1
Mutual Funds and Hedge Funds
Services of Investment Companies Types of Investment Companies Types of Mutual Funds Cost of Mutual funds Return of Mutual Funds Exchange Traded Funds Hedge Funds and Their strategies
2
Services of Investment Companies
Administration & record keeping Diversification & divisibility Professional management Reduced transaction costs
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Net Asset Value
Used as a basis for valuation of investment company shares Selling new shares Redeeming existing shares
NAV=
Market Value of Assets - Liabilities
Shares Outstanding
4
Types of Investment Organizations
Unit Trusts Managed Investment Companies
Open-End Closed-End
Other investment organizations Commingled funds REITs Hedge Funds
5
Open-End and Closed-End Funds
Shares Outstanding Closed-end: no change unless new stock is
offered Open-end: changes when new shares are sold
or old shares are redeemed
Pricing Open-end: Net Asset Value(NAV) Closed-end: Premium or discount to NAV
6
Investment Policies
Money Market Equity Specialized Sector Bond Balance & Income Asset Allocation Indexed International
7
Costs of Investing in Mutual Funds
Fee Structure Front-end load Back-end load
Operating expenses 12 b-1 charges
distribution costs paid by the fund Alternative to a load
Fees and performance
8
Example
An open-end fund has a total asset of $120 million and a liability of $10 million. It has 10 million shares outstanding. What is its NAV? It is sold with a front-end load of 5%. What is its offering price?
9
Fund Returns
Page 106
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Table 4.2 Impacts of Costs on Investment Performance
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Exchange Traded Funds
ETF allow investors to trade index portfolios like shares of stock
Examples - SPDRs and Webs Potential advantages
Trade continuously Lower taxes Lower costs
Potential disadvantages
12
First Look at Mutual Fund Performance
Average mutual fund performance is generally less than broad market performance
Over certain horizons there is persistence in positive performance Evidence is not conclusive Some inconsistencies
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Figure 4.3 Diversified Equity Funds versus Wilshire 5000 Index
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Sources of Information on Mutual Funds
Wiesenberger’s Investment Companies Morningstar (www.morningstar.com) Yahoo (biz.yahoo.com / funds) Investment Company Institute (www.ici.org) Popular press Investment services
15
Hedge Funds vs. Mutual Funds
Hedge Fund Transparency: Limited
Liability Partnerships that provide only minimal disclosure of strategy and portfolio composition
No more than 100 “sophisticated”, wealthy investors
Mutual Fund Transparency: Regulations
require public disclosure of strategy and portfolio composition
Number of investors is not limited
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Hedge Funds vs. Mutual Funds
Hedge Fund Investment strategy: Very
flexible, funds can act opportunistically and make a wide range of investments
Often use shorting, leverage, options
Liquidity: Often have lock-up periods, require advance redemption notices
Mutual Fund Investment strategy:
Predictable, stable strategies, stated in prospectus
Limited use of shorting, leverage, options
Liquidity: Can often move more easily into and out of a mutual fund
17
Hedge Funds vs. Mutual Funds
Hedge Fund Compensation structure:
Typically charge a management fee of 1-2% of assets and an incentive fee of 20% of profits
Mutual Fund Compensation structure:
Fees are usually a fixed percentage of assets, typically 0.5% to 1.5%
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Hedge Fund Strategies
Directional Bets that one sector or another will
outperform other sectors Non-directional
Exploit temporary misalignments in relative valuation across sectors
Buy one type of security and sell another Strives to be market neutral
1926-19
Table 26.1 Hedge Fund Styles
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Statistical Arbitrage
Uses quantitative systems that seek out many temporary and modest misalignments in prices
Involves trading in hundreds of securities a day with short holding periods
Pairs trading: Pair up similar companies whose returns are highly correlated but where one is priced more aggressively
Data mining to uncover systematic pricing patterns
2126-21
Portable Alpha
1. Invest wherever you can find alpha.
2. Hedge the systematic risk of the investment to isolate its alpha.
3. Establish exposure to desired market sectors by using passive products such as indexed mutual funds or ETFs.
Transfer alpha from the sector where you find it to the asset class in which you ultimately establish exposure.