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Transcript of FIN3102 01 Introduction
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FIN 3102
Investment Analysis and
Portfolio Management
Prof. Luis Goncalves-Pinto
Lecture 1:
Introduction
• Course Introduction and Syllabus
• Overview of Capital Markets
Readings:
BKMJ chapters 2, 3, and 4
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• Luis Goncalves-Pinto (just call me Luis, easy!)
• Office hours: Fridays 14.00-16.00
• Office: MRB BIZ1 / 7-43 (7th floor of Mochtar Riady
Building)
• By appointment (set up after class or by email)
• Post questions on https://ivle.nus.edu.sg/
• By email: [email protected]
(If of general interest, your questions will be posted
on IVLE together with my answers)
How to reach me:
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- Course Introduction:
. What is this class about?
. Syllabus and course details
- Overview of Capital Markets:
. Investing directly: markets and trading
. Delegated portfolio management: mutual
funds
Lecture Outline:
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What Is This Class About?
Introductory knowledge of portfolio management:
How much should I invest in each asset?
1. Optimal portfolio selection
What’s the trade-off between risk and return?
2. Asset pricing theories
How can I assess my portfolio’s performance?
3. Performance evaluation
Should I invest beyond equities?
4. Fixed income securities, Derivatives
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1. Optimal portfolio selection
• How do we pick the portfolio (of asset classes or of
individual securities) that maximizes return for a
given level of risk?
• How does this allocation depend on our investment
horizon, risk aversion, and existing assets in place?
• How can we solve implementation problems
stemming from estimation error, short-sale
restrictions, and portfolio constraints?
What Is This Class About?
Harry Markowitz
(Nobel prize)
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[Lecture 3]: How Vanguard does it
Source: Vanguard
preview
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[Lecture 3]: How Vanguard does it
Source: Vanguard
preview
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2. The relation between risk and return
• What is the relevant measure of risk in each risk-
return tradeoff?
• What expected return should the market demand for
each asset?
– CAPM
– APT
– characteristic-based model
• How well does the evidence support these theories?
What Is This Class About?
William Sharpe
(Nobel prize)
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preview
[Lectures 5-6]: Fama-French 3-Factor Model
Three Equity Factors:
. MARKET : Stocks have higher expected returns than bonds
. SIZE: Small caps beat large caps (on average)
. VALUE: “Value" stocks beat “Growth" stocks (on average)
Source: Dimensional Fund Advisors
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3. Performance Evaluation
• How can a fund manager’s performance be measured?
• Can we separate skill in picking stocks from skill in picking sectors?
• How do we test the manager’s ability to time the market?
What Is This Class About?
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[Lecture 9]: Performance Evaluation of Fidelity Magellan
(FMAGX in finance.yahoo.com)
hit “Profile”
preview
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[Lecture 9]: Performance Evaluation of Fidelity Magellan
(FMAGX in finance.yahoo.com)
hit “Performance Details”
preview
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[lecture 9]: Performance Evaluation of Fidelity Magellan
(FMAGX in finance.yahoo.com)
hit “Risk Details”
preview
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4. Other Instruments
• Fixed Income Securities: [* FIN 3131 *]
- What portfolio of bonds should be purchased to
satisfy a given investment objective?
- What is the relation between prices, interest
rates, and yields? How risky are bonds of
different maturities and issuers?
• Options and Futures: [* FIN 3116 *]
- What are the reasons to trade derivatives?
- What is the fair value of a derivative?
What Is This Class About?
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What This Class Is Not Really About
• How to pick stocks (i.e. individual stock selection)
• How to trade (trading and exchanges)
• How companies invest (capital budgeting)
• Banking and financial intermediaries
• Focus on equity, will not be thorough examination of:
- fixed income, derivatives, real estate, etc.
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Syllabus Highlights
• Prerequisites
– Intro finance course, statistics course, Excel
• Readings:
– Bodie, Kane, Marcus, and Jain
Investments,
Asia Global Edition
– Lecture Notes
– Extra Readings (Finance Press)
• All course materials will be distributed using IVLE
(http://ivle.nus.edu.sg)
– Lecture Notes, Group Assignments,
Supplementary Reading Material
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Syllabus Highlights
• Grading (Continuous Assessment):
- Group Assignments:
. Case Studies and www.stocktrak.com
- Test 1: <Sat, 04 Oct 2014, 10-12, Room TBA>
- Test 2: <Sat, 08 Nov 2014, 10-12, Room TBA>
• Test 1 30%
Test 2 20%
Assignments 35% (20% Case, 15% StockTrak)
Class Participation 10%
CFA Ethics Test 5% (Prof. Lee Hon Sing)
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Syllabus Highlights
• Student Teams of 4-6 People (Due Next Class: Name, Composition/Identification, and Photos of Members, Sample Form on IVLE under “Assignments”)
• Case Studies (1 Case Per 2 Teams, Assigned Randomly):
1. Gold as a Portfolio Diversifier
2. Warren Buffett
3. Dimensional Fund Advisors
4. Behavioral Finance at JP Morgan
5. Zeus Asset Management
• StockTrak
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• Why invest in an asset?
