Mutual Funds and Hedge Funds


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Mutual Funds and Hedge Funds

  1. 2. Overview <ul><li>In this segment: Mutual Funds and Hedge Funds: </li></ul><ul><ul><li>Activities of mutual </li></ul></ul><ul><ul><li>Size, structure and composition </li></ul></ul><ul><ul><li>Balance sheets and recent trends </li></ul></ul><ul><ul><li>Regulation of mutual funds </li></ul></ul><ul><ul><li>Activities of hedge funds </li></ul></ul><ul><ul><li>Global issues </li></ul></ul><ul><ul><li>Size, structure and composition </li></ul></ul><ul><ul><li>Balance sheets and recent trends </li></ul></ul><ul><ul><li>Regulation of hedge funds </li></ul></ul>
  2. 3. Mutual Funds <ul><li>Diversification opportunities enhanced for small investors </li></ul><ul><ul><li>Economies of scale </li></ul></ul><ul><ul><li>Predominantly open-ended funds </li></ul></ul>
  3. 4. Mutual Funds <ul><li>Rapid growth in funds during the 1990s </li></ul><ul><li>Slower rate of growth in the industry in early 2000s than in 1990s </li></ul><ul><ul><li>Trading abuses contributed to slowdown </li></ul></ul><ul><li>2007: </li></ul><ul><ul><li>Almost 7,100 stock and bond mutual companies. </li></ul></ul><ul><ul><li>Total assets of $8.21 trillion. </li></ul></ul><ul><ul><li>8,125 firms and $10.57 trillion if money market mutual funds included </li></ul></ul>
  4. 5. Size, structure and composition <ul><ul><li>First mutual fund: Boston, 1924. </li></ul></ul><ul><ul><li>Slow growth, initially. </li></ul></ul><ul><ul><li>Advent of money market mutual funds, 1972. </li></ul></ul><ul><ul><ul><li>Regulation Q. </li></ul></ul></ul><ul><ul><li>Total assets in stock and bond mutual funds: </li></ul></ul><ul><ul><ul><li>1940: $0.5 billion. </li></ul></ul></ul><ul><ul><ul><li>1990: $1,065.2 billion </li></ul></ul></ul><ul><ul><ul><li>2000: $6,964.6 billion </li></ul></ul></ul><ul><ul><ul><li>2006: $10,413.7 </li></ul></ul></ul><ul><ul><li>Institutional funds </li></ul></ul><ul><ul><ul><li>80 percent of retirement plan investments </li></ul></ul></ul>
  5. 6. Size, Structure and Composition <ul><ul><li>By asset size, mutual fund industry second most important FI group. </li></ul></ul><ul><ul><li>Recent inroads by commercial banks and insurance companies </li></ul></ul><ul><ul><ul><li>Mellon purchase of Dreyfus </li></ul></ul></ul><ul><ul><ul><li>State Farm (9,000 agents) </li></ul></ul></ul><ul><ul><ul><li>As of 2006, insurance companies managed approximately 10% of mutual fund assets </li></ul></ul></ul>
  6. 7. Types of Mutual Funds <ul><li>Long-term funds </li></ul><ul><ul><li>74.3% of assets, 1999 </li></ul></ul><ul><ul><li>2002, long-term funds dropped to 62.1% of assets, losing ground to MMMFs </li></ul></ul><ul><ul><li>75.4% in 2006 </li></ul></ul><ul><li>Types of Long-term Funds: </li></ul><ul><ul><li>Bond and income funds. </li></ul></ul><ul><ul><li>Equity funds. </li></ul></ul><ul><ul><li>Hybrid. </li></ul></ul>
  7. 8. Types of Mutual Funds <ul><li>Short-term funds </li></ul><ul><ul><li>25.7% of assets, 1999. </li></ul></ul><ul><ul><li>37.9% of assets, 2002. </li></ul></ul><ul><ul><li>24.6% in 2006 </li></ul></ul><ul><ul><li>Taxable and tax-exempt MMMFs </li></ul></ul><ul><ul><li>Generally higher returns than bank deposits but uninsured. </li></ul></ul><ul><li>Impact of low interest rates during early to mid 2000s </li></ul><ul><ul><li>Decline in MMMFs </li></ul></ul><ul><ul><li>Lowering of MMMF fees </li></ul></ul>
  8. 9. Number of Mutual Funds
