- Week 2: Mutual Funds and Hedge Funds
2.
- Managed Investment Companies(like mutual funds)
- Other investment organizations
-
- CTAs (commodity trading advisors)
Investment Organizations 3.
- Closed-end: no change unless new stock is offered.
- Open-end: changes when new shares are sold or old shares are
redeemed.
- Open-end: Net Asset Value(NAV)
- Closed-end: Premium or discount to NAV
Open-End and Closed- End Funds: Key Differences 4. Figure 4.1
Closed-End Mutual Funds 5. Figure 4.2 Listing of Mutual Fund
Quotations 6.
InvestmentStrategie s 7. Table 4.1 U.S. Mutual Funds by
Investment Classification, December 2004 8. What Is a Mutual
Fund?
- F inancial intermediaries that pool the financial resources of
investors and invest those resources in diversified portfolios of
assets
- Why do we hold diversified portfolios?
- In mid-200 6 , more than 8, 1 00 mutual funds held total assets
of $ 9.5trillion
9. Why Invest in a Mutual Fund?
- E conomies of scale :lower transaction costs and
commissions
- V ariety ,l iquidity ,a ffordability ,and c onvenience
- Administration and e ase of recordkeeping
- S t r ict government regulation and full disclosure
10. Shareholder Sentiment
- recent trading scandal and bear market
11. Histor y
- First mutual fund established in 1924
- Advent of MMMF in 1972 as investors looked for ways to earn
market rates on short-term funds
- Tax-exempt MMMF introduced in 1979
- Special-purpose equity, bond, emerging market, and derivative
funds exploded on the scene during the 1990s bull market
12. Growth of the Mutual Fund Market 13. How manyhousehold s own
mutual funds?
- 92 million individuals in 53.9 million U.S. households (48.1
percent of all)
- U.S. Household Ownership of Mutual Funds, 1998-2004 ( in
millions)
14. Types of Mutual Funds Owned by Fund Shareholders, 2004 15.
Investor Returns from Mutual Fund Ownership
- The return for the investor reflects three aspects of the
underlying portfolio of mutual fund assets
-
- portfolio earns income and dividends on those assets
-
- experiences capital gainsat the fund level
-
- capital appreciation in the underlying values of its existing
assets adds to the value of mutual fund shares
- Daily marking to market -asset and balance sheet values are
adjusted to reflect current market prices
- NAV -the net asset value of a mutual fund -- equal to the
market value of the assets in the mutual fund portfolio divided by
number of shares outstanding
16. Example 1
- An investor purchases a mutual fund share for $100
- The fund pays dividends of $2, distributes a capital gains of
$5, and charge a fee of $1.5 when the fund is sold one year later
for $10 5 .
- Net rate of return=(2+5-1.5+ 5 )/100=1 0 .5%
17. Calculation of NAV; Classes of Funds Calculation of NAV on
an Open-End Mutual Fund NAV=Total market value of assets under
management Number of mutual fund shares outstanding Open-end mutual
fund -a fund for which the supply ofshares is not fixed but can
increase or decrease daily withpurchases and redemptions of shares
Closed-end investment companies- specialized investmentcompanies
that have a fixed supply of outstanding sharesbut invest in the
securities and assets of other firms REIT- a closed-end investment
company that specializes in investing in mortgages, property, or
real estate shares 18. Example 2
- 200 shares of Microsoft$29.31
- NAV =(37.49*100+29.31*200)/100= $ 96.11
19. Mutual Fund Costs
- Mutual funds charge shareholders a price or fee
- Threetypes of fees are incurred by investors
-
- Load versus No-load Funds
-
-
- Load fund- a mutual fund with an up-front sales or commission
charge that the investor must pay
-
-
- No-load fund- a mutual fund that does not charge up-front sales
or commission charges on the sale of mutual fund shares to
investors
-
-
- annual fees charged to cover all fund level expenses
experienced as a percent of fund assets
-
-
- distribution costs paid by the fund
20. Mutual Fund Fee Table Required by Federal Law 21. Table 4.2
Impacts of Costs on Investment Performance 22. Calculating Cost
Basis
- Buy100 shares ofPioneerFund at $10 each and paid an up-front
sales charge of 2 percent, or $20, on the purchase.