Put cash-flow today in exchange for cash-flow in future
• Future cash-flow may be:
- Certain (money market, government bonds)
- Uncertain (stocks, corporate bonds, etc)
• What are the issues?
- Time value
- Riskiness of investments
… make the problem challenging
1. Overview of Capital Markets:
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• Which assets to invest in?
Real vs. financial assets
- Real assets: Assets used to produce goods and
services (ex: factories, land, human capital, etc)
- Financial assets (focus of this class): Claims on real
assets (ex: money, stocks, bonds, etc)
1. Overview of Capital Markets:
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• Taxonomy of Financial Assets:
http://online.wsj.com/mdc/public/page/marketsdata.html
- Money Markets
short-term deposits
- Fixed Income Securities
bonds: promises fixed stream of income
- Equity
ownership, claim to funds after all debts
have been paid
- Investment Companies
mutual funds, pension funds, hedge funds
- Derivatives
payoff depends upon values of other assets
1. Overview of Capital Markets:
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• How do financial asset returns compare?
1. Overview of Capital Markets:
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• Going forward: what happened after 2000?
(type ^RUT in http://finance.yahoo.com/)
1. Overview of Capital Markets:
Nasdaq
Dow Jones
S&P500
Russsel 2000
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• Going forward: the 2007-08 Credit Crisis
1. Overview of Capital Markets:
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• The long-run picture is still that equity beats bonds!
1. Overview of Capital Markets:
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• This course: focus on Equity
• Equity:
- Future cash-flows are (typically) uncertain
- Maturity is (typically) indefinite
- High risk, variable liquidity
• Two main classes of equities:
> Common stocks
> Preferred stocks (more like debt than equity)
2. Equity Markets:
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2. Equity Markets:
• Investing in Equity :
go long (+) go short (-)
directly: buy short-sell
buy on margin
indirectly: mutual funds, pension funds
hedge funds
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• How do you buy a stock in a company?
- Buy on the primary market:
New issues to raise capital for firm: IPO (Initial
Public Offering), SEO (Seasoned Offering)
- Buy on the secondary market:
Existing owner sells to another party, does not
raise capital for firm (not involved)
- Organized Exchanges.
- Over-the-Counter (shorthand OTC).
- Electronic Networks.
2. Equity Markets:
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• Types of Orders:
Market orders
Price-Contingent orders:
2. Equity Markets:
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• Costs of Trading
Commission: fee paid to broker for making the
transaction
Spread: cost of trading with dealer/ market
Bid: price dealer will buy from you
Ask: price dealer will sell to you
Spread = Ask - Bid
2. Equity Markets:
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- Buy on Margin (Margin Purchase):
> The investor borrows part of the purchase
price of a security from his broker
> The interest charged to the investor is the
broker’s call money rate plus a service spread
> The securities purchased by the investor are
held by the broker as a collateral on the loan
made (lose voting rights)
2. Equity Markets:
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2. Equity Markets:
• Initial margin is set by the Fed
– Currently 50%
• Maintenance margin
– Minimum equity that must be kept in the margin
account
– Margin call if value of securities falls too much
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- Buy on Margin (Margin Purchase): Example 1
2. Equity Markets:
Share price $100
60% Initial Margin
30% Maintenance Margin
100 Shares Purchased
Initial Position
Stock $10,000 Borrowed $4,000
Equity $6,000
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- Buy on Margin (Margin Purchase): Example 1
Maintenance Margin
2. Equity Markets:
Stock price falls to $70 per share
New Position
Stock $7,000 Borrowed $4,000
Equity $3,000
Margin% = $3,000/$7,000 = 43% (still some slack!)
