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 <ul><li>Reading: Chapter 4 </li></ul><ul><li>Practice Problem S...
Managing Your Money Your portfolio Do it yourself Delegate to a professional
Invest with Warrant Buffet?
Learning Objectives <ul><li>Advantages and disadvantages of investing with an investment company </li></ul><ul><li>Compare...
Investment Companies <ul><li>Functions: </li></ul><ul><li>Pooling of Assets </li></ul><ul><li>Diversification </li></ul><u...
Net Asset Value (NAV) <ul><li>Used as a basis for valuation of investment company shares </li></ul><ul><ul><li>Selling new...
Investment Companies <ul><li>Unmanaged </li></ul><ul><li>Managed  - Securities continually bought and sold </li></ul><ul><...
Types of Investment Organizations <ul><li>Unit Trusts </li></ul><ul><li>Managed Investment Companies </li></ul><ul><ul><li...
Unit Investment Trusts <ul><ul><ul><li>Fixed portfolio </li></ul></ul></ul><ul><ul><ul><li>Usually fixed-income </li></ul>...
Commingled Funds <ul><li>Investment pools </li></ul><ul><li>Offered by a bank or insurance company </li></ul><ul><li>Used ...
Real Estate Investment Trusts  (REITs) <ul><li>Similar to a  closed-end  mutual fund </li></ul><ul><li>Equity trusts  inve...
Hedge Funds <ul><li>Not registered, not subject to SEC regulation (like individual investors) </li></ul><ul><li>Open only ...
Open-End and Closed-End Funds:  Key Differences <ul><li>Shares Outstanding </li></ul><ul><li>Closed-end: no change unless ...
Figure 4.1 Closed-End Mutual Funds
Figure 4.2 Listing of Mutual Fund Quotations
Types of Mutual Funds <ul><li>Investment policies, styles, management </li></ul><ul><li>Money Market funds </li></ul><ul><...
Table 4.1 Classification  of U.S. Mutual Funds
Trading in Mutual Funds <ul><li>NAV (for open ended) and  </li></ul><ul><li>Share price (for closed ended) are Quoted Dail...
How Funds Are Sold <ul><li>Directly marketed </li></ul><ul><li>Sales force distributed </li></ul><ul><li>Revenue sharing o...
Potential Conflicts of  Interest - Revenue Sharing <ul><li>Brokers put investors in funds that may that may not be the mos...
Investment Companies in HK and China <ul><li>HK:  </li></ul><ul><ul><li>the number of retail funds offered to the public h...
HK Funds  (in US$ million) As at end  截至 Bond 債券基金 Equity 股票基金 Diversified  多元化基金 Money Market  貨幣市場基金 Fund of Funds 基金的基金...
Mutual Funds Expenses <ul><li>Front-End Load (0%-6.25%)  </li></ul><ul><li>Back-End Load (5%-6%, decreasing with time) </l...
Table 4.2 Impacts of Costs on Investment Performance
Trading Scandal with Mutual Funds <ul><li>Late trading  –  allowing some investors to purchase or sell later than other in...
Potential Reforms <ul><li>Strict 4:00 PM cutoff with late orders executed the following trading day </li></ul><ul><li>Fair...
Mutual Fund Returns <ul><ul><ul><li>All NAV’s are net of loads and other expenses </li></ul></ul></ul>
Mutual Fund Returns <ul><li>Example:  Consider a fund with $100 million in assets at the start of the year and 10 million ...
Problem 11, Chapter 4(p.110) <ul><li>A closed-end fund starts the year with a net asset value of $12.00. By year-end, NAV ...
Problem 13, Chapter 4(p.110) <ul><li>Consider a mutual fund with $200 million in assets at the start of the year and with ...
Problem 16, Chapter 4(p.110) <ul><li>You purchased 1,000 shares of the New Fund at a price of $20 per share at the beginni...
Taxes on Mutual Funds <ul><li>Investor directed portfolios can be structured to take advantage of taxes while mutual funds...
Exchange Traded Funds (ETF) <ul><li>ETF allow investors to trade index portfolios like shares of stock </li></ul><ul><li>E...
