Mutual Funds and Hedge Funds
27
Mutual Funds Mutual Funds and Hedge and Hedge Funds Funds Chapter 5 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin
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Transcript of Mutual Funds and Hedge Funds
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2. Overview
- In this segment: Mutual Funds and Hedge Funds:
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- Activities of mutual
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- Size, structure and composition
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- Balance sheets and recent trends
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- Regulation of mutual funds
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- Activities of hedge funds
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- Global issues
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- Size, structure and composition
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- Balance sheets and recent trends
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- Regulation of hedge funds
3. Mutual Funds
- Diversification opportunities enhanced for small investors
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- Economies of scale
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- Predominantly open-ended funds
4. Mutual Funds
- Rapid growth in funds during the 1990s
- Slower rate of growth in the industry in early 2000s than in 1990s
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- Trading abuses contributed to slowdown
- 2007:
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- Almost 7,100 stock and bond mutual companies.
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- Total assets of $8.21 trillion.
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- 8,125 firms and $10.57 trillion if money market mutual funds included
5. Size, structure and composition
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- First mutual fund: Boston, 1924.
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- Slow growth, initially.
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- Advent of money market mutual funds, 1972.
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- Regulation Q.
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- Total assets in stock and bond mutual funds:
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- 1940: $0.5 billion.
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- 1990: $1,065.2 billion
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- 2000: $6,964.6 billion
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- 2006: $10,413.7
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- Institutional funds
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- 80 percent of retirement plan investments
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6. Size, Structure and Composition
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- By asset size, mutual fund industry second most important FI group.
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- Recent inroads by commercial banks and insurance companies
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- Mellon purchase of Dreyfus
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- State Farm (9,000 agents)
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- As of 2006, insurance companies managed approximately 10% of mutual fund assets
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7. Types of Mutual Funds
- Long-term funds
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- 74.3% of assets, 1999
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- 2002, long-term funds dropped to 62.1% of assets, losing ground to MMMFs
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- 75.4% in 2006
- Types of Long-term Funds:
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- Bond and income funds.
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- Equity funds.
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- Hybrid.
8. Types of Mutual Funds
- Short-term funds
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- 25.7% of assets, 1999.
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- 37.9% of assets, 2002.
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- 24.6% in 2006
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- Taxable and tax-exempt MMMFs
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- Generally higher returns than bank deposits but uninsured.
- Impact of low interest rates during early to mid 2000s
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- Decline in MMMFs
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- Lowering of MMMF fees
9. Number of Mutual Funds 10. Interest Rate Spread and Net New Cash Flow to MMMFs 11. Overview of Mutual Funds
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- Objectives (and adherence to stated objectives), rates of return and risk characteristics vary.
- Examples:
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- Capital appreciation funds
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- World equity
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- Corporate bond
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- High-yield bond
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- World bond
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- Government bond
12. Returns to Mutual Funds
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- Income and dividends of underlying portfolio.
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- Capital gains on trades by mutual fund management.
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- Capital appreciation in values of assets held in the portfolio.
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- Marked-to-market.
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- Net-asset value (NAV).
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13. Web Resources
- For information on the performance of mutual funds, visit:
- Morningstarwww.morningstar.com
14. Types of Funds
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- Open-ended funds: comparable to most corporate securities traded on stock exchanges.
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- Closed-end investment companies:
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- Fixed number of shares
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- Example: REITs.
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- May trade at premium or discount.
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- Exchange traded funds (ETFs)
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- Load versus no-load funds.
15. Mutual Fund Costs
- Two types of fees:
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- Sales loads
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- Generally, negative effect on performance outweighs benefits
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- Short term versus long term investment alters impact of loads on cost
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- Fund operating expenses
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- Management fee
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- 12b-1 fees
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- Front end and back end fees
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- Class A, Class B and Class C differences
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- SEC creation of new rules
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- Sweeping decreases in fees, 2005 and 2006
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16. Balance Sheet and Trends
- Money Market Funds
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- Key assets are short-term securities (consistent with deposit-like nature)
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- 2006: $1,514.9 billion (65.5% of total assets)
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- Most have share values fixed at $1 and adjust number of shares owned by the investor.
17. Balance Sheet and Trends
- Long-term Funds
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- Stocks comprised over 70.7 % of asset portfolios in 2006.
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- Credit market instruments 27.2% of asset portfolios
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- Shift to other securities such as credit market instruments, U.S. Treasuries, municipal bonds etc. when equity markets not performing as well.
18. Regulation
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- One of the most closely regulated among non-depository FIs.
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- Primary regulator: SEC
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- Emphasis on full disclosure and anti-fraud measures to protect small investors.
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- NASD supervises mutual fund share distributions.
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19. Regulatory Changes
- Prosecutions in light of trading abuses in early 2000s.
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- Market timing
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- Late trading
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- Directed brokerage
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- Improper fee assessments
- Changes include: SEC requirements for independent board members; reporting and disclosure requirements
20. Legislation
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- Securities Act 1933, 1934
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- Investment Advisers Act, 1940.
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- Insider Trading and Securities Fraud Enforcement Act of 1988.
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- Market Reform Act of 1990
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- Allows SEC to halt trading and introduce circuit breakers.
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- National Securities Markets Improvement Act of 1996.
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- Exempts mutual fund sellers from state securities regulatory oversight.
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- Sarbanes-Oxley Act of 2002
21. Global Issues
- Worldwide growth in mutual fund investment not as great as in the U.S.
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- $2.575 trillion in 1996 to $10.490 trillion in 2006
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- Over 307% growth
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- Larger returns in U.S.stock markets
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- Greatest development in countries with most advanced markets
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- Opportunities from declining Japanese markets
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- Efforts to reduce barriers for U.S. mutual fund sponsors
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- China and other Asian countries
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22. Hedge Funds
- Not technically mutual funds
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- Not subject to SEC regulation
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- Organized as limited partnership
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- Small number of sophisticated investors
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- Common feature is use of leverage
- High returns in 1990s
23. Hedge Funds
- Near collapse of Long-Term Capital Management
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- $3.6 billion bailout
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- Precipitated SEC scrutiny of hedge funds
24. Types of Hedge Funds
- More risky
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- Market directional
- Moderate risk
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- Market neutral or value orientation
- Risk avoidance
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- Moderate, consistent returns with low risk as objectives
- Fees
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- Generally management fees and performance fees
25. Offshore Hedge Funds
- Major centers include Cayman Islands, Bermuda, Dublin, Luxembourg.
- Rules
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- Generally not burdensome
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- Anonymity
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- Tax advantages
26. Regulation of Hedge Funds
- Generally unregulated
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- Exemption for less than 100 investors
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- Exemption if accredited
- Scandals such as Canary Capital Partners
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- Illegal trading with mutual funds
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- Amaranth Advisors, 2006
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- SEC scrutiny
27. Pertinent Websites
- American Fundswww.americanfunds.com
- Federal Reservewww.federalreserve.gov
- Fidelity Investmentswww.fidelity.com
- Investment Company Institutewww.ici.org
- Morningstar, Inc.www.morningstar.com
- NASD:www.nasd.com
- SEC:www.sec.gov
- Vanguardwww.vanguard.com
- Wall Street Journalwww.wsj.com