Perspectives on Global Asset Management: Beyond mutual funds?
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Transcript of Perspectives on Global Asset Management: Beyond mutual funds?
Perspectives on Global Asset Management:
Beyond mutual funds?
Professor Massimo Massa
BNP-PARIBAS
The Vanguard ApproachMain Features
• What type of approach? Main Characteristic?
“Mutualistic”. Customer focus, not product or performance. The goal is to serve shareholders.
• What is the market?
Wholesale.
• What type of service?
- Low cost, no load, low fee pricing.- Plain vanilla products, which attempt to offer “dependable return”.- They have cornered the market on the low fee game – huge barriers to
entry before someone else could try to compete with them.- Economies of scales means lower average fees in future.
The Vanguard ApproachMain Features
• Does it depend on star/dog strategies?
No
• Does it depend on load/fee based strategies?
• Is there a scope for tunneling?
• Is there a scope for incubation?
No
No
Scarce
How is demand related to performance and fees?
The Vanguard ApproachMain Features
• Is there a conglomerate strategy?
Well it depends on size. But then liquidity effects.
• What is the role of advertising?
- Well, more as a symbol of frugality. - What about Bogle?
- Relies on Free Press- Little paid advertising or promotion.- Focus on candor
• Is there a branding role of managers?
The Vanguard ApproachVulnerability
• It has corned itself: the only way to improve is by offering lower and lower fee products. How much can they be lowered?
• Management succession? Why are the top employees so young? Will the organization be able to keep the same focus when he leaves?
• Difficult to get in sophisticated niche.
• Given that they do not pay Fidelity’s scale wages, how will they be able to attract top quality personnel?
• What is the money market fund has a default on one of its payment and the net asset value falls below $1? Vanguard has no capital reserves to cover the fund as others have.
• Does the fact that they are a technology follower doom them to poorer service ad a reputation for being “behind the times”?
• It brings price competition and alters (ruin?) the industry’s price structure
The Vanguard ApproachResponse from Competition
• Fidelity:
– Introduce Spartan Index Line
– Open retail stores around the country
– Leading edge technology
– Distribution
– Continue to focus on the “star system”
– More specialization.
• Merril Lynch:
– Specialize even more in sellers of convenience.
– Emphasize customer service staff.
– Lower fees.
• ETFs and TRACKERs
– Even lower costs.
Exchange Traded Funds Assets($ Billions)
$1$20
$34
$66$83
$102
$151
$226$252
1993 1998 1999 2000 2001 2002 2003 2004 2005
The Vanguard ApproachResponse from Competition
The Vanguard Approach is therefore:
the Henry Ford of the Industry: everybody can choose the color of the car…provided it is black
20 years later another approach get prominence:
the A+J+O Approach
What is long/short investing?
• “Leverage” = ($10 + $10)/$10 = 2• What is required return on the whole portfolio?
Cash $10: required return = TBill Initial investment = $10
Long positions: $10 alpha Short positions: $10 alpha
“Identical” systematic risk on both sides.
Assets Liabilities
Sector Weights A+J+O Dollar-Neutral Long/Short
Long Short
Russell 3000 (equal
weighted)
S&P 500
Capital goods 7.8% 8.8% 6.3% 7.5% Consumer discretionary
18.1 18.6 14.3 13.1
Consumer durables
2.6 2.6 2.3 0.9
Consumer staples
7.6 7.8 4.1 9.2
Energy 4.9 4.7 4.0 6.2 Financial 22.0 22.2 20.8 19.8 Healthcare 8.1 7.8 13.1 15.6 Materials 7.7 7.7 4.3 2.7 Services 5.7 5.6 5.0 1.7 Technology 6.5 5.4 18.9 15.0 Telecom 0.4 0.0 1.7 3.7 Transportation 2.2 2.2 1.8 1.7 Utilities 6.4 6.6 3.4 2.9 Note: P/E excludes negatives.
The A+J+O ApproachMain Features
• What type of approach? Main Characteristic?