Mutual Fund Performance <ul><li>How can we measure Mutual Fund Performance? </li></ul><ul><li>Benchmark Performance </li><...
First Look at Mutual Fund Performance <ul><li>Evidence shows that average mutual fund performance is generally less than b...
Figure 4.3 Percentage of Funds  Below Wilshire 5000
Table 4.4 Consistency of  Investment Results
Sources of Information  on Mutual Funds <ul><li>Prospectus, Annual Reports </li></ul><ul><li>Morningstar (www.morningstar....
Summary <ul><li>Type of investment companies </li></ul><ul><li>Mutual fund expenses </li></ul><ul><li>Mutual fund performa...
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Chapter 4

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  • Buys securities and sales “redeemable trust certificates” to investors at a price above NAV.
  • Chapter 4

    1. 1. FINA 2802: Investments and Portfolio Analysis Institutional Investing Dragon Yongjun Tang January 28 & February 2, 2010
    2. 2. Lecture 6 & 7: Mutual Funds and other Investment Companies <ul><li>Reading: Chapter 4 </li></ul><ul><li>Practice Problem Sets: 1,2,3,4,6,7,8,9,10,12,13,14,18,20,21 </li></ul>
    3. 3. Managing Your Money Your portfolio Do it yourself Delegate to a professional
    4. 4. Invest with Warrant Buffet?
    5. 5. Learning Objectives <ul><li>Advantages and disadvantages of investing with an investment company </li></ul><ul><li>Compare open-end mutual funds with closed-end funds and unit investment trusts </li></ul><ul><li>Define net asset value and measure the rate of return of a mutual fund </li></ul><ul><li>Classify mutual funds according to investment style </li></ul><ul><li>Demonstrate the impact of expenses and turnover on mutual fund investment performance </li></ul>
    6. 6. Investment Companies <ul><li>Functions: </li></ul><ul><li>Pooling of Assets </li></ul><ul><li>Diversification </li></ul><ul><li>Professional management </li></ul><ul><li>Lower transaction costs (economies of scale) </li></ul><ul><li>Record keeping </li></ul>
    7. 7. Net Asset Value (NAV) <ul><li>Used as a basis for valuation of investment company shares </li></ul><ul><ul><li>Selling new shares </li></ul></ul><ul><ul><li>Redeeming existing shares </li></ul></ul><ul><li>Calculation </li></ul><ul><li> Market Value of Assets - Liabilities </li></ul><ul><li> Shares Outstanding </li></ul>NAV=
    8. 8. Investment Companies <ul><li>Unmanaged </li></ul><ul><li>Managed - Securities continually bought and sold </li></ul><ul><ul><li>Open-End </li></ul></ul><ul><ul><ul><ul><li>Redeem Shares at NAV </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Shares Outstanding Varies </li></ul></ul></ul></ul><ul><ul><li>Closed-End </li></ul></ul><ul><ul><ul><ul><li>Fixed number of Shares Outstanding </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Trade on Exchanges like stocks </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Values are different from NAV </li></ul></ul></ul></ul>
    9. 9. Types of Investment Organizations <ul><li>Unit Trusts </li></ul><ul><li>Managed Investment Companies </li></ul><ul><ul><li>Open-End </li></ul></ul><ul><ul><li>Closed-End </li></ul></ul><ul><li>Other investment organizations </li></ul><ul><ul><li>Commingled funds </li></ul></ul><ul><ul><li>REITs </li></ul></ul><ul><ul><li>Hedge Funds </li></ul></ul>
    10. 10. Unit Investment Trusts <ul><ul><ul><li>Fixed portfolio </li></ul></ul></ul><ul><ul><ul><li>Usually fixed-income </li></ul></ul></ul><ul><ul><ul><li>Not actively managed </li></ul></ul></ul>
    11. 11. Commingled Funds <ul><li>Investment pools </li></ul><ul><li>Offered by a bank or insurance company </li></ul><ul><li>Used for trust or retirement account </li></ul>