- The cost basis for each share=$10.20 ($1,020 divided by
100).
- If you later sell the 100 shares for $1,500, your capital gain
will be $480 ($1,500 - $1,020).
23. Key Considerations About Performance
- Past performance cannot predict future results.
- Short-term returns may not tell the whole story.
- -Think of inflation as an invisible tax that erodes the
purchasing power of any investment.
24. A First Look at Fund Performance
-
- Most funds underperform(Figure 4.3)
-
- Not fair comparison because of costsand cash position
- Adjustedb enchmark: Wilshire 5000 with passive management costs
considered.
-
- The majority of funds still under-perform.
25. Figure 4.3 Diversified Equity Funds versus Wilshire 5000
Index 26. Consistency of Fund Performance
- Do some mutual funds consistently outperform?
- Evidence suggests that some funds show consistent stronger
performance.
-
- Depends on measurement interval
- Evidence shows consistent poor performance.
27. Table 4.4 Consistency of Investment Results 28.
- Wiesenbergers Investment Companies
- Investment Company Institute
- Center for Research in Security Prices
- http://gsbwww.uchicago.edu/research/crsp
Sources of Information on Mutual Funds 29. Growth of Hedge
Funds: 1990 to 2003 Source: Hedge Fund Research Growth of Hedge
Funds: 1990-2003 30. Number of Hedge Funds:1990 to 2003 Source:
Hedge Fund Research Number of Hedge Funds: 1990-2003 31. The
History of Hedge Fund (I)
- The first hedge fund was created in 1949 by Alfred Winslow
Jones. Jones longed the undervalue stocks and shorted the
overvalued stock
- In 1966, Carol Loomis mentioned the spectacular performance of
Jones fund in the Fortune Magazine.
- In 1986, the Institutional Investor cited the superior
performance (43% per year for the first 6 years) of Julian
Robertsons Tiger Fund
- In 1992, George Soros Quantum Fund made a famous attack on the
British Sterling and made a profit of 1 billion BP.
- In 1997, hedge funds were accused for responsible for the Asian
currency crisis.
32. The History of Hedge Fund (II)
- In 1998, Long-Term Capital Management (LTCM) lost 90% of their
money and was bailed out by a dozen Wall Street firms.
- In 2004, the SEC has passed the rule for hedge funds to
register as investment advisors.
- In Feb. 2006, the SEC required major hedge funds to register as
investment advisers
- In June, 2006, the U.S. Court of Appeals for the District of
Columbia Circuit vacated the SEC rule changes
33. Hedging
- Strategy used to offset investment risk. A perfect hedge is one
eliminating the possibility of future gain or loss.
- Example: You own 100 shares of XYZ stock, selling at $70 per
share. You can hedge your position by buying a put option giving
you the right to sell 100 shares of XYZ stock at $70 per share. If
the stock falls, you can exercise your option to sell the stocks
while preserving your holding.
34. Investment Strategies-Mutual Funds
-
- Small cap, medium cap, large cap
-
- Low quality, medium quality, high quality
-
- Short term, intermediate term, long term
-
- Balanced portfolio between stocks and bonds
35. Investment Strategies-Hedge Funds Hedge Funds Equity market
neutral Market timing Risk arbitrage Global macro Convertible
arbitrage Short seller Fund of funds Emerging markets Fixed income
arbitrage Distressed securities Event driven Multi-strategy Dynamic
trading strategies 36. Evolution of Hedge Fund Strategies Source:
HFR Evolution of Hedge Fund Strategies 37. Hedge Funds:
Characteristics
- One of the fastest growing sectors in finance
- Private partnership or off-shore corporation
- Managers personal investment
- Levered-up (50 times of equity for LTCM)
- High minimum investment requirement ($10 million for LTCM)
- Long lock-up period (1 year for LTCM)
- Incentive fee structure (20% of profits)
- Absolute performers instead of relative performers
- Dynamic trading strategy (vs. buy-and-hold)
- Estimated number of funds: over 8,000
- Estimated fund assets: over $800 billion
Hedge Fund Characteristics 38. The New Startup: Eton Park
- See the WSJ on Nov. 3, 2004
- Founder: Eric Mindich, 37, a former star trader at Goldman
Sachs
- Startup assets: more than $3 billion-one of the largest
start-up funds in history
- Redemption fee: 6% if withdraw money within 4.5 years.
