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Mutual Funds

Mutual Funds. Diversification opportunities enhanced for small investors Economies of scale Predominantly open-ended funds, also Closed-end ETF. Size, structure and composition. First mutual fund: Boston, 1924. Slow growth, initially. Advent of money market mutual funds, 1972.

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Mutual Funds

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  1. Mutual Funds • Diversification opportunities enhanced for small investors • Economies of scale • Predominantly open-ended funds, also • Closed-end • ETF

  2. 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

  3. 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

  4. Mutual Funds As Retirement Assets Source: Investment Company Institute

  5. Mutual Funds • Rapid growth in funds during the 1980s &1990’s • 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

  6. Mutual Fund Business Functions Investment Management Product Design Processing Distribution Investors

  7. Mutual Fund Scoreboard Advantages: 5.Liquidity 6. Easy indexing 7. Reliable return data 8. Payment Mechanism • Diversification • Professional mgt • Convenience • Cost saving Disadvantages: • No Intra-day trading in traditional funds • Cost saving not passed on • Potential tax issues • Poorly defined objectives

  8. 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.

  9. 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

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

  11. Mutual Fund Assets By Asset Class

  12. 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.

  13. 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.

  14. 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).

  15. 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.

  16. Load Versus No-Load Fund Assets

  17. Mutual Fund Expenses • Front-end Loads • Back-end Loads • Annual Expenses • Expense Ratio (includes the following) • Management Fee • Operating Expenses • 12-b-1 Charges (Service/Load)

  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. Web Resources • For information on the performance of mutual funds, visit: Morningstar www.morningstar.com

  23. 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 • Lack of correlation has not held up recently

  24. Hedge Funds Different From Mutual Funds • Investment by manager • Limited to high net worth investors • Concentrated bets • Fees – large • Little regulatory oversight • Lack of liquidity • Lack of transparency • Asset allocation is slippery • High attrition • Can hold riskier assets • Significant leverage

  25. Estimated Growth of Assets / Net Asset Flow Hedge Fund Industry 1990 – Q1 2007

  26. Some Hedge Fund Strategies • Mutual funds are long-only • Long/short equity • Statistical arbitrage • Market neutral • Event Driven • Global Macro • Arbitrage • Convertibles arbitrage • Relative value

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

  28. 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

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

  30. The following 5 slides* are from: AIMA’s Roadmap To Hedge Funds published November, 2008 Alternative Investment Management Association * Also slide # 29

  31. Hedge Fund Fee Justification

  32. Returns According to Industry Group (IAMA)

  33. Pertinent Websites Moneycentral.com Federal Reserve www.federalreserve.gov Fidelity Investments www.fidelity.com Investment Company Institute www.ici.org Morningstar, Inc. www.morningstar.com NASD: www.nasd.com SEC: www.sec.gov Vanguard www.vanguard.com Etfconnect.com for ETFs & Closed End www.closed-endfunds.com for closed end http://www.hedgefundresearch.com/ hedge funds http://www.aima.org/ hedge funds

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