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Indirect Investing(see Ch. 3 Jones)

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Alternative to direct investment in or ownership of securities

Refers to buying and selling the shares of intermediaries that hold securities in portfolio- Shares are ownership interest in portfolio entitled

to portfolio income- Shareholders also pay expenses

3-2

Indirect Investing

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Diversification Professional management Low capital requirement Reduced transaction costs Access to illiquid markets Access to non-traditional trading strategies

Investment Companies

An investment company invests a pool of funds belonging to many individuals in a portfolio of individual investments such as stocks and bonds

Financial firm that sells shares to the public and uses the proceeds to invest in marketable securitiesBenefits:

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Mutual funds- Open-End- Closed-End (Stock trades on secondary market; Net asset value (NAV) is

determined daily, but market price determined by supply and demand)

- ETFs (Exchange Traded Funds)

Hedge Funds Private equity/venture capital funds [Not covered in text]

Types of Investment Organizations

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Mutual Funds An investment company that issues its portfolio shares to investors.

Money from shareholders are pooled and invested in a wide range of stocks, bonds, or money market securities.- Managed by professional managers

Each investor shares proportionately in the income and investment gains and losses, as well as the brokerage expenses and management fees.

Open end fund: # of shares issued solely depends on investor demand- Bought and sold directly through the investment company (not an exchange)

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Used as a basis for valuation of mutual funds.- Selling new shares- Redeeming existing shares

Calculation:

Market Value of Assets – Fund Expenses - Liabilities

Shares Outstanding

A mutual fund has $100 mil in assets and $3 mil in short term liabilities. 10.765 mil shares outstanding. What is the NAV?

Solution ($100 mil - $3 mil) / 10.765 mil = $9.0107 per share

Net Asset Value

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Sources of Information Lipper Inc.: leading provider of data and analysis on the

investment company business ( www.lipperweb.com ) Morningstar.com: provide unbiased data and analysis and

candid editorial commentary (www.morningstar.com) Vanguard Group: providing competitive investment

performance and lowest operating expenses ( www.vanguard.com )

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Money Market Fixed Income Equity Balance & Income Asset Allocation Indexed Specialized Sector

Mutual Funds: Investment Policies

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Mutual Fund Organization Mutual fund shareholders: own mutual

funds, elect the board of directors

Majority of the directors must be independent directors

Investment advisor: manages the day-to-day operations

Principal underwriter, administrator, transfer agent, custodian, and independent public accountant

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Sales charge (loads)- Front-end load- Back-end load

Redemption fee Exchange fee

Direct Costs of Investing in Funds

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Indirect Costs of Investing in Funds

Account maintenance fee (Operating expenses) 12 b-1 charges

- distribution costs paid by the fund- Alternative to a load

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Mutual funds: Performance It’s not conclusive Most of the studies suggest that the average MF underperforms its

benchmark There is some evidence of short-term performance persistence

The evidence show that it’s not easy to find funds that outperform

for a long period of time Nonetheless, “hot” funds receive a disproportionately amount of

new money

Benchmarks

Survivorship bias

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Closed-End Funds Issues a fixed number of shares at a given point in time

Collect money from investors through and IPO and use this money to invest in securities.

# of shares are fixed at the time of IPO.

When the market price exceeds its NAV, selling at a premium, otherwise, selling at a discount (closed-end funds typically sell at a discount)

Suited to specialized investing in small or illiquid markets

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Exchange Traded Funds Are similar to closed-end funds: traded securities; entails

commission costs Each ETF is a claim on a trust that holds a specified pool of assets

(e.g. S&P500 index components) Examples:SPDRS,ishares,HOLDERS Advantages:

Liquidity Taxes Can be purchased on margin or sell short

ETF are appropriate for short-term investors and the ones who buy in large lots

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Morningstar rating Created in 1984 to provide comprehensive assessment of mutual

funds The star system was not meant to predict future performance 5* - the top 20% of the funds 1* the bottom 20%

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Hedge Funds Considerable confusion exists concerning hedge funds –

what they are (and are not) and how they work Hedge funds are privately organized, pooled investment vehicle

with no restrictions in terms of investment strategies, asset classes and use of leverage

Many of them registered off-shore for tax and regulatory reasons Can’t have more than 100 “accredited” investors or 500 “super-

accredited” investors Accredited investor: net worth > 1 million or income of $200,000

in each of the past two years Super-Accredited investor: net worth > 5 million

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Hedge Funds Are not allowed to advertise broadly and engage in

“ general solicitation” to the investing public Charge 1-2% of assets under management and 20-25% of profits First hedge fund on record, Jones Hedge Fund, was established in 1949 He hedged the US equity market risk and focused on stock selection By 2011, more than 10,000 funds in existence world-wide Common features:

- shorting

- leverage

- concentration

Do they all hedge?

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Learning objectives- Discuss the advantages and disadvantages of mutual funds- Know how to calculate NAV- Define and Discuss the differences between open end, closed end and ETFs- Briefly discuss the costs, loads and fees of investing in mutual funds- Morningstar and Style boxes- Benchmarks- Survivorship bias and Chasing the Hot funds (p. 73-74)- Hedge FundsEnd of chapter questions 3.1 to 3.13