A client’s base portfolio: – variable fraction of customer money:
• % in riskless (or interest sensitive assets)• % in market index (or equity sensitive assets)
– Or all in riskless + index futures– To match the customer consumption profile
Enhancement– Use fraction (possibly >100%) of what is invested in riskless to put into L/S hedge funds, to enhance returns– It does not matter how (using what instrument) alpha is generated: alpha is portable– Or use futures to enhance.
The A+J+O ApproachMain Features
• What is the main benefit of the Long/Short?
“Long/Short”. Focus on performance.
• For Standard Mutual Funds portfolio selection is based in benchmarks
• long portfolio will be evaluated against (style) benchmark (witness the use of tracking errors as a measure of active risk) => become “closet indexers”
• Benchmark used and alpha constructed to measure the performance of a manager that is supposed to maximize utility of return.
• But the measure is not “incentive compatible”. It changes the behavior of the manager
• L/S will be free from any benchmark!!!
The A+J+O ApproachMain Features
• What type of approach? Main Characteristic?
“Long/Short”. Focus on performance.
• What is the market?
Not clear yet. Presumably still niche market. Benchmark are used to describe to the clientele the kind of assets the L/Sinvests in.
• What type of service?
Stock-picking services– Value– Management (e.g., insider trading)– Earnings momentum
The A+J+O ApproachMain Features
• What are the main drivers of performance?
Purely in-house, quantitative screening of firms
• What approach to costs?
• Since they don’t use outside research, no soft dollars needed to purchase this research
Forces brokers to compete on order execution
Get better execution.
• Usage of package trading.
• Communicate to clients on execution costs
The A+J+O ApproachMain Features
• Does it depend on star/dog strategies?
No
• Does it depend on load/fee based strategies?
• Is there a scope for tunneling?
• Is there a scope for incubation?
No
No
Scarce
How is demand related to performance and fees?
The A+J+O ApproachMain Features
• Is there a conglomerate strategy?
Maybe.
• What is the role of advertising?
- Yes! Huge. It is mostly a name-based business.
- Based on Absolute Performance.
• Is there a branding role of managers?
Packaged trading
• What is packaged trading?
• Why does it work/exist?
– Double-blind auction idea
– If package composition were disclosed, every bidder, including losing bidders, would be able to front-run the trades of either the asset manager or the winning bidder
– If the broker’s book were known, the manager would know actual cost of execution and could bring bid down
• By their measure, packaged trading one-way average cost is $.246 a share whereas traditional brokerage costs $.562
Panel B: Aggregate package statistics
Number of stocks 30 Total number of shares 843,000 Average closing price $37.13
Total value of package ($Mil) $24.73
% of stocks that are Nasdaq 13.3 % of stocks that are buys 50 Median market capitalization ($ billions) of stocks in Package $3.878
Mean price inverse for stocks in package (%) 3.75
Mean shares traded per stock 28117 Mean (VolRatio) for stocks in package (%) 10.68 Skewness (VolRatio) for stocks in package (%) 4.55
Packaged trading
Exhibit 5: Example Transaction Cost Report to a Client (transaction costs for fourth quarter 2002)
Broker One-Way Costs (%)
Average Share Price
One-Way Costs (cents/share)
Market Value ($)
% of Total Commission
Total nontraditional (1.15) 27.54 (31.7) 36,847,222 46.1 26,257 Total traditional (2.58) 21.76 (56.2) 43,058,004 53.9 66,014 Total trades executed (1.92) 24.09 (46.3) 79,905,226 100.0 92,271
Nontraditional Crossing Instinet Crossing (2.68) 23.42 (62.8) 1,117,009 3.0 477 ITG POSIT (3.54) 33.42 (118.4) 818,910 2.2 490 Jefferies Crossing (0.02) 40.86 (1.0) 792,721 2.2 194
(2.17) 29.79 (64.6) 2,728,640 7.4 1,161 Package
Goldman package (0.78) 29.17 (22.8) 12,856,366 34.9 8,816 Deutsche package (1.02) 30.27 (30.9) 9,853,384 26.7 6,510 Weeden package (0.76) 31.81 (24.3) 6,012,667 16.3 3,780 Salomon package (4.45) 1.91 (8.5) 148.098 0.4 1,550 Merrill package (0.72) 35.93 (25.8) 1,354,519 3.7 754
(0.87) 28.23 (24.6) 30,225,035 82.0 21,410 Other Archipelago (3.44) 20.93 (72.1) 3,165,248 8.6 3,024 Bloomberg Trdbk 3.06 33.14 101.5 563,38 1.5 510 Liquidnet (5.84) 21.70 (126.6) 164,919 0.4 152
(2.60) 22.15 (57.7) 3,893,547 10.6 3,686
Packaged trading
The future
• How can we envision future division of labor between types of funds?