    12. 12. Real Estate Investment Trusts (REITs) <ul><li>Similar to a closed-end mutual fund </li></ul><ul><li>Equity trusts invest in real estate directly </li></ul><ul><li>Mortgage trusts invest in mortgage or construction loans </li></ul><ul><li>Highly leveraged </li></ul>
    13. 13. Hedge Funds <ul><li>Not registered, not subject to SEC regulation (like individual investors) </li></ul><ul><li>Open only to wealthy or institutional investors </li></ul><ul><li>Highly levered, very sophisticated, “market neutral” strategies, risky! </li></ul><ul><li>- Long-Term Capital Management (LTCM) </li></ul><ul><ul><li>- Citadel </li></ul></ul>
    14. 14. Open-End and Closed-End Funds: Key Differences <ul><li>Shares Outstanding </li></ul><ul><li>Closed-end: no change unless new stock is offered </li></ul><ul><li>Open-end: changes when new shares are sold or old shares are redeemed </li></ul><ul><li>Pricing </li></ul><ul><li>Open-end: Net Asset Value(NAV) </li></ul><ul><li>Closed-end: Premium or discount to NAV </li></ul>
    15. 15. Figure 4.1 Closed-End Mutual Funds
    16. 16. Figure 4.2 Listing of Mutual Fund Quotations
    17. 17. Types of Mutual Funds <ul><li>Investment policies, styles, management </li></ul><ul><li>Money Market funds </li></ul><ul><li>Bond funds - Taxable </li></ul><ul><ul><ul><li>- Tax-free </li></ul></ul></ul><ul><ul><ul><li>- High-income (junk bonds) </li></ul></ul></ul><ul><li>Stock funds - Aggressive Growth </li></ul><ul><ul><li>- Growth </li></ul></ul><ul><ul><li>- Growth and income </li></ul></ul><ul><ul><li>- Income </li></ul></ul><ul><li>Balanced and income funds </li></ul><ul><li>Specialized sector funds </li></ul><ul><li>Index funds </li></ul>
    18. 18. Table 4.1 Classification of U.S. Mutual Funds
    19. 19. Trading in Mutual Funds <ul><li>NAV (for open ended) and </li></ul><ul><li>Share price (for closed ended) are Quoted Daily </li></ul><ul><li>No margin or short positions </li></ul><ul><li>(not for Exchange Traded Funds or ETF !) </li></ul><ul><li>May have tax disadvantages </li></ul>
    20. 20. How Funds Are Sold <ul><li>Directly marketed </li></ul><ul><li>Sales force distributed </li></ul><ul><li>Revenue sharing on sales force distributed </li></ul><ul><ul><li>Potential conflicts of interest </li></ul></ul><ul><li>Financial supermarkets </li></ul>
    21. 21. Potential Conflicts of Interest - Revenue Sharing <ul><li>Brokers put investors in funds that may that may not be the most appropriate </li></ul><ul><li>Mutual funds could direct trading to higher cost brokers </li></ul><ul><li>Revenue sharing is not illegal but it must be disclosed to the investor </li></ul>
    22. 22. Investment Companies in HK and China <ul><li>HK: </li></ul><ul><ul><li>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 </li></ul></ul><ul><ul><li>including exchange-traded funds, index funds, guaranteed funds and hedge funds </li></ul></ul><ul><ul><li>Can invest in China through QFII </li></ul></ul><ul><li>China: </li></ul><ul><ul><li>Industry size RMB3.2T (including HF and PE) </li></ul></ul><ul><ul><li>In June 2007, the CSRC announced that QDII fund management companies and securities firms are allowed to invest in overseas </li></ul></ul><ul><ul><li>Allow foreign investors since joining WTO </li></ul></ul>
    23. 23. HK Funds (in US$ million) As at end 截至 Bond 債券基金 Equity 股票基金 Diversified 多元化基金 Money Market 貨幣市場基金 Fund of Funds 基金的基金 Warrant 權證基金 Index * 指數基金 * Guaranteed ** 保證基金 ** Hedge 對沖基金 Other Specialised* ** 其他特別基金 * ** Total 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
    24. 24. Mutual Funds Expenses <ul><li>Front-End Load (0%-6.25%) </li></ul><ul><li>Back-End Load (5%-6%, decreasing with time) </li></ul><ul><li>Operating Expenses (0.2%-2%) </li></ul><ul><li>12b-1 Charges (1%) </li></ul><ul><li>Soft Dollars </li></ul><ul><li>“ Fee is the most robust predictor of performance” </li></ul>
    25. 25. Table 4.2 Impacts of Costs on Investment Performance