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-Buy on Margin (Margin Purchase): Example 1
Margin Call:
2. Equity Markets:
How far can the stock price fall before a margin call? Let maintenance margin = 30%
Equity = 100P - $4000
Percentage margin = (100P - $4,000) / 100P
(100P - $4,000) / 100P = 0.30
Solve to find:
P = $57.14
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-Buy on Margin (Margin Purchase): Example 2
Downside Risk of Buying on Margin:
P(0)=$100, Margin=$10,000, Loan=$10,000, Interest
rate on the loan: 9%/year
2. Equity Markets:
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- Buy on Margin (Margin Purchase): A message from FINRA –
Financial Industry Regulatory Authority http://www.finra.org/Investors/ProtectYourself/InvestorAlerts/MarginAndBorrowing/P005973
Investing with Borrowed Funds: No "Margin" for Error
Investor purchases of securities "on margin" have grown dramatically in recent months. The
amount of debt taken on to buy securities has been growing steadily over the past few
months and reached a record high of $321.2 billion in February 2007.
We are re-issuing this Alert because we are concerned that many investors may
underestimate the risks of trading on margin and misunderstand the operation and reason
for margin calls. Investors who cannot satisfy margin calls can have large portions of their
accounts liquidated under unfavorable market conditions. These liquidations can create
substantial losses for investors.
Before you decide to open a margin account, make sure you understand the following risks:
- Your firm can force the sale of securities in your accounts to meet a margin call
- Your firm can sell your securities without contacting you
- You are not entitled to choose which securities or other assets in your accounts are sold
- Your firm can increase its margin requirements at any time and is not required to provide you with
advance notice
- You are not entitled to an extension of time on a margin call
- You can lose more money than you deposit in a margin account
- More advice from the SEC
…http://www.sec.gov/investor/pubs/margin.htm
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- Short Sale:
> Sell something you don’t own: selling shares
of a firm not owned by borrowing security, and
later replacing it (cover it)
> A profit is made if the short position is covered
at a price lower than the one at which it was
established
> Short sale proceeds must remain with the
broker and investor is required to deposit a
collateral (to “post margin”)
2. Equity Markets:
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2. Equity Markets:
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- Short Sale: Example (Bearish on Dot-Bomb)
2. Equity Markets:
Dot Bomb 1000 Shares
50% Initial Margin
30% Maintenance Margin
$100 Initial Price
Sale Proceeds $100,000
Margin & Equity $50,000
Stock Owed 1000 shares
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- Short Sale: Example (Dot Bomb Falls to $70)
2. Equity Markets:
Assets
$100,000 (sale proceeds)
$50,000 (initial margin)
Liabilities
$70,000 (buy shares)
Equity
$80,000
Profit = ending equity – beginning equity
= $80,000 - $50,000 = $30,000
= decline in share price x number of shares sold short
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- Short Sale: (Margin Call)
2. Equity Markets:
How much can the stock price rise before a margin call
(maintenance margin = 30%)?
($150,000* - 1000P) / (1000P) = 30%
P = $115.38
* Initial margin ($50,000) + sale proceeds ($100,000)
1000P = value of shares owed
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What more to talk about on short-selling? …
- Margins/fees
- “Naked short-selling”
- Dividends / Voting: The short-seller pays the dividend to the
stock lender. The naked short-seller pays the dividend to the
buyer of the promised stock. Vote: “holder of record.”
- More advice from the SEC …
http://www.sec.gov/spotlight/keyregshoissues.htm
- NYSE Top 100 Stocks by short interest
http://www.nyse.com/financials/sitable.html
- Stocks with High Short interest
http://www.highshortinterest.com/
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Regulating short-selling:
- U.S.: SEC banned for 900 financial firms (lifted Oct 8)
- U.K.: FSA banned for 34 financial stocks (lifted 2009)
- France: AMF banned for bank stocks (Sept 22 for 3 months)
…
2008 Credit Crisis :
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2008 Credit Crisis (cont.):
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The curious case of a “short squeeze” …
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• Investing in Equity :
go long (+) go short (-)
directly: buy short-sell
buy on margin
indirectly: mutual funds, pension funds
hedge funds
3. Delegated Portfolio Management:
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• Why do individuals use investment companies (mutual
funds, pension funds, hedge funds)?
- each invests $10,000 individually
- add all classes’ money and invest collectively
3. Delegated Portfolio Management:
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• U.S. Households Investments In Funds, Bonds, Stocks
3. Delegated Portfolio Management:
Source: ICI
FactBook
2014
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• Why do individuals use investment companies (mutual
funds, pension funds, hedge funds)?
- Investment diversification at lower transaction cost
- Security selection skills (?) or portfolio tailoring to meet
specific objectives
- High liquidity and lower administration costs (record
keeping, reinvesting dividends)
- Sophisticated tax management (?)
