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  1. 2. 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, also </li></ul></ul><ul><ul><ul><li>Closed-end </li></ul></ul></ul><ul><ul><ul><li>ETF </li></ul></ul></ul>
  2. 3. 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>
  3. 4. 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>
  4. 5. From Ch 1
  5. 7. Mutual Funds As Retirement Assets Source: Investment Company Institute
  6. 8. Mutual Funds <ul><li>Rapid growth in funds during the 1980s &1990’s </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>
  7. 13. Mutual Fund Business Functions Product Design Processing Investment Management Investors Distribution
  8. 14. Mutual Fund Scoreboard Advantages: <ul><li>Diversification </li></ul><ul><li>Professional mgt </li></ul><ul><li>Convenience </li></ul><ul><li>Cost saving </li></ul>Disadvantages: <ul><li>No Intra-day trading in traditional funds </li></ul><ul><li>Cost saving not passed on </li></ul><ul><li>Potential tax issues </li></ul><ul><li>Poorly defined objectives </li></ul>5. Liquidity 6. Easy indexing 7. Reliable return data 8. Payment Mechanism
  9. 15. 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>
  10. 16. 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>
  11. 17. 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 (US Equity) </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>
  12. 18. Mutual Fund Assets By Asset Class
  13. 19. 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>
  14. 20. 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>
  15. 21. 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>
  16. 22. 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>
  17. 23. Load Versus No-Load Fund Assets
  18. 24. Mutual Fund Expenses <ul><li>Front-end Loads </li></ul><ul><li>Back-end Loads </li></ul><ul><li>Annual Expenses </li></ul><ul><li>Expense Ratio (includes the following) </li></ul><ul><ul><li>Management Fee </li></ul></ul><ul><ul><li>Operating Expenses </li></ul></ul><ul><ul><li>12-b-1 Charges (Service/Load) </li></ul></ul>
  19. 25. 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>
  20. 26. 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>
  21. 27. 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>
  22. 28. 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>
  23. 29. Web Resources <ul><li>For information on the performance of mutual funds, visit: </li></ul><ul><li>Morningstar www.morningstar.com </li></ul>
  24. 30. 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><ul><ul><li>Lack of correlation has not held up recently </li></ul></ul>
  25. 31. Hedge Funds Different From Mutual Funds <ul><li>Investment by manager </li></ul><ul><li>Limited to high net worth investors </li></ul><ul><li>Concentrated bets </li></ul><ul><li>Fees – large </li></ul><ul><li>Little regulatory oversight </li></ul><ul><li>Lack of liquidity </li></ul><ul><li>Lack of transparency </li></ul><ul><li>Asset allocation is slippery </li></ul><ul><li>High attrition </li></ul><ul><li>Can hold riskier assets </li></ul><ul><li>Significant leverage </li></ul>
  26. 32. Estimated Growth of Assets / Net Asset Flow Hedge Fund Industry 1990 – Q1 2007
  27. 33. Some Hedge Fund Strategies <ul><li>Mutual funds are long-only </li></ul><ul><li>Long/short equity </li></ul><ul><ul><li>Statistical arbitrage </li></ul></ul><ul><ul><li>Market neutral </li></ul></ul><ul><li>Event Driven </li></ul><ul><li>Global Macro </li></ul><ul><li>Arbitrage </li></ul><ul><ul><li>Convertibles arbitrage </li></ul></ul><ul><ul><li>Relative value </li></ul></ul>
  28. 35. 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>
  29. 36. 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>
  30. 37. 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>
  31. 38. <ul><li>The following 5 slides* are from: </li></ul><ul><li>AIMA’s Roadmap To Hedge Funds </li></ul><ul><li>published November, 2008 </li></ul><ul><li>Alternative Investment Management Association </li></ul><ul><li>* Also slide # 29 </li></ul>
  32. 39. Hedge Fund Fee Justification
  33. 41. Returns According to Industry Group (IAMA)
  34. 44. Pertinent Websites <ul><li>Moneycentral.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>NASD: www.nasd.com </li></ul><ul><li>SEC: www.sec.gov </li></ul><ul><li>Vanguard www.vanguard.com </li></ul><ul><li>Etfconnect.com for ETFs & Closed End </li></ul><ul><li>www.closed-endfunds.com for closed end </li></ul><ul><li>http://www.hedgefundresearch.com/ hedge funds </li></ul><ul><li>http://www.aima.org/ hedge funds </li></ul>