  9. 10. Interest Rate Spread and Net New Cash Flow to MMMFs
  10. 11. Overview of Mutual Funds <ul><ul><li>Objectives (and adherence to stated objectives), rates of return and risk characteristics vary. </li></ul></ul><ul><li>Examples: </li></ul><ul><ul><li>Capital appreciation funds </li></ul></ul><ul><ul><li>World equity </li></ul></ul><ul><ul><li>Corporate bond </li></ul></ul><ul><ul><li>High-yield bond </li></ul></ul><ul><ul><li>World bond </li></ul></ul><ul><ul><li>Government bond </li></ul></ul>
  11. 12. Returns to Mutual Funds <ul><ul><li>Income and dividends of underlying portfolio. </li></ul></ul><ul><ul><li>Capital gains on trades by mutual fund management. </li></ul></ul><ul><ul><li>Capital appreciation in values of assets held in the portfolio. </li></ul></ul><ul><ul><ul><li>Marked-to-market. </li></ul></ul></ul><ul><ul><ul><li>Net-asset value (NAV). </li></ul></ul></ul>
  12. 13. Web Resources <ul><li>For information on the performance of mutual funds, visit: </li></ul><ul><li>Morningstar </li></ul>
  13. 14. Types of Funds <ul><ul><li>Open-ended funds: comparable to most corporate securities traded on stock exchanges. </li></ul></ul><ul><ul><li>Closed-end investment companies: </li></ul></ul><ul><ul><li>Fixed number of shares </li></ul></ul><ul><ul><ul><li>Example: REITs. </li></ul></ul></ul><ul><ul><ul><li>May trade at premium or discount. </li></ul></ul></ul><ul><ul><ul><li>Exchange traded funds (ETFs) </li></ul></ul></ul><ul><ul><li>Load versus no-load funds. </li></ul></ul>
  14. 15. Mutual Fund Costs <ul><li>Two types of fees: </li></ul><ul><ul><li>Sales loads </li></ul></ul><ul><ul><ul><li>Generally, negative effect on performance outweighs benefits </li></ul></ul></ul><ul><ul><ul><li>Short term versus long term investment alters impact of loads on cost </li></ul></ul></ul><ul><ul><li>Fund operating expenses </li></ul></ul><ul><ul><ul><li>Management fee </li></ul></ul></ul><ul><ul><ul><li>12b-1 fees </li></ul></ul></ul><ul><ul><ul><li>Front end and back end fees </li></ul></ul></ul><ul><ul><ul><ul><li>Class A, Class B and Class C differences </li></ul></ul></ul></ul><ul><ul><ul><ul><li>SEC creation of new rules </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Sweeping decreases in fees, 2005 and 2006 </li></ul></ul></ul></ul>
  15. 16. Balance Sheet and Trends <ul><li>Money Market Funds </li></ul><ul><ul><li>Key assets are short-term securities (consistent with deposit-like nature) </li></ul></ul><ul><ul><ul><li>2006: $1,514.9 billion (65.5% of total assets) </li></ul></ul></ul><ul><ul><li>Most have share values fixed at $1 and adjust number of shares owned by the investor. </li></ul></ul>
  16. 17. Balance Sheet and Trends <ul><li>Long-term Funds </li></ul><ul><ul><li>Stocks comprised over 70.7 % of asset portfolios in 2006. </li></ul></ul><ul><ul><li>Credit market instruments 27.2% of asset portfolios </li></ul></ul><ul><ul><li>Shift to other securities such as credit market instruments, U.S. Treasuries, municipal bonds etc. when equity markets not performing as well. </li></ul></ul>
  17. 18. Regulation <ul><ul><li>One of the most closely regulated among non-depository FIs. </li></ul></ul><ul><ul><li>Primary regulator: SEC </li></ul></ul><ul><ul><ul><li>Emphasis on full disclosure and anti-fraud measures to protect small investors. </li></ul></ul></ul><ul><ul><ul><li>NASD supervises mutual fund share distributions. </li></ul></ul></ul>
