, more as a symbol of frugality.
  • What about Bogle?

5
The Vanguard ApproachVulnerability
  • It brings price competition and alters (ruin?)
    the industrys price structure
  • It has corned itself the only way to improve is
    by offering lower and lower fee products. How
    much can they be lowered?
  • Difficult to get in sophisticated niche.
  • Management succession? Why are the top employees
    so young? Will the organization be able to keep
    the same focus when he leaves?
  • Given that they do not pay Fidelitys scale
    wages, how will they be able to attract top
    quality personnel?
  • What is the money market fund has a default on
    one of its payment and the net asset value falls
    below 1? Vanguard has no capital reserves to
    cover the fund as others have.
  • Does the fact that they are a technology follower
    doom them to poorer service ad a reputation for
    being behind the times?

6
The Vanguard ApproachResponse from Competition
  • Fidelity
  • Introduce Spartan Index Line
  • Open retail stores around the country
  • Leading edge technology
  • Distribution
  • Continue to focus on the star system
  • More specialization.
  • Merril Lynch
  • Specialize even more in sellers of convenience.
  • Emphasize customer service staff.
  • Lower fees.
  • ETFs and TRACKERs
  • Even lower costs.

7
The Vanguard ApproachResponse from Competition
Exchange Traded Funds Assets ( Billions)
8
The Vanguard Approach is thereforethe Henry
Ford of the Industry everybody can choose the
color of the carprovided it is black20 years
later another approach get prominence the
AJO Approach
9
What is long/short investing?
Assets
Liabilities
  • Leverage (10 10)/10 2
  • What is required return on the whole portfolio?

10
(No Transcript)
11
The AJO ApproachMain Features
  • What type of approach? Main Characteristic?
  • A clients base portfolio
  • variable fraction of customer money
  • in riskless (or interest sensitive assets)
  • in market index (or equity sensitive assets)
  • Or all in riskless index futures
  • To match the customer consumption profile
  • Enhancement
  • Use fraction (possibly gt100) of what is invested
    in riskless to put into L/S hedge funds, to
    enhance returns
  • It does not matter how (using what instrument)
    alpha is generated alpha is portable
  • Or use futures to enhance.

12
The AJO ApproachMain Features
  • What is the main benefit of the Long/Short?
  • Long/Short. Focus on performance.
  • For Standard Mutual Funds portfolio selection is
    based in benchmarks
  • long portfolio will be evaluated against (style)
    benchmark (witness the use of tracking errors as
    a measure of active risk) gt become closet
    indexers
  • Benchmark used and alpha constructed to measure
    the performance of a manager that is supposed to
    maximize utility of return.
  • But the measure is not incentive compatible. It
    changes the behavior of the manager
  • L/S will be free from any benchmark!!!

13
The AJO ApproachMain Features
  • What type of approach? Main Characteristic?

Long/Short. Focus on performance.
  • What is the market?

Not clear yet. Presumably still niche market.
Benchmark are used to describe to the clientele
the kind of assets the L/S invests in.
  • What type of service?
  • Stock-picking services
  • Value
  • Management (e.g., insider trading)
  • Earnings momentum

14
The AJO ApproachMain Features
  • What are the main drivers of performance?

Purely in-house, quantitative screening of firms
  • What approach to costs?
  • Since they dont use outside research, no soft
    dollars needed to purchase this research
  • ? Forces brokers to compete on order execution
    ?
  • ? Get better execution.
  • Usage of package trading.
  • Communicate to clients on execution costs

15
The AJO ApproachMain Features
  • How is demand related to performance and fees?
  • Does it depend on star/dog strategies?

No
  • Does it depend on load/fee based strategies?

No
  • Is there a scope for tunneling?

Scarce
  • Is there a scope for incubation?

No
16
The AJO ApproachMain Features
  • Is there a conglomerate strategy?

Maybe.
  • What is the role of advertising?
  • Based on Absolute Performance.
  • Is there a branding role of managers?
  • Yes! Huge. It is mostly a name-based business.

17
Packaged trading
  • What is packaged trading?
  • Why does it work/exist?
  • Double-blind auction idea
  • If package composition were disclosed, every
    bidder, including losing bidders, would be able
    to front-run the trades of either the asset
    manager or the winning bidder
  • If the brokers book were known, the manager
    would know actual cost of execution and could
    bring bid down
  • By their measure, packaged trading one-way
    average cost is .246 a share whereas traditional
    brokerage costs .562

18
Packaged trading
19
Packaged trading
20
The future
  • How can we envision future division of labor
    between types of funds?
  • Polarization into beta and alpha strategies
  • Only two extremes should exist
  • index funds or ETFs
  • hedge funds doing L/S
  • Everything else is a combination of these two,
    which is less transparent than the two extremes
  • No benchmarks
  • No soft dollars

21
the industry gets polarized.
Polarization of Investments Process
Polarization
Market-Linked Products
Alternative Investments
Exchange Traded Funds
Other Alternative Investments
Venture Capital Private Equity
Inverse Index Funds
Leveraged Index Funds
Index Funds
Hedge Funds
Real Estate
22
Alternative Investments Markets Assets Under
Management ( Billions)
23
What is a Hedge Fund?
  • US
  • Hedge funds are private unregistered investment
    pools for wealthy individuals or institutional
    investors.
  • Hedge funds invest in a variety of securities and
    use return enhancing tools such as leverage,
    derivatives and arbitrage
  • Legally structured as a private investment
    limited partnership (LP) or a limited liability
    corporation (LLC)
  • Typically charges a management fee (1-3) and an
    incentive fee (15-25)
  • Europe
  • A fund management firm that charges an incentive
    fee.
  • Looks to create absolute returns, I.e. returns in
    excess of those predicted by CAPM or other asset
    pricing models.

24
Key Differences Between Hedge Funds and Mutual
Funds
  • Absolute return objective (10 to 25 per year)
    versus relative returns (out-performance of an
    index).
  • Often clearly stated risk objective, e.g. 20
    p.a.
  • Market volatility presents opportunities since
    hedge funds can trade from both the long and
    short of the market.
  • Managers compensation is primarily based on
    performance, not based on the size of the assets
    under management (better aligning interests of
    managers with investors).
  • Many funds are closed or give an explicit size at
    which they will close
  • Limited capacity for most strategies, managers
    try to grow by steps, e.g. 100 MUSD, 400 MUSD,
    1000 MUSD in order to avoid failure
  • Moore returned 3bn to investors in 2001

25
Hedge Fund Fees
  • The fee structure is homogenous
  • A management fee of a 1-3 p.a. and,
  • An incentive fee of 10-30 of profits
  • Often a reference rate must be met before
    incentive fees are paid, e.g. 3 month T-bill
    200 bp.
  • Incentive fee gives incentive and protects from
    earnings dilution'' due to size constraints of
    a particular strategy.
  • High watermark
  • The manager only receives the incentive fee on
    new high-highs', typically calculated monthly
    or quarterly.
  • Reduces risk taking incentives of managers
  • Locks in investors when the fund is in
    drawdown (100 participation in first
    profits)
  • Gives managers a downside

26
Hedge Fund Styles by Assets
27
The Strategy Universe
40
Aggressive Growth
Market Timing
35
Opportunistic
30
SP 500
25
Event Driven
Market Neutral
20
Fund of Funds
MSCI World Equity
Distressed
15
Equity Arbitrage
Securities
Income
Convertible Arbitrage
Emerging Markets
10
Average Bond
Mutual Fund
5
Short Selling
0
-5
-10
0
5
10
15
20
25
30
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