– Polarization into “beta” and “alpha” strategies:
• Only two extremes should exist:– index funds or ETFs– hedge funds doing L/S
– Everything else is a combination of these two, which is less transparent than the two extremes
• No benchmarks
• No soft dollars
Polarization of Investments Process
Polarization
Market-Linked Products
Alternative Investments
Index FundsExchange
Traded FundsInverse Index
FundsLeveraged
Index FundsHedge Funds
Other Alternative
InvestmentsReal Estate
Venture Capital &
Private Equity
…the industry gets polarized.
Alternative Investments MarketsAssets Under Management ($ Billions)
$750
$350
$225 $200
Hedge Funds Private Equity &Venture Capital
Real Estate Structure Debt
What is a Hedge Fund?
• US– Hedge funds are private unregistered investment pools for wealthy
individuals or institutional investors. – Hedge funds invest in a variety of securities and use return enhancing
tools such as leverage, derivatives and arbitrage– Legally structured as a private investment limited partnership (LP) or a
limited liability corporation (LLC)– Typically charges a management fee (1-3%) and an incentive fee (15-
25%)
• Europe– A fund management firm that charges an incentive fee.
• Looks to create absolute returns, I.e. returns in excess of those predicted by CAPM or other asset pricing models.
Key Differences Between Hedge Funds and Mutual Funds
• Absolute return objective (10% to 25% per year) versus relative returns (out-performance of an index).
• Often clearly stated risk objective, e.g. 20% p.a.
• Market volatility presents opportunities since hedge funds can trade from both the long and short of the market.
• Managers compensation is primarily based on performance, not based on the size of the assets under management (better aligning interests of managers with investors).
• Many funds are closed or give an explicit size at which they will close – Limited capacity for most strategies, managers try to grow by steps,
e.g. 100 MUSD, 400 MUSD, 1000 MUSD in order to avoid failure– Moore returned 3bn to investors in 2001
Hedge Fund Fees
• The fee structure is homogenous:
– A management fee of a 1-3% p.a. and,– An incentive fee of 10%-30% of profits– Often a reference rate must be met before incentive fees are paid, e.g.
3 month T-bill + 200 bp.
• Incentive fee gives incentive and protects from ``earnings dilution'' due to size constraints of a particular strategy.
• High watermark– The manager only receives the incentive fee on new ``high-highs'‘,
typically calculated monthly or quarterly.– Reduces risk taking incentives of managers– Locks in investors when the fund is in ``drawdown’’ (100% participation
in first profits)– Gives managers a downside
Hedge Fund Styles by Assets
Long/ short equity40%
Managed futures14%
Event-driven15%
Global Macro14%
Fixed income arb.7%
Convertible arb4%
Other6%
The Strategy Universe
Income
Opportunistic
Convertible Arbitrage
MSCI World Equity
Market Timing Aggressive Growth
Event Driven
Distressed Securities
Fund of Funds
Market Neutral
Average Bond Mutual Fund
Short Selling
S&P 500
Emerging Markets
Equity Arbitrage
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
35%
40%
0% 5% 10% 15% 20% 25% 30%