3. Delegated Portfolio Management:
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• U.S. Households Financial Assets in Investment Firms
3. Delegated Portfolio Management:
Source: ICI FactBook 2014
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3. Delegated Portfolio Management:
• Some mutual fund management companies: • Independent (Vanguard)
• Broker-dealer (Charles Schwab)
• Bank (Wells Fargo)
• Insurance company (USAA)
• Browse http://www.morningstar.com/cover/funds.aspx
Source: ICI FactBook 2014
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3. Delegated Portfolio Management:
• Investment policies for all tastes …
- Bonds (“fixed income”), stocks (“equity”), or mixed
(“balanced”). Attractive to investors with different
horizons and levels of sophistication
Source: ICI
FactBook
2014
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3. Delegated Portfolio Management:
• Equity Mutual Funds and Market Returns (96-10)
Source: ICI
FactBook
2014
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3. Delegated Portfolio Management:
• Redemption Rates of Equity Funds (86-10)
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3. Delegated Portfolio Management:
Source: ICI
FactBook
2014
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3. Delegated Portfolio Management:
• Fees are in the forms of:
- Management and operating expenses (0.4%-3.0%/year)
- Sales load (0%-5% at purchase [front-end load] or sale
[back-end load])
- 12b-1 fees (advertising)
- Incentive fees (for hedge funds, up to 20% of gains)
• use FINRA mutual fund expense analyzer:
http://apps.finra.org/investor_Information/ea/1/mfetf.aspx
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3. Delegated Portfolio Management:
• Funds typically have more than 1 Share Class:
Class A Class B Class C No-Load***
Front-end load 5%* 0% 0% 0%
Back-end load 0% 4%** 1% 0%
12b-1 fees 0.25% 1% 1% 0.5%
Expense Ratio 1% 1% 1% 1%
*: depends on size of investment
**: depends on number of years till sale
***: sold directly by fund sponsor or fund supermarket
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3. Delegated Portfolio Management:
• Fees … . 56% of funds have sales load. Mean = 3.6%. 2003 cost = $2.8B
. 66% of funds charge 12b-1 (marketing) fees. 2003 cost = $9.5B
. Operating expenses in 2003 = $38.1B
. Trading costs in 2003 about $16B
Total of $66 Billion represents about 1% of NAV. These
are yearly direct costs.
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3. Delegated Portfolio Management:
• Turnover Rate of Equity Funds (1974-2010)
Source: ICI
FactBook
2014
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Source: ICI
FactBook
2014
3. Delegated Portfolio Management:
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3. Delegated Portfolio Management:
Open-End Closed-End
Capital structure Open, new shares
issued for subscriptions
Closed, like any
ordinary firm, the nr. of
shares is fixed
Buying / Selling into
fund …
Subscription may
involve sales charge
(load)
From another investor,
like buying/selling a
stock: trading costs but
no loads.
Cost of a share Redemption of
investments is at net
asset value (NAV)
May deviate from NAV.
Two risks: NAV and
changing discount.
Performance is reduced
by fees and
transactions costs
yes yes
• Types of Mutual Funds:
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3. Delegated Portfolio Management:
• Passive vs. Active Management
Passive: - Aims to track (come as close as possible to) a
fixed portfolio of stocks, such as the S&P500.
- Minimizes costs and trades as little as possible.
Active: - Portfolio manager chooses strategy: “bottom
up”: security analysis; “top down”: asset allocation
Source: ICI
FactBook
2014
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3. Delegated Portfolio Management:
• Passive vs. Active: Performance
Percentage of active funds below Wilshire 500
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3. Delegated Portfolio Management:
• “Co-Insurance in Mutual Fund Families,”
by Goncalves-Pinto and Schmidt
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3. Delegated Portfolio Management:
• Passive vs. Active:
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• Investing in Equity :
go long (+) go short (-)
directly: buy short-sell
buy on margin
indirectly: mutual funds, pension funds
hedge funds
new: ETFs that replicate
investment classes
“Do-it-Yourself” Portfolio Management:
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Source: ICI
FactBook
2014
3. Delegated Portfolio Management:
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Exchange-Traded Funds (ETFs)
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Exchange-Traded Funds (ETFs)
• ETFs offer public investors an undivided interest in a pool
of securities and other assets
• Shares can be traded throughout the day on a securities
exchange. ETFs do not sell or redeem at NAV. Financial
institutions purchase and redeem ETF shares directly in
large blocks called "creation units" (in kind, a basket of
securities in the same proportion held by the ETF)
• Many types:
• Indices (ex: SPDRs, Diamonds, Cubes, iShares),
leveraged, short, commodities, etc.
• …
• Other ETFs include value (growth) stocks of all sizes and
all small (large) cap stocks of all sizes.
