Class 3

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Class 3

  1. 1. <ul><li>Chapter Five: </li></ul><ul><li>Mutual Funds </li></ul>07/09/10 08:28
  2. 2. Overview <ul><li>In this segment ... Mutual Funds: </li></ul><ul><ul><li>Activities of mutual funds </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>Global issues </li></ul></ul><ul><ul><li>Hedge funds* </li></ul></ul>07/09/10 08:28
  3. 3. Mutual Funds <ul><li>Open-ended </li></ul><ul><li>Closed-end </li></ul><ul><li>End of 2003: </li></ul><ul><ul><li>More than 7,100 stock and bond mutual companies. </li></ul></ul><ul><ul><li>Total assets of $5.36 trillion. </li></ul></ul><ul><ul><li>8,200 firms and $7.41 trillion if money market mutual funds included </li></ul></ul><ul><li>Slower rate of growth in the industry in early 2000s than in 1990s </li></ul>07/09/10 08:28
  4. 4. 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: $0.4 billion. </li></ul></ul></ul><ul><ul><ul><li>1990: $1,065.2 billion </li></ul></ul></ul><ul><ul><ul><li>2003: $7,414.1 billion. </li></ul></ul></ul>07/09/10 08:28
  5. 5. 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 2004, insurance companies managed approximately 14% of mutual fund assets </li></ul></ul></ul>07/09/10 08:28
  6. 6. 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><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>07/09/10 08:28
  7. 7. 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>30.2% of assets, 2002. </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 2000s </li></ul>07/09/10 08:28
  8. 8. Number of Mutual Funds
  9. 9. 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>Growth funds </li></ul></ul><ul><ul><li>High-yield bond </li></ul></ul><ul><ul><li>World equity </li></ul></ul><ul><ul><li>Corporate bond </li></ul></ul>07/09/10 08:28
  10. 10. 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>07/09/10 08:28
  11. 11. Web Resources <ul><li>For information on the performance of mutual funds, visit: </li></ul><ul><li>Morningstar www.morningstar.com </li></ul>07/09/10 08:28
  12. 12. Types of Funds <ul><ul><li>Open-ended funds: contrast with 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><li>Load versus no-load funds. </li></ul></ul>07/09/10 08:28
  13. 13. 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><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>07/09/10 08:28
  14. 14. Mutual Fund Share Quotes <ul><li>Quotes include: </li></ul><ul><ul><li>Fund NAV, Fund name, Objective, one-month through ten-year return and rating (A through E), Maximum initial charges, and Annual expenses. </li></ul></ul>07/09/10 08:28
  15. 15. 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>2003: $1,395.9 billion (69.2% of total assets) </li></ul></ul></ul><ul><ul><li>Many have share values fixed at $1 and adjust number of shares owned by the investor. </li></ul></ul>07/09/10 08:28
  16. 16. Balance Sheet and Trends <ul><li>Long-term Funds </li></ul><ul><ul><li>Stocks comprised over 65.6 % of asset portfolios in 2000. </li></ul></ul><ul><ul><li>Credit market instruments 32.3% of asset portfolios </li></ul></ul><ul><ul><li>Shift to U.S. Treasuries, municipal bonds etc. when equity markets not performing as well. </li></ul></ul>07/09/10 08:28
  17. 17. 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>07/09/10 08:28
  18. 18. 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>07/09/10 08:28
  19. 19. 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>07/09/10 08:28
