PROFESSIONAL ASSET

MANAGEMENT

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Basic Categories Private Management: Clients each have a separate

account {popular with institutions}

Investor 1

Investor 2

Asset manager

Account 1$

$

$

2

Account Account

2$

Basic CategoriesInvestment Companies: Sell shares of the fund and

invest the proceeds in a portfolio of stocks, bonds, or other assets

Investor 1

Investor 2

Asset managerFund Portfolio

$

$

$$

Fund Shares

Fund Shares

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Professional Asset Management vs. Individuals

1. Diversification

2. Record Keeping

3. Professional Management

4. Lower Transaction Costs

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Net Asset Value

gOutstandin Shares Fund Total

Expenses FundPortfolio of ValueMarket Total NAV

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

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Traditional Closed End FundsShares of the fund trade like stock on an exchangeFund does not usually offer additional shares or repurchase

sharesFund is actively managedMarket price is NOT NECESSARILY EQUAL to NAV

Premium or discount reflects investors’ opinions of manager’s ability to select good investments in future

Poor history of long-run returns

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Open-End Funds (Mutual Funds)

Fund manager is always willing to buy back (redeem) shares or sell additional shares at the NAV.

Shares may not be bought from or sold to anyone except the Fund.

Shares of the fund are always valued at NAV (calculated at the end of each day).

Total number of shares outstanding will change as fund sells/buys shares.

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Loads: Sales Charge

• Front End: Paid when shares are purchased.• 3% of NAV is typical

• Back End: Paid when shares are redeemed• 5-10% fee on sale. Typically drops by 1% every

year. No-Load: No sales charge.

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12b-1 Fees

An alternative to a load to cover advertising & marketing expenses. Can be found in both loaded and no-load funds

Can deduct as much as .75% of assets annually to cover fund advertising & marketing.

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Records Fees

Funds can charge as much as .25% of assets annually for records fees.

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Management Fees

Range is typically .20% to 1.00%.

Does not include trading commissions

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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 and not trading commissions)

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Expense Ratio

Studies find that funds with lower expense ratios earn higher (net) returns than those with higher expense ratios.

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Turnover & TaxesTurnover: Fraction of portfolio replaced each year.

Studies indicate that funds with a lower turnover achieve higher returns

Mutual funds have pass-through-status which means that taxes are paid only by the investor, not the mutual fund.Investors can be taxed on gains they never received

Not an issue if in a tax-deferred retirement account

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PerformanceMany Studies find active managers (on average)

underperform benchmarks after costs and fees by about 1% per year.

Good performance is associated with low expense ratio.

Very low correlation between top funds one year and top funds the next year.

Some positive correlation between bottom funds one year and bottom funds the next year.

Investors tend to put more money in funds that have recently done well

Investors in mutual funds tend to overweight growth stocks

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ETFsExchange Traded FundsClose-end index funds

Indexes for every sector, region and styleMost trade on AMEXLow expense ratiosTrade like stocks

Can be shortedCan be purchased on margin

More transparent than mutual fundsTrade very close to NAV

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Hedge FundsSimilar to Mutual FundsLightly RegulatedOnly open to “Accredited” InvestorsOnly recently allowed to advertiseNo secondary marketNot regularly marked-to-market due to

illiquid investmentsCan be highly leveragedOften require a lockup period for investors

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Common Hedge Fund Investment StrategiesLong/Short – Market NeutralConvertible ArbitrageMerger ArbitrageStatistical ArbitrageDistressed Companies

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Compensation StructureManagement Fee similar to mutual funds

Usually 1-2% of AUM(assets under management)

Performance Fee – typically 20% of profitsLeads to emphasis on absolute return rather

than relative returnMay be a hurdle rate for performance fee

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ResultsOften difficult to know for sureSome appear to be very highSome studies say the industry averages are

no better than mutual fundsAdditional fees can cut into positive results –

Especially funds of funds

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Some Well-Known Hedge FundsRenaissanceCitadelMilleniumPaulson and Co. MaverickS.A.C. Capital Advisors

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