- Strategy: equity long/short-70% money in traditional equity in
US, Latin America, Eastern Europe, and South Africa, and 30% in
less liquid private transactions.
- Investors: Goldman Sachs Asset Management, former Goldman
partners, Harvard University, and other large investors
39. The Debacle of LTCM
- The best finance faculty in the world
- Bet on converging credit spreads on different bonds
- In August 1998, the default on Russian debt caused credit
spread to widen
- Lost more than 90% of its $4.7 billion assets (at one time the
position was more than $100 billion)
- In September 1998, 14 financial institutions infused $3.625
billion to bailout the hedge fund giant, with the help from the
Fed
- Hedge funds should be hedged
- High leverage ratio is extremely risky (margin calls)
- Lenders should be more careful in granting loans (they should
be more informed)
- More disclosure on hedge funds?
40. Hedge Funds vs. Mutual Funds
- Structure Private partnership/ Public funds
- Regulation Not required for registrationSEC
registration/Prospectus
- Investor Wealthy (accredited)/institutional Small/institutional
Up to 500 investors
- Min. investment $250,000 0
- Compensation Incentive fee plus Management fee only
- Lockup period 3 months None
- Advance notice 1 month None
- Concentrated position Yes Rare
Hedge Funds vs. Mutual Funds 41. Hedge Funds vs. Mutual
Funds
-
- Diversification lower value at risk
-
- Smaller unit size of investment
-
- Professional management / Due diligence
-
- Access to otherwise closed funds
Fund of Hedge Funds 42. Fees on Fees in Fund of Funds Fees on
Fees in Funds of Funds Hedge fund 1 Hedge Fund 2 Hedge Fund 3 Fund
of Fund Start of year ($M) $1.00 $1.00 $1.00 $3.00 Annual Return
20% 40% -75% -5% End of year ($M) $1.20 $1.40 $0.25 $2.85 Incentive
fee ($M) $0.04 $0.08 $0.00 $0.12 After fee return 16% 32% -75% -9%
43. Hedge Fund Performance
- For the past ten years ending Sept. 30, 2004
- The US stock mutual funds have averaged 9.4%
- The S&P 500 has gained 11.1%
- Hedge funds rose about 11.9%; however, as a group, the risk of
hedge funds are not as high as the S&P 500.
44. Hedge Funds vs. the S&P Hedge Funds vs. the S&P 500
45. Regulation
- On July 28, 2004, the Securities Exchange Commission (SEC)
published for comment in the Federal Register rules to require
hedge fund advisers to register with the SEC under the Investment
Advisers Act of 1940.
- Hurdle: minimum assets of $30 million which allow redemptions
within two years.
- Prior to that, hedge funds are largely unregistered due to the
nature of partnership and accredited investors.
- Some funds are registered with CFTC (Commodity Futures Trading
Commission)
46. Resources at Isenberg
- The Center for International Securities and Derivatives Market
(CISDM)http://cisdm.som.umass.edu/
- Journal of Alternative Investments
- http://www.iijournals.com/JAI/default.asp
- Chartered Alternative Investment Analysts
(CAIA)http://www.caia.org/
- Professors Ben Branch, Hossein Kazemi, Bing Liang, Tom
Schneeweis, Mila Sherman
47. Useful Websites http://cisdm.som.umass.edu/
https://www.hfr.com/ http://www.tremont.com/ http://hedgefund.net
http://vanhedge.com/ http://hedgeworld.com/ http://ssrn.com/