  20. 20. Pertinent Websites <ul><li>American Banker www.americanbanker.com </li></ul><ul><li>American Funds www.americanfunds.com </li></ul><ul><li>Federal Reserve www.federalreserve.gov </li></ul><ul><li>Fidelity Investments www.fidelity.com </li></ul><ul><li>Investment Company Institute www.ici.org </li></ul><ul><li>Morningstar, Inc. www.morningstar.com </li></ul><ul><li>SEC: www.sec.gov </li></ul><ul><li>NASD: www.nasd.com </li></ul><ul><li>Vanguard www.vanguard.com </li></ul><ul><li>Wall Street Journal www.wsj.com </li></ul>07/09/10 08:28
  21. 21. Global Issues <ul><li>Worldwide growth in mutual fund investment not as great as in the U.S. </li></ul><ul><ul><li>$1.626 trillion in 1992 to $6.543 trillion in 2003 </li></ul></ul><ul><ul><ul><li>Over 300% growth compared to 350% in U.S. </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 developed 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>07/09/10 08:28
  22. 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>07/09/10 08:28
  23. 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>2003 SEC scrutiny of hedge funds </li></ul></ul><ul><ul><li>Scandals such as Canary Capital Partners involving trades with mutual funds </li></ul></ul>07/09/10 08:28
  24. 24. <ul><li>Chapter Six: </li></ul><ul><ul><li>Finance Companies </li></ul></ul>07/09/10 08:28
  25. 25. Overview <ul><li>In this segment we discuss Finance Companies: </li></ul><ul><ul><li>Activities of finance companies </li></ul></ul><ul><ul><li>Competitive environment </li></ul></ul><ul><ul><li>Size, structure and composition </li></ul></ul><ul><ul><li>Regulation </li></ul></ul><ul><ul><li>Global issues </li></ul></ul>07/09/10 08:28
  26. 26. Historical Perspective <ul><li>Finance companies originated during the depression. </li></ul><ul><ul><li>Installment credit </li></ul></ul><ul><ul><li>General Electric Capital Corporation. </li></ul></ul><ul><ul><li>Competition from banks increased during 1950s. </li></ul></ul><ul><li>Expansion of product lines </li></ul><ul><ul><li>GMACCM is largest commercial mortgage lender in U.S. </li></ul></ul><ul><li>Industry is highly concentrated </li></ul><ul><ul><li>Largest 20 firms account for more than 75% of assets. </li></ul></ul>07/09/10 08:28
  27. 27. Finance Companies <ul><li>Activities similar to banks, but no depository function. </li></ul><ul><li>May specialize in installment loans (e.g. automobile loans) or may be diversified, providing consumer loans and financing to corporations, especially through factoring. </li></ul><ul><li>Commercial paper is key source of funds. </li></ul><ul><li>Captive Finance Companies: e.g. GMAC </li></ul>07/09/10 08:28
  28. 28. Major Types of Finance Companies <ul><li>Sales finance institutions </li></ul><ul><ul><li>Ford Motor Credit and Sears Roebuck Acceptance Corp. </li></ul></ul><ul><li>Personal credit institutions </li></ul><ul><ul><li>Household International Corp. and AIG American General. </li></ul></ul><ul><li>Business credit institutions </li></ul><ul><ul><li>CIT Group and Fleet Boston Financial. </li></ul></ul><ul><ul><li>Equipment leasing and factoring. </li></ul></ul>07/09/10 08:28
  29. 29. Web Resources <ul><li>For information on finance companies, visit: </li></ul><ul><li>www.ge.com </li></ul><ul><li>www.gmacfs.com </li></ul><ul><li>www.fordcredit.com </li></ul><ul><li>www.household.com </li></ul><ul><li>www.americangeneral.com </li></ul><ul><li>www.citgroup.com </li></ul>07/09/10 08:28
  30. 30. Largest Finance Companies