    26. 26. Trading Scandal with Mutual Funds <ul><li>Late trading – allowing some investors to purchase or sell later than other investors </li></ul><ul><li>Market timing – allowing investors to buy or sell on stale net asset values </li></ul><ul><ul><li>International </li></ul></ul><ul><li>Net effect is to transfer wealth from existing owners to the new purchasers or sellers </li></ul>
    27. 27. Potential Reforms <ul><li>Strict 4:00 PM cutoff with late orders executed the following trading day </li></ul><ul><li>Fair value pricing with net asset values being adjusted for trading in open markets </li></ul><ul><li>Imposition of redemption fees </li></ul>
    28. 28. Mutual Fund Returns <ul><ul><ul><li>All NAV’s are net of loads and other expenses </li></ul></ul></ul>
    29. 29. Mutual Fund Returns <ul><li>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? </li></ul>
    30. 30. Problem 11, Chapter 4(p.110) <ul><li>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. </li></ul><ul><li>a. What is the rate of return to an investor in the fund during the year? </li></ul><ul><li>b. What would have been the rate of return to an investor who held the same securities as the fund manager during the year? </li></ul>
    31. 31. Problem 13, Chapter 4(p.110) <ul><li>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? </li></ul>
    32. 32. Problem 16, Chapter 4(p.110) <ul><li>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? </li></ul>
    33. 33. Taxes on Mutual Funds <ul><li>Investor directed portfolios can be structured to take advantage of taxes while mutual funds cannot </li></ul><ul><li>Pass-through of capital gains and dividend income </li></ul><ul><li>High turnover (=Amount of Sales/Fund Value) leads to tax inefficiency </li></ul><ul><li>More disclosure on taxes was required in 2000 </li></ul>
    34. 34. Exchange Traded Funds (ETF) <ul><li>ETF allow investors to trade index portfolios like shares of stock </li></ul><ul><li>Examples – Spiders, Diamonds, Cubes, Viper, and Webs </li></ul><ul><li>Potential advantages </li></ul><ul><ul><li>Trade continuously </li></ul></ul><ul><ul><li>Lower taxes </li></ul></ul><ul><ul><li>Lower costs </li></ul></ul><ul><li>Potential disadvantages </li></ul>
    35. 35. Mutual Fund Performance <ul><li>How can we measure Mutual Fund Performance? </li></ul><ul><li>Benchmark Performance </li></ul><ul><ul><ul><li>Wilshire 5000 </li></ul></ul></ul><ul><ul><ul><li>S&P 500 </li></ul></ul></ul><ul><li>What is the proper benchmark? </li></ul><ul><li>How can we disentangle skill from luck? </li></ul>
    36. 36. First Look at Mutual Fund Performance <ul><li>Evidence shows that average mutual fund performance is generally less than broad market performance </li></ul><ul><li>Evidence suggests that over certain horizons some persistence in positive performance </li></ul><ul><ul><li>Evidence is not conclusive </li></ul></ul><ul><ul><li>Some inconsistencies </li></ul></ul><ul><li>“ Past performance is not necessarily indicative of future results. ” </li></ul>
    37. 37. Figure 4.3 Percentage of Funds Below Wilshire 5000
    38. 38. Table 4.4 Consistency of Investment Results
    39. 39. Sources of Information on Mutual Funds <ul><li>Prospectus, Annual Reports </li></ul><ul><li>Morningstar (www.morningstar.com) </li></ul><ul><li>Yahoo (biz.yahoo.com/funds) </li></ul><ul><li>Wiesenberger ’ s Investment Companies </li></ul><ul><li>Investment Company Institute </li></ul><ul><li>Popular press </li></ul><ul><li>Investment services </li></ul>
    40. 40. Summary <ul><li>Type of investment companies </li></ul><ul><li>Mutual fund expenses </li></ul><ul><li>Mutual fund performance </li></ul><ul><li>Next Class: Risk and Return </li></ul>

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