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PROFESSIONAL ASSET MANAGEMENT

PROFESSIONAL ASSET MANAGEMENT. Basic Categories. Private Management : Clients each have a separate account {popular with institutions}. Investor 1. $. $$. Account 1 Account 2. Asset manager. $. Investor 2. Basic Categories.

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PROFESSIONAL ASSET MANAGEMENT

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  1. PROFESSIONAL ASSET MANAGEMENT

  2. Basic Categories Private Management: Clients each have a separate account {popular with institutions} Investor 1 $ $$ Account 1 Account 2 Asset manager $ Investor 2

  3. Basic Categories Investment Companies: Sell shares of the fund and invest the proceeds in a portfolio of stocks {popular with individuals} Investor 1 Fund Shares $$ Fund Portfolio $ $ Asset manager Investor 2 Fund Shares

  4. Professional Asset Management vs. Individuals 1. Diversification 2. Record Keeping 3. Professional Management 4. Lower Transaction Costs

  5. Net Asset Value Example Market Value = $100 mil Number of Shares = 10 mil NAV = $100 / 10 = $10 / share Suppose Market Value goes up to $112.5 mil, and the management fees during that period were $0.1 mil. What is the ending NAV? NAV = (112.5 – 0.1) / 10 = $11.24 / share

  6. Types of Investment Companies • Closed-end funds • Open-end funds (a.k.a. mutual funds)

  7. Closed End Funds • Stock of the fund trades on the regular secondary market • Fund does not usually offer additional shares or repurchase shares • NAV computed twice daily • Market price is NOT NECESSARILY EQUAL to NAV

  8. Open-End (Mutual Fund) • Buy back (redeem) shares or sell additional shares at the NAV. • May be a sales charge (load) when the fund sells the shares to customers. • May charge a redemption fee when the customers sell their shares back to the fund.

  9. Mutual Funds • Equity funds invest primarily in stocks. • Most hold some money market instruments to provide liquidity regarding redemptions. • May also hold fixed income or other securities.

  10. Mutual Funds • Income Funds: Bonds and High Dividend yield stocks. • Growth Funds: Forego dividend yield for capital gains. Invest in well-established firms. • Aggressive Growth: Seek maximum capital growth by investing in smaller, younger companies.

  11. Loads: Sales Charge Front End: Paid when shares are purchased. • Load: 3% of NAV is typical • No-Load: No sales charge.

  12. Back-End Loads • 5-10% fee on sale. Typically drops by 1% every year.

  13. 12b-1 Fees An alternative to a load to cover advertising & marketing expenses. Some No-Load and Low-Load funds use these. • Can deduct as much as .75% of assets annually to cover fund advertising & marketing.

  14. Sales & Marketing Fee Choice • Some funds give you a choice as to how you want to pay your share of the expenses. • Offer alternatives called choices “A”, “B” or “C” for example.

  15. Sales & Marketing Fee Choice A: front-end load B: 12b-1 & rear-end load that decrease the longer you hold shares. C: Perpetual 12b-1 fees

  16. Records Fees • Funds can charge as much as .25% of assets annually for records fees.

  17. Management Fees • Range is typically .20% to 1.00%. • Does not include trading commissions

  18. Expense Ratio Expense Ratio = Annual Expenses/$ Amt of Fund Assets Annual Expenses are: Management fees, 12b-1 fees, records fees (NOT front or back-end loads)

  19. Expense Ratio • Studies find that funds with lower expense ratios earn higher returns than those with higher expense ratios.

  20. Examples Vanguard 500: Expense Ratio = .18%, no-load, Mgmt fee is .16%. Janus 20: Expense Ratio = .87%, no-load, Mgmt fee is .65%. Fidelity Magellan: Expense Ratio = .74%, 3% front load, Mgmt fee = .57%.

  21. Turnover & Taxes • Turnover: Fraction of portfolio replaced each year. • Mutual funds have pass-through-status which means that taxes are paid only by the investor, not the mutual fund. Not an issue if in a tax-deferred retirement account

  22. Performance • Many Studies find active managers underperform benchmarks after costs and fees by about 1% per year. • Risk does increase as stated objectives become more aggressive. • Some evidence of short run persistence in performance particularly for high expense funds (may be due to momentum strategies)

  23. Performance • Less than half outperform a broad market index after costs and fees. • Good performance associated with low expense ratio. • Lack of consistency in performance of funds over time except for poor funds. Poor funds show persistence. • Recent data shows some persistence for growth style managers (momentum style)

  24. ETFs • Exchange Traded Funds • Close-end index funds • Most trade on AMEX • SPDR – S&P 500 • QQQQ – Nasdaq 100 • Diamonds – Dow Jones Ind. Ave. • Low expenses

  25. Hedge Funds • Similar to Mutual Funds • Lightly Regulated • Only open to Qualified Investors • Not allowed to advertise • No secondary market • Not regularly marked to market • Often require a lockup period for investors

  26. Investment Strategies • Long/Short – Market Neutral • Convertible Arbitrage • Merger Arbitrage • Statistical Arbitrage • Distressed Companies

  27. Compensation Structure • Management Fee similar to mutual funds • Performance Fee – typically 20% of profits

  28. Results • Often difficult to know for sure • Some appear to be very high • Some studies say the industry averages no better than mutual funds • Additional fees can cut into positive results – Especially funds of funds

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