  31. 31. Balance Sheet and Trends <ul><li>Business and consumer loans are the major assets </li></ul><ul><ul><li>51.9% of total assets, 2003. </li></ul></ul><ul><ul><li>Reduced from 95.1% in 1977. </li></ul></ul><ul><li>Increases in real estate loans and other assets. </li></ul><ul><li>Growth in leasing (largely due to tax incentives of 1981 Economic Recovery Act). </li></ul><ul><li>Finance companies face credit risk, interest rate risk and liquidity risk. </li></ul>07/09/10 08:28
  32. 32. Balance Sheet and Trends <ul><li>Consumer loans </li></ul><ul><ul><li>Primarily motor vehicle loans and leases. </li></ul></ul><ul><ul><li>Recent low auto finance company rates are anomalous — partly due to 9/11 effects. </li></ul></ul><ul><ul><ul><li>Attempts to boost new vehicle sales via 0.0% loans lasted into 2004. </li></ul></ul></ul><ul><ul><ul><li>By 2003, rates 3.5% lower than banks on new vehicle rates </li></ul></ul></ul>07/09/10 08:28
  33. 33. Consumer loans (continued) <ul><li>Generally riskier customers than banks serve. </li></ul><ul><ul><li>Subprime mortgage lenders </li></ul></ul><ul><ul><li>Jayhawk Acceptance Corp. </li></ul></ul><ul><ul><ul><li>From auto loans to tummy tucks and nose jobs </li></ul></ul></ul><ul><li>Increase in “loan shark” firms with rates as high as 30% or more. </li></ul><ul><li>Other consumer loans about 24.7% of consumer loan portfolio, 2003. </li></ul>07/09/10 08:28
  34. 34. Balance Sheet and Trends <ul><li>Mortgages </li></ul><ul><ul><li>Recent addition to finance company assets </li></ul></ul><ul><ul><li>Smaller regulatory burden than banks </li></ul></ul><ul><ul><li>May be direct mortgages, or as securitized mortgage assets. </li></ul></ul><ul><ul><li>Growth in home equity loans since passage of Tax Reform Act of 1986. </li></ul></ul><ul><ul><ul><li>Tax deductibility issue. </li></ul></ul></ul><ul><ul><ul><li>Conversion of credit card debt </li></ul></ul></ul><ul><ul><ul><li>2003 average home equity loan $69,513 </li></ul></ul></ul>07/09/10 08:28
  35. 35. Web Resources <ul><li>For information on home equity loans, visit the Consumer Bankers Association at: </li></ul><ul><li>www.cbanet.org </li></ul>07/09/10 08:28
  36. 36. Business Loans <ul><li>Business loans comprise largest portion of finance company loans. </li></ul><ul><li>Advantages over commercial banks: </li></ul><ul><ul><li>Fewer regulatory impediments to types of products and services. </li></ul></ul><ul><ul><li>Not depository institutions hence less regulatory scrutiny and lower overheads. </li></ul></ul><ul><ul><li>Often have substantial expertise and greater willingness to accept riskier clients. </li></ul></ul>07/09/10 08:28
  37. 37. Business Loans <ul><li>Major subcategories: </li></ul><ul><ul><li>Retail and wholesale motor vehicle loans and leases </li></ul></ul><ul><ul><li>Equipment loans </li></ul></ul><ul><ul><ul><li>tax issues associated when finance company leases the equipment directly to the customer </li></ul></ul></ul><ul><ul><li>Other business loans and securitized business assets </li></ul></ul>07/09/10 08:28
  38. 38. Liabilities <ul><li>Major liabilities: commercial paper and other debt (longer-term notes and bonds). </li></ul><ul><li>Finance firms are largest issuers of commercial paper (frequently through direct sale programs). </li></ul><ul><ul><li>Commercial paper maturities up to 270 days. </li></ul></ul><ul><li>Consequently, management of liquidity risk differs from commercial banks relying on deposits </li></ul>07/09/10 08:28
  39. 39. Industry Performance <ul><li>Strong loan demand </li></ul><ul><li>Strong profits for the largest firms </li></ul><ul><ul><li>e.g. Household International, Associates First Capital, Beneficial </li></ul></ul><ul><ul><li>Effects of low interest rates </li></ul></ul><ul><li>Most successful have become takeover targets </li></ul><ul><ul><li>Citigroup/Associates First Capital, </li></ul></ul><ul><ul><li>Household International/HSBC Holdings </li></ul></ul>07/09/10 08:28
