Mutual Funds and Hedge Funds

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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

  • 1.

2. Overview

  • In this segment: Mutual Funds and Hedge Funds:
    • Activities of mutual
    • Size, structure and composition
    • Balance sheets and recent trends
    • Regulation of mutual funds
    • Activities of hedge funds
    • Global issues
    • Size, structure and composition
    • Balance sheets and recent trends
    • Regulation of hedge funds

3. Mutual Funds

  • Diversification opportunities enhanced for small investors
    • Economies of scale
    • 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
    • Trading abuses contributed to slowdown
  • 2007:
    • Almost 7,100 stock and bond mutual companies.
    • Total assets of $8.21 trillion.
    • 8,125 firms and $10.57 trillion if money market mutual funds included

5. Size, structure and composition

    • First mutual fund: Boston, 1924.
    • Slow growth, initially.
    • Advent of money market mutual funds, 1972.
      • Regulation Q.
    • Total assets in stock and bond mutual funds:
      • 1940: $0.5 billion.
      • 1990: $1,065.2 billion
      • 2000: $6,964.6 billion
      • 2006: $10,413.7
    • Institutional funds
      • 80 percent of retirement plan investments

6. Size, Structure and Composition

    • By asset size, mutual fund industry second most important FI group.
    • Recent inroads by commercial banks and insurance companies
      • Mellon purchase of Dreyfus
      • State Farm (9,000 agents)
      • As of 2006, insurance companies managed approximately 10% of mutual fund assets

7. Types of Mutual Funds

  • Long-term funds
    • 74.3% of assets, 1999
    • 2002, long-term funds dropped to 62.1% of assets, losing ground to MMMFs
    • 75.4% in 2006
  • Types of Long-term Funds:
    • Bond and income funds.
    • Equity funds.
    • Hybrid.

8. Types of Mutual Funds

  • Short-term funds
    • 25.7% of assets, 1999.
    • 37.9% of assets, 2002.
    • 24.6% in 2006
    • Taxable and tax-exempt MMMFs
    • Generally higher returns than bank deposits but uninsured.
  • Impact of low interest rates during early to mid 2000s
    • Decline in MMMFs
    • 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

    • Objectives (and adherence to stated objectives), rates of return and risk characteristics vary.
  • Examples:
    • Capital appreciation funds
    • World equity
    • Corporate bond
    • High-yield bond
    • World bond
    • Government bond

12. Returns to Mutual Funds

    • Income and dividends of underlying portfolio.
    • Capital gains on trades by mutual fund management.
    • Capital appreciation in values of assets held in the portfolio.
      • Marked-to-market.
      • Net-asset value (NAV).

13. Web Resources

  • For information on the performance of mutual funds, visit:
  • Morningstarwww.morningstar.com

14. Types of Funds

    • Open-ended funds: comparable to most corporate securities traded on stock exchanges.
    • Closed-end investment companies:
    • Fixed number of shares
      • Example: REITs.
      • May trade at premium or discount.
      • Exchange traded funds (ETFs)
    • Load versus no-load funds.

15. Mutual Fund Costs

  • Two types of fees:
    • Sales loads
      • Generally, negative effect on performance outweighs benefits
      • Short term versus long term investment alters impact of loads on cost
    • Fund operating expenses
      • Management fee
      • 12b-1 fees
      • Front end and back end fees
        • Class A, Class B and Class C differences
        • SEC creation of new rules
        • Sweeping decreases in fees, 2005 and 2006

16. Balance Sheet and Trends

  • Money Market Funds
    • Key assets are short-term securities (consistent with deposit-like nature)
      • 2006: $1,514.9 billion (65.5% of total assets)
    • Most have share values fixed at $1 and adjust number of shares owned by the investor.

17. Balance Sheet and Trends

  • Long-term Funds
    • Stocks comprised over 70.7 % of asset portfolios in 2006.
    • Credit market instruments 27.2% of asset portfolios
    • Shift to other securities such as credit market instruments, U.S. Treasuries, municipal bonds etc. when equity markets not performing as well.

18. Regulation

    • One of the most closely regulated among non-depository FIs.
    • Primary regulator: SEC
      • Emphasis on full disclosure and anti-fraud measures to protect small investors.
      • NASD supervises mutual fund share distributions.

19. Regulatory Changes

  • Prosecutions in light of trading abuses in early 2000s.
    • Market timing
    • Late trading
    • Directed brokerage
    • Improper fee assessments
  • Changes include: SEC requirements for independent board members; reporting and disclosure requirements

20. Legislation

    • Securities Act 1933, 1934
    • Investment Advisers Act, 1940.
    • Insider Trading and Securities Fraud Enforcement Act of 1988.
    • Market Reform Act of 1990
      • Allows SEC to halt trading and introduce circuit breakers.
    • National Securities Markets Improvement Act of 1996.
      • Exempts mutual fund sellers from state securities regulatory oversight.
    • Sarbanes-Oxley Act of 2002

21. Global Issues

  • Worldwide growth in mutual fund investment not as great as in the U.S.
    • $2.575 trillion in 1996 to $10.490 trillion in 2006
      • Over 307% growth
    • Larger returns in U.S.stock markets
    • Greatest development in countries with most advanced markets
    • Opportunities from declining Japanese markets
    • Efforts to reduce barriers for U.S. mutual fund sponsors
      • China and other Asian countries

22. Hedge Funds

  • Not technically mutual funds
    • Not subject to SEC regulation
    • Organized as limited partnership
      • Small number of sophisticated investors
    • Common feature is use of leverage
  • High returns in 1990s

23. Hedge Funds

  • Near collapse of Long-Term Capital Management
    • $3.6 billion bailout
    • Precipitated SEC scrutiny of hedge funds

24. Types of Hedge Funds

  • More risky
    • Market directional
  • Moderate risk
    • Market neutral or value orientation
  • Risk avoidance
    • Moderate, consistent returns with low risk as objectives
  • Fees
    • Generally management fees and performance fees

25. Offshore Hedge Funds

  • Major centers include Cayman Islands, Bermuda, Dublin, Luxembourg.
  • Rules
    • Generally not burdensome
    • Anonymity
    • Tax advantages

26. Regulation of Hedge Funds

  • Generally unregulated
    • Exemption for less than 100 investors
    • Exemption if accredited
  • Scandals such as Canary Capital Partners
      • Illegal trading with mutual funds
    • Amaranth Advisors, 2006
    • 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