Securities Firms (I) – Investment Funds

1. Securities Firms (I) – Investment Funds • Security Firm Overview • Mutual Funds Overview • Funds Types • Fee Structure • Disclosure Requirement • Fund NAV, Returns and Performance measures • Hedge Funds

2. Overview of Securities Firms’ Business • Investment Banking Business • Brokage Service • Investment Funds • Mutual Funds • Hedge Funds

3. Mutual Fund Overview • Management/investment company • e.g., Fidelity Management and Research Corporation, a subsidiary of Fidelity Investments • Providing investment advice • Mutual Funds independent directors • Have independent directors • Transfer agent (servicing existing fund shareholders) • Underwriter/distributor (selling funds) • Fund Managers • Fund brokers • Fund custodians

4. Mutual Funds on the Rise

5. Distribution of Mutual Fund Net Assets by Type of Fund

6. Household Ownership of Mutual Funds

7. Fund Types • Open-end funds versus close-end funds • Open-end Fund: shares can be redeemed at any time at a price that is tied to the asset value of the fund (net asset value, abbreviated as NAV). When we talk about mutual fund, we usually refer to open end fund • Closed-end fund: a fixed number of nonredeemable shares are sold at an initial offering and then traded in OTC market like a common stock. Price of share could be different from NAV.

8. Fund Types • Based on investment objectives (way to create peer group) • Morningstar has 48 categories (Morningstar StyleMap) • Lipper has 91 categories (Lipper Style box classification) • Means to compare fund performance • Is a fund necessarily good if it consistently outperforms S&P 500 for 5 years?

9. Mutual Fund Types • Balanced Funds • Bond Funds • Value Funds – low P/E, P/B, M/B ratio • Growth Funds – high growth, P/E, P/B, M/B • Growth and Income Funds – high Div payout • Index Funds – low fee, diversified • - exchange traded funds (ETFs) • Money Market Mutual Funds – low risk, high liquidity • - T Rowe Price Associate

10. Fee Structure • No-Load Funds • funds without sales commissions/front-end charges • Load Funds • funds with sales commissions/front-end charges

11. Fees in addition to Front loads • Back-end load/Redemption fee/deferred load • Contingent deferred sales charge (CDSC) • 12b-1 fee • Covering distribution costs, advertising and marketing expense, limited to 1% per year • Operating expense • Costs incurred in operating the portfolio, measured by expense ratio (0.2-2%) • Management fee • 12b-1 fees • Exchange fee • Account maintenance fee

12. Fund Classes • Funds from alternative classes have the same portfolio of securities but impose different combination of fees. Investors select the best combination of fees • Class A shares sold with front-end loads of 4%-5%, no 12b-1 fee • Class B shares impose 12b-1 charges and back-end loads • Class C shares don’t impose back-end redemption fees, but have 12b-1 fees higher than those in class B (1%) • Class D shares include front end loads and 12-1 charges of 0.25% • Class I shares: institutional shares (no front-end charge and low annual operating expense) • Fee and loads contingent on scale of investment • Breakpoint: Dollar levels of investment in a fund that qualify you for reduced sales charges.

13. Break Points • Class A shares have a front-end load 8.5% while decrease depending on the amount of money you initially invest • 0 – 9,999 8.5% • 10,000 – 24,999 7.75% • 25,000 - 49,999 6.25% • 50,000 – 99,999 4.00% • 100,000 – and up 0.00%

14. Disclosure Requirement • Funds are registered with SEC, providing • Prospectus: (1) objective • (2) fees and expenses • (3) investment strategy and risk • (4) how to buy and sell • Shareholder Report • (1) fund performance • (2) fund financial statement • (3) required to report semiannually

15. Calculating Mutual Fund Return • Net Asset Value (NAV) • Total value of the mutual fund’s stocks, bonds, cash, and other assets minus any liabilities such as accrued fees, divided by the number of shares outstanding. • Return

16. Fund NAV and Return • Stocks $35,000,000 • Bonds $15,000,000 • Cash $3,000,000 • Total value of assets $53,000,000 • Liabilities -$800,000 • Net worth $52,200,000 • Outstanding shares 15 million • NAV =

17. Now suppose value of stocks increases to $40 million, and that of bonds increases to 20 million, while other things being equal what is new NAV? What is return of the fund? Stocks Bonds Cash total value of assets liabilities net worth shares

18. Performance measures • Sharpe ratio: • Treynor measure: • Jensen measure:

19. Hedge Funds • 1. Take advantage of unusual spreads between security prices • Long undervalued securities, short overvalued securities • Market-neutral investment • 2. Often highly leveraged • Using leverage to increase ROE • 3. Strong managerial incentive • Fund managers receive 1% annual management fee, 14% annual profit when fund return exceeds “high water mark” • 4. Relatively unregulated • Domestic hedge fund (fewer than 100 investors, limited partnership) • Offershore hedge funds (non-U.S. corporations), not subject to SEC regulations