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Mutual funds and the Institutional environment

Chapter 4: overview of institutional investing and institutions’ role in portfolio selection and management

A. Institutional investorsB. Mutual funds / ETFs / Segregated fundsC. Pension Funds

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A. Institutional InvestorsPension fundsEndowment fundsFinancial institutions, e.g., banks and

insurance companiesLarge portfolio managers

Mutual Funds, hedge Funds … etc.

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Constraints in Portfolio Management

LiquidityInvestment horizonLimits on country holdingsLimits on sector holdingsLimits on individual firm holdingsLimits on trading strategiesRegulatory constraints ESG

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B. Mutual FundsMajor categories:Money market fundsEquity funds (market cap, style, sector)Fixed-income fundsIncome fundsBalanced fundsAsset allocation funds

Have a market-timing componentIndex funds

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Net Asset Value

Used as basis for valuation of mutual fund shares

Calculation (once per day):

dingtanOutsSharessLiabilitieAssetsofValueMarket

NAV

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Open-End vs. Closed-End FundsShares OutstandingClosed-end

no change unless new shares are offeredTraded on stock exchanges or OTC

Open-endchanges when new shares are sold or old shares are

redeemed

PricingOpen-end: net asset value (NAV)Closed-end: premium or discount to NAV

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Costs of Investing in Mutual Funds

Sales chargesFront-end load (%, pay when purchase)Back-end load (%, pay when redeem)

Typically declines with the holding periodNo load (early redemption fee may be charged)

Operating expensesManagement expense ratio (MER)Expressed as a percentage of total assets

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Exchange-Traded FundsSince 1993ETFs, iShares, iUnitsPassive versus active investingCompare MER with that of index fundsBroad index as well as specialized ETFs: Fixed income,

sector, international, style, leveragedhttp://www.nyse.com/about/listed/funds.htmlhttp://www.ishares.ca

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ETFsClear Indexes LLC runs a student competition: Create the

next ETF2007 winner: US Exporters Index ETF

ETFs are different from closed-end mutual funds There is always an underlying index# of shares outstanding changes daily (ETF manager issues

and redeems shares to keep the ETF in line with the underlying index)

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Segregated Funds An insurance contract that provides investment

management (mutual fund) plus protection

Offered by insurance companies, but “segregated” from the other assets of the insurance company

Some have in-house fund management, e.g., TransAmerica Life

May also wrap an insurance policy around an existing mutual fund, e.g., Great-West life policy around MacKenzie Financial funds

MERs e.g., MacKenzie Financial: 2.7 - 2.9%

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Main Differences 3 main differences from mutual funds

1. Bankruptcy protection (governed by the Insurance Act) Fund shielded from creditors in case of personal

bankruptcy

2. Protection of principal if held for 10 yrs + 75% by law, but new generation 100%

3. Death benefit Within 10 years, beneficiary receives the greater of

principal or market value

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Pension PlansTwo major types of pension plan

DBDC (In the U.S., 401(k) plans)Hybrid

Who bears the risk in each type?

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Pension Funds as Institutional InvestorsInvestment of pension assetsAll bonds (to “match” liabilities)Stocks and bonds (traditional: 60%, 40%)Stocks and bonds + alternative assets

A pioneer: British Rail Pension Plan in the 70s invested in a portfolio of art

More generally: real estate, infrastructure, private equity, 130/30, hedge funds

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Ontario Teachers’ Pension PlanIn 1990, the fund's $19 billion of assets were all in

Ontario government bonds $108 on December 31, 2007$87.4 on December 31, 2008278,000 plan membersManage some of its own assets

Active in derivatives/hedge fundsHas a private capital division with $16 billion in assets

Largest professional single pension plan in Canada

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OTPPHow do assets in the fund grow? 2006 figures

Stock:Net assets $108.5 billionFlow:Investment income $4.7 billion Benefits paid $4.0 billion Annual contributions* $2.1 billion

*Teachers and the Ontario government

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Contrast with 2008 Figures

Stock:Net assets $87.4 billionFlow:Investment income ($19 billion) Benefits paid $4.2 billion Annual contributions* $2.3 billion

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CPPIBIncorporated as a federal crown corporation in 1997Investments began in 1999. Before: 100% provincial

bondsLargest pension fund in Canada

$127.7 billion (June 30, 2008)$117.4 billion (September 30, 2008)$108.9 billion (December 31, 2008)$116.6 (June 30, 2009)

17 million plan membershttp://www.cppib.ca

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CPPIBWhat types of assets are held? Allocation?

I. Equities (59.9%) Public: 46.8% (Domestic: less than half) Private: 13.1%

II. Fixed income (26.8%) Federal and provincial bonds

III. Inflation-sensitive assets (returns tied to inflation) (13.3%) Real estate: 6.2% Infrastructure: 3.1% Real-return bonds: 4%

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Responsible Investing PolicyA non-financial factor/policyExample

Norwegian Government Pension Fund does not invest in:Walmart (human rights issues)Boeing, Honeywell International (nuclear weapons)Freeport McMoRan Cooper and Gold

(environmental damages)

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Responsible Investing PolicyMcLean Budden’s non-financial screen for their “Select”

family of fundsExclude companies with more than 10% of their gross

annual revenue from the sale of tobacco, alcohol, gambling facilities, pornography, and armaments.

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CPPIB“ CPPIB has committed to build an engagement capability and

use its ownership positions in companies to encourage improved performance in and disclosure of environmental, social, and governance factors ”

Example of “engagement activity”: Burma. In discussion with Senior Execs at Ivanhoe mines

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Both CPPIB and OTPP

Investment belief: Artificial constraints decrease returns and/or increase risk over time

Hence, they do not screen stocks based on non-financial criteria alone

Believe that engagement is a more effective approach

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Global perspective on sizeLargest funds in Canada

CPPIBSeptember 30, 2008: CDN $117 billion

• Caisse de depot et placement du Quebec $120 billion (net)Largest in North America

CALPERS:November 30, 2008: US$180.9 billion

Largest in the worldJapan Government Pension Investment FundSeptember 2008: US$1.3 trillion