ch4_1_ by shimeiyan4

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									FINA 2802: Investments and Portfolio Analysis
           Institutional Investing
              Dragon Yongjun Tang
          January 28 & February 2, 2010
Lecture 6 & 7: Mutual Funds and
other Investment Companies

 Reading: Chapter 4
 Practice Problem Sets:
    1,2,3,4,6,7,8,9,10,12,13,14,18,20,21




                                           2
Managing Your Money

                 Your portfolio




Do it yourself               Delegate to a professional




                                                          3
Invest with Warrant Buffet?




                              4
Learning Objectives
   Advantages and disadvantages of investing with
    an investment company
   Compare open-end mutual funds with closed-end
    funds and unit investment trusts
   Define net asset value and measure the rate of
    return of a mutual fund
   Classify mutual funds according to investment
    style
   Demonstrate the impact of expenses and turnover
    on mutual fund investment performance

                                                      5
Investment Companies

Functions:
1.   Pooling of Assets
2.   Diversification
3.   Professional management
4.   Lower transaction costs (economies of scale)
5.   Record keeping


                                                    6
   Net Asset Value (NAV)

      Used as a basis for valuation of investment
       company shares
       – Selling new shares
       – Redeeming existing shares
  Calculation
           Market Value of Assets - Liabilities
NAV=
                 Shares Outstanding

                                                     7
Investment Companies

   Unmanaged
   Managed - Securities continually bought and sold
     – Open-End
            –Redeem Shares at NAV
            –Shares Outstanding Varies
     – Closed-End
            –Fixed number of Shares Outstanding
            –Trade on Exchanges like stocks
            –Values are different from NAV



                                                       8
Types of Investment
Organizations

   Unit Trusts
   Managed Investment Companies
    – Open-End
    – Closed-End
   Other investment organizations
    – Commingled funds
    – REITs
    – Hedge Funds
                                     9
Unit Investment Trusts

    •Fixed portfolio

    •Usually fixed-income

    •Not actively managed


                            10
Commingled Funds

• Investment pools

• Offered by a bank or insurance
  company

• Used for trust or retirement
  account

                                   11
Real Estate Investment Trusts
(REITs)

 • Similar to a closed-end mutual fund
 • Equity trusts invest in real estate
   directly
 • Mortgage trusts invest in mortgage or
   construction loans
 • Highly leveraged
                                           12
Hedge Funds

   Not registered, not subject to SEC regulation
    (like individual investors)
   Open only to wealthy or institutional investors
   Highly levered, very sophisticated, “market
    neutral” strategies, risky!
         - Long-Term Capital Management (LTCM)
        - Citadel




                                                      13
Open-End and Closed-End Funds:
Key Differences
     Shares Outstanding
    Closed-end: no change unless new stock is
     offered
    Open-end: changes when new shares are
     sold or old shares are redeemed
     Pricing
    Open-end: Net Asset Value(NAV)
    Closed-end: Premium or discount to NAV
                                                 14
Figure 4.1 Closed-End Mutual Funds




                                     15
Figure 4.2 Listing of Mutual
Fund Quotations




                               16
Types of Mutual Funds
Investment policies, styles, management
• Money Market funds
• Bond funds - Taxable
              - Tax-free
              - High-income (junk bonds)
• Stock funds - Aggressive Growth
               - Growth
               - Growth and income
               - Income
• Balanced and income funds
• Specialized sector funds
• Index funds
                                           17
Table 4.1 Classification
of U.S. Mutual Funds




                           18
Trading in Mutual Funds

 NAV (for open ended) and
 Share price (for closed ended) are Quoted Daily

 No margin or short positions
 (not for Exchange Traded Funds or ETF!)

 May have tax disadvantages



                                                   19
How Funds Are Sold

   Directly marketed
   Sales force distributed
   Revenue sharing on sales force distributed
    – Potential conflicts of interest
   Financial supermarkets



                                                 20
Potential Conflicts of
Interest - Revenue Sharing

    Brokers put investors in funds that may that
     may not be the most appropriate
    Mutual funds could direct trading to higher
     cost brokers
    Revenue sharing is not illegal but it must be
     disclosed to the investor


                                                     21
Investment Companies in HK and China

    HK:
     – the number of retail funds offered to the public has grown from 783
       at the end of 1989 to 1,980 in 2007. In value terms, the size of retail
       funds has grown 22 times, from HKD283 B to HKD6,154 B
     – including exchange-traded funds, index funds, guaranteed funds and
       hedge funds
     – Can invest in China through QFII

    China:
     – Industry size RMB3.2T (including HF and PE)
     – In June 2007, the CSRC announced that QDII fund management
       companies and securities firms are allowed to invest in overseas
     – Allow foreign investors since joining WTO
                                                                                 22
             HK Funds (in US$ million)

             Bond      Equity                    Money                                       Guaranteed    Hedge               Other
As at end   債券基        股票基      Diversified      Market Fund of Funds    Warrant Index*              **    對沖基        Specialised***      Total
截至              金          金    多元化基金         貨幣市場基金      基金的基金          權證基金 指數基金*          保證基金**           金      其他特別基金***             總值
12/1997     12,718    100,503        9,586        7,078           591        277    n.a.            n.a.     n.a.               1,629   132,383

12/1998      28,891   124,840       14,266         12,676        1,036      306       n.a.          n.a.      n.a.              1,078   183,092