  18. 19. Regulatory Changes <ul><li>Prosecutions in light of trading abuses in early 2000s. </li></ul><ul><ul><li>Market timing </li></ul></ul><ul><ul><li>Late trading </li></ul></ul><ul><ul><li>Directed brokerage </li></ul></ul><ul><ul><li>Improper fee assessments </li></ul></ul><ul><li>Changes include: SEC requirements for independent board members; reporting and disclosure requirements </li></ul>
  19. 20. Legislation <ul><ul><li>Securities Act 1933, 1934 </li></ul></ul><ul><ul><li>Investment Advisers Act, 1940. </li></ul></ul><ul><ul><li>Insider Trading and Securities Fraud Enforcement Act of 1988. </li></ul></ul><ul><ul><li>Market Reform Act of 1990 </li></ul></ul><ul><ul><ul><li>Allows SEC to halt trading and introduce circuit breakers. </li></ul></ul></ul><ul><ul><li>National Securities Markets Improvement Act of 1996. </li></ul></ul><ul><ul><ul><li>Exempts mutual fund sellers from state securities regulatory oversight. </li></ul></ul></ul><ul><ul><li>Sarbanes-Oxley Act of 2002 </li></ul></ul>
  20. 21. Global Issues <ul><li>Worldwide growth in mutual fund investment not as great as in the U.S. </li></ul><ul><ul><li>$2.575 trillion in 1996 to $10.490 trillion in 2006 </li></ul></ul><ul><ul><ul><li>Over 307% growth </li></ul></ul></ul><ul><ul><li>Larger returns in U.S.stock markets </li></ul></ul><ul><ul><li>Greatest development in countries with most advanced markets </li></ul></ul><ul><ul><li>Opportunities from declining Japanese markets </li></ul></ul><ul><ul><li>Efforts to reduce barriers for U.S. mutual fund sponsors </li></ul></ul><ul><ul><ul><li>China and other Asian countries </li></ul></ul></ul>
  21. 22. Hedge Funds <ul><li>Not technically mutual funds </li></ul><ul><ul><li>Not subject to SEC regulation </li></ul></ul><ul><ul><li>Organized as limited partnership </li></ul></ul><ul><ul><ul><li>Small number of sophisticated investors </li></ul></ul></ul><ul><ul><li>Common feature is use of leverage </li></ul></ul><ul><li>High returns in 1990s </li></ul>
  22. 23. Hedge Funds <ul><li>Near collapse of Long-Term Capital Management </li></ul><ul><ul><li>$3.6 billion bailout </li></ul></ul><ul><ul><li>Precipitated SEC scrutiny of hedge funds </li></ul></ul>
  23. 24. Types of Hedge Funds <ul><li>More risky </li></ul><ul><ul><li>Market directional </li></ul></ul><ul><li>Moderate risk </li></ul><ul><ul><li>Market neutral or value orientation </li></ul></ul><ul><li>Risk avoidance </li></ul><ul><ul><li>Moderate, consistent returns with low risk as objectives </li></ul></ul><ul><li>Fees </li></ul><ul><ul><li>Generally management fees and performance fees </li></ul></ul>
  24. 25. Offshore Hedge Funds <ul><li>Major centers include Cayman Islands, Bermuda, Dublin, Luxembourg. </li></ul><ul><li>Rules </li></ul><ul><ul><li>Generally not burdensome </li></ul></ul><ul><ul><li>Anonymity </li></ul></ul><ul><ul><li>Tax advantages </li></ul></ul>
  25. 26. Regulation of Hedge Funds <ul><li>Generally unregulated </li></ul><ul><ul><li>Exemption for less than 100 investors </li></ul></ul><ul><ul><li>Exemption if accredited </li></ul></ul><ul><li>Scandals such as Canary Capital Partners </li></ul><ul><ul><ul><li>Illegal trading with mutual funds </li></ul></ul></ul><ul><ul><li>Amaranth Advisors, 2006 </li></ul></ul><ul><ul><li>SEC scrutiny </li></ul></ul>
  26. 27. Pertinent Websites <ul><li>American Funds </li></ul><ul><li>Federal Reserve </li></ul><ul><li>Fidelity Investments </li></ul><ul><li>Investment Company Institute </li></ul><ul><li>Morningstar, Inc. </li></ul><ul><li>NASD: </li></ul><ul><li>SEC: </li></ul><ul><li>Vanguard </li></ul><ul><li>Wall Street Journal </li></ul>