  40. 40. Industry Performance <ul><li>High risk has a downside: </li></ul><ul><ul><li>Subprime lending: Jayhawk Acceptance Corporation </li></ul></ul><ul><ul><li>Cityscape Financial Corp., Aames Financial Corp., Advanta, FirstPlus Financial Group, The Money Store, Associates First Capital </li></ul></ul><ul><ul><li>FTC scrutiny of subprime lending practices violating Truth in Lending Act, Fair Credit Reporting Act, Equal Opportunity Act </li></ul></ul><ul><ul><li>2002, Citigroup $200 million settlement for predatory lending via Associates First Capital </li></ul></ul>07/09/10 08:28
  41. 41. Electronic Lending <ul><li>Mainly mortgages completed over the Internet </li></ul><ul><ul><li>E-Loan </li></ul></ul><ul><ul><li>Suffered with the dot-com downturn </li></ul></ul>07/09/10 08:28
  42. 42. Web Resources <ul><li>For additional information, visit: </li></ul><ul><li>www.household.com </li></ul><ul><li>www.firstunion.com </li></ul><ul><li>www.citigroup.com </li></ul><ul><li>www.ftc.gov </li></ul>07/09/10 08:28
  43. 43. Regulation of Finance Companies <ul><li>Federal Reserve definition of Finance Company </li></ul><ul><ul><li>Firm, other than depository institution, whose primary assets are loans to individuals and businesses. </li></ul></ul><ul><li>Subject to state-imposed usury ceilings. </li></ul><ul><li>Much lower regulatory burden than depository institutions. </li></ul><ul><ul><li>Not subject to Community Reinvestment Act. </li></ul></ul><ul><ul><li>Lack the banks’ regulatory safety-net </li></ul></ul>07/09/10 08:28
  44. 44. Regulation <ul><li>With less regulatory scrutiny, finance companies must signal safety and soundness to capital markets in order to obtain funds. </li></ul><ul><li>Lower leverage than banks (15.1% capital-assets versus 9.1% for commercial banks). </li></ul><ul><li>Captive finance companies may employ default protection guarantees from parent company or other protection such as letters of credit. </li></ul>07/09/10 08:28
  45. 45. Global Issues <ul><li>In foreign countries, Finance companies are generally subsidiaries of commercial banks or industrials </li></ul><ul><li>In Japan, ownership of finance companies by banks created opportunities when banks hit by increase in nonperforming loans </li></ul><ul><ul><li>GE Capital/Japan Leasing Corporation </li></ul></ul>07/09/10 08:28
  46. 46. Pertinent Websites <ul><li>Aames Financial Corp. www.aames.net </li></ul><ul><li>Advanta www.advanta.com </li></ul><ul><li>American General www.aigag.com </li></ul><ul><li>Federal Reserve www.federalreserve.gov </li></ul><ul><li>CIT Group www.citgroup.com </li></ul><ul><li>Citigroup www.citigroup.com </li></ul><ul><li>Consumer Bankers Association www.cbanet.org </li></ul><ul><li>Federal Trade Commission www.ftc.gov </li></ul><ul><li>First Union Bank www.firstunion.com </li></ul>07/09/10 08:28
  47. 47. Pertinent Websites <ul><li>Ford Motor Credit www.fordcredit.com </li></ul><ul><li>GE Capital Corp. www.ge.com </li></ul><ul><li>GMAC www.gmacfs.com </li></ul><ul><li>Household International www.household.com </li></ul><ul><li>The Wall Street Journal www.wsj.com </li></ul>07/09/10 08:28
  48. 48. Team Names for Paper & Presentation? <ul><li>Names are due NEXT CLASS . </li></ul><ul><li>The Finished Paper is due February 28 th , </li></ul><ul><li>at the Start of Class. </li></ul><ul><li>Your Presentations will be done March 4 th & 6 th </li></ul>07/09/10 08:28

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