12/1999      31,383   226,861       26,296         11,193        1,227      419       n.a.          n.a.      n.a.              1,501   298,879

12/2000      44,544   219,934       26,869         15,788        2,529        22      n.a.          n.a.      n.a.              1,765   311,449

12/2001      48,499   181,547       26,123         12,222        2,283       1.3     5,210         5,780      n.a.              3,545   285,210

12/2002      77,703   143,290       28,842         69,739        2,375       n.a.    7,870        11,734     160                 421    342,134

12/2003     112,048   270,582       41,095         81,472        3,863       n.a.    8,139        15,999     405                 685    534,288

12/2004     112,486   272,962       38,433         94,540        4,813       n.a.    7,362        18,403    1,174               1,046   551,219

12/2005     147,379   356,731       37,650         92,574        5,528       n.a.    8,970        16,455    1,038               1,260   667,585

12/2006     184,431   510,371       55,033        126,790        6,794       n.a.   11,632        11,838    1,662               1,703   910,254




                                                                                                                                            23
Mutual Funds Expenses

   Front-End Load (0%-6.25%)
   Back-End Load (5%-6%, decreasing with time)
   Operating Expenses (0.2%-2%)
   12b-1 Charges (1%)
   Soft Dollars

“Fee is the most robust predictor of performance”

                                                    24
Table 4.2 Impacts of Costs on
Investment Performance




                                25
Trading Scandal with
Mutual Funds
   Late trading – allowing some investors to
    purchase or sell later than other investors
   Market timing – allowing investors to buy
    or sell on stale net asset values
    – International
   Net effect is to transfer wealth from existing
    owners to the new purchasers or sellers


                                                     26
Potential Reforms

   Strict 4:00 PM cutoff with late orders
    executed the following trading day
   Fair value pricing with net asset values being
    adjusted for trading in open markets
   Imposition of redemption fees



                                                     27
Mutual Fund Returns


                 NAVt 1 - NAVt  Income and Cap. Gain Dist.
Rate of Return 
                                    NAVt




      All NAV’s are net of loads
       and other expenses
Mutual Fund Returns
Example: Consider a fund with $100 million in assets at
the start of the year and 10 million shares outstanding.
The fund invests in a portfolio of stocks that provides no
income but that increases in value by 10%. The expense
ratio, including 12b-1 fees, is 1%. What is the rate of
return for an investor in the fund?




                                                             29
Problem 11, Chapter 4(p.110)

A closed-end fund starts the year with a net asset value of
$12.00. By year-end, NAV equals $12.10. At the beginning of
the year, the fund is selling at a 7% discount to NAV. The fund
paid year-end distributions of income and capital gains of $1.50.
a. What is the rate of return to an investor in the fund during the
year?

b. What would have been the rate of return to an investor who
held the same securities as the fund manager during the year?


                                                                 30
Problem 13, Chapter 4(p.110)

 Consider a mutual fund with $200 million in assets at the
 start of the year and with 10 million shares outstanding. The
 fund invests in a portfolio of stocks that provides dividend
 income at the end of the year of $2 million. The stock
 included in the fund’s portfolio increase in price by 8%, but
 no securities are sold, and there are no capital gains
 distributions. The fund charges 12b-1 fees of 1%, which are
 deducted from portfolio assets at year-end. What is net asset
 value at the start and end of the year? What is the rate of
 return for an investor in the fund?


                                                                 31
Problem 16, Chapter 4(p.110)

 You purchased 1,000 shares of the New Fund at a price of
 $20 per share at the beginning of the year. You paid a front-
 end load of 4%. The securities in which the fund invests
 increase in value by 12% during the year. The fund’s
 expense ratio is 1.2%. What is your rate of return on the
 fund if you sell your shares at the end of the year?




                                                                 32
Taxes on Mutual Funds

    Investor directed portfolios can be structured to
     take advantage of taxes while mutual funds cannot
    Pass-through of capital gains and dividend income
    High turnover (=Amount of Sales/Fund Value)
     leads to tax inefficiency
    More disclosure on taxes was required in 2000



                                                         33
Exchange Traded Funds (ETF)
    ETF allow investors to trade index portfolios
     like shares of stock
    Examples – Spiders, Diamonds, Cubes, Viper,
     and Webs
    Potential advantages
     – Trade continuously
     – Lower taxes
     – Lower costs
    Potential disadvantages
                                                     34
Mutual Fund Performance
How can we measure Mutual Fund Performance?

   Benchmark Performance
        Wilshire 5000

        S&P 500



 What is the proper benchmark?
 How can we disentangle skill from luck?

                                              35
First Look at Mutual Fund
Performance
     Evidence shows that average mutual fund
      performance is generally less than broad
      market performance
     Evidence suggests that over certain horizons
      some persistence in positive performance
       – Evidence is not conclusive
       – Some inconsistencies

  “Past performance is not necessarily indicative of future results.”
                                                                        36
Figure 4.3 Percentage of Funds
Below Wilshire 5000




                                 37
Table 4.4 Consistency of
Investment Results




                           38
Sources of Information
on Mutual Funds
     Prospectus, Annual Reports
     Morningstar (www.morningstar.com)
     Yahoo (biz.yahoo.com/funds)
     Wiesenberger’s Investment Companies
     Investment Company Institute
     Popular press
     Investment services


                                            39
Summary

   Type of investment companies
   Mutual fund expenses
   Mutual fund performance
   Next Class: Risk and Return




                                   40

								
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