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Exchange-Traded Funds (ETFs)
• Many types:
• Indices (ex: SPDRs, iShares), leveraged, short
• Commodities
• …
http://etf.peacefulgains.com/A-List-of-exchange-traded-funds/
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Mispricing of ETFs
• “Intraday Pricing Inefficiencies in International-Based
Exchange-Traded Funds,” by Goncalves-Pinto, Chua,
and Stefanescu (2012)
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Investing directly into Value-Growth & Size
• Ex: iShares are exchange traded funds (ETFs) that
replicate the 9 Morningstar styles
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Why the Lack of Interest for
ETFs in Singapore?
• Field Study Supervised by Goncalves-Pinto and Zahalka
in 2014:
Client Company: Singapore Exchange (SGX)
Survey Evidence:
- Small range of ETF product offerings
- Lack of knowledge by retail investors
- Home bias investing
- Value opinion of financial advisors highly
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• Investing in Equity :
go long (+) go short (-)
directly: buy short-sell
buy on margin
indirectly: mutual funds, pension funds
hedge funds
new: ETFs that replicate
investment classes
“Do-it-Yourself” Portfolio Management:
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3. Delegated Portfolio Management:
• Hedge Funds:
- Growing. Assets may exceed $2Trln (in Q3 2007,
Institutional Investors)
- No legal definition. Generally, a private investment fund open to limited range of qualified/accredited investors
- Invest in more complex and more risky investments (short-selling, derivatives, leverage). Dominate some specialty areas (derivatives, high-yield/distressed bonds, macro strategies)
- Many of these so-called "hedge funds" do not actually hedge their investments!
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3. Delegated Portfolio Management:
• Hedge Funds:
- Only available to “sophisticated investors”.
– Partnership organization with max # of investors
– Large minimum investment
– Significant minimum holding period
– Performance-based compensation.
- No requirement to register with SEC, unlike open-to-the-public "retail" funds (e.g., U.S. mutual funds)
- Difficult to benchmark. Have a tendency to “blow up”
- Effective Activists
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3. Delegated Portfolio Management:
• Hedge Fund Activism:
Daniel Loeb
Third Point Management
Carl Ichan
Ichan Enterprises
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Short-Squeeze Risk and Activist HFs
Honours Thesis by
Gavin Loh (2014),
supervised by Luis
Goncalves-Pinto
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3. Delegated Portfolio Management:
• Some Well-Known Hedge Fund Companies:
Amaranth Advisors
Citadel Investment Group
D. E. Shaw & Co.
Fortress Investment Group
Goldman Sachs Asset Management
Long Term Capital Management
Renaissance Technologies
Soros Fund Management
…
Hedge Funds: Risk and Return, study by Prof. Burton Malkiel
http://www.cfapubs.org/doi/pdf/10.2469/faj.v61.n6.2775
• For a critical look at hedge fund performance numbers:
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3. Delegated Portfolio Management:
• Hedge Fund Styles:
Global macro – seeking assets that deviated from some anticipated
relationship. Heavy in bonds, FX and derivatives.
Arbitrage – seeking assets that are mispriced
Convertible arbitrage – (convertible bond vs. equity)
Fixed income arbitrage – (between related bonds)
Risk arbitrage – (between securities whose prices appear
to imply different probabilities for one event)
Statistical arbitrage– (between securities that have deviated
from some statistically estimated relationship)
Derivative arbitrage – (between a derivative and its security)
Long / short equity – hedged investment in equities
Short bias – (emphasizing short positions)
Equity market neutral – (balance long and short positions)
–> “Twice the risk and half the reward”?
-> Ex: George Soros
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3. Delegated Portfolio Management:
• Hedge Fund Styles:
Event driven –
Distressed securities – (companies close to bankruptcy)
Regulation D – (distressed companies issuing securities)
Merger arbitrage – (between acquiring and target companies)
Other –
Emerging markets- (unhedged long in emerging markets)
Fund of hedge funds – (long only positions in hedge funds)
Quantitative
130-30 funds
-> Bet is on the probability that the merger happens
-> Usually contrarian
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HF Prospectus
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HF Prospectus
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HF Prospectus
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HF Prospectus
Fees are
• related to fund performance
• large
• option-like
• mostly paid only after the “high water mark” is met
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To Do (For Next Class)
• Finish reading BKMJ Chapters 3, 4
• Read BKM Chapter 5.4, 5.5. and 5.6. and review
your statistics (Expected values, Standard deviations,
variances, Covariance, correlations) !
• Next class we will assign the case studies to be
presented/discussed by each group – submit your
group formation 4-6 people ASAP!
• People without a group come talk to me and I will
assign them to one!