Version 1.2 Copyright © 2000 by Harcourt, Inc. All rights reserved. Requests for permission to make copies of any part of the work should be mailed to: Permissions Department Harcourt, Inc Sea Harbor Drive Orlando, Florida Lecture Presentation Software to accompany Investment Analysis and Portfolio Management Sixth Edition by Frank K. Reilly & Keith C. Brown Chapter 26

Copyright © 2000 by Harcourt, Inc. All rights reserved. Chapter 26 Professional Asset Management Questions to be answered: What are the different ways that professional asset management firms can be organized? How has the structure of the asset management industry changed over time? How are managers at investment advisory firms compensated?

Copyright © 2000 by Harcourt, Inc. All rights reserved. Chapter 26 Professional Asset Management Who manages the investment company portfolio and how are its managers compensated? How do you compute the net asset value (NAV) for an investment company? What is the difference between closed-end and open-end investment companies? What is the difference between the NAV and market price for a closed-end fund?

Copyright © 2000 by Harcourt, Inc. All rights reserved. Chapter 26 Professional Asset Management What are load fees, 12b-1 fees, and management fees and how do they influence investment company performance? What are the two major means of fund distribution and what has been the trend for each approach? Given the breakdown of all funds by investment objectives, which groups have experienced relative growth or decline?

Copyright © 2000 by Harcourt, Inc. All rights reserved. Chapter 26 Professional Asset Management Given a desire to have a personal portfolio manager perform certain functions for you, how do investment companies help fulfill this need? What are the ethical dilemmas involved in the professional asset management industry? What has been the risk-adjusted performance of mutual funds relative to alternative market indexes?

Copyright © 2000 by Harcourt, Inc. All rights reserved. The Asset Management Industry: Structure and Evolution 1. Contract directly with a management and advisory firm relationship with client assets under management (AUM) separate accounts customized 2. Commingling of investment capital of several clients in an investment company

Copyright © 2000 by Harcourt, Inc. All rights reserved. What is an Investment Company? An investment company invests a pool of funds belonging to many individuals in a portfolio of individual investments such as stocks and bonds The total market value of all investments divided by the number of fund shares outstanding is the net asset value (NAV) Portfolio management is handled by an investment management company

Copyright © 2000 by Harcourt, Inc. All rights reserved. Closed-End Versus Open-End Investment Companies Closed-end investment company –Stock trades on secondary market –Net asset value (NAV) is determined twice daily, but market price determined by supply and demand –Discounts from NAV can be opportunities Closed-end fund index Open-end investment companies –Mutual funds –Sell and repurchase shares at NAV

Copyright © 2000 by Harcourt, Inc. All rights reserved. Mutual Fund Costs Load versus no-load open-end funds –Load funds charge sales commission up to 8.5% of NAV, but usually not a redemption fee –No-load imposes no initial sales charge, so it sells shares at NAV, but may charge a small redemption fee of 1/2% –Low-load imposes a front-end sales charge in the 3% range

Copyright © 2000 by Harcourt, Inc. All rights reserved. Other Expenses: 12b-1 Fees, Rear-End Loads, Management Contingent deferred sales loads, or redemption charges, or “rear-end loads”, decline over time Annual 12b-1 fee Details about funds charges are found in the fund’s prospectus Fund management fees Portfolio turnover Expense ratios

Copyright © 2000 by Harcourt, Inc. All rights reserved. Types of Investment Companies Based on Portfolio Objectives Common stock funds Balanced funds Taxable bond funds Municipal bond funds Money market funds

Copyright © 2000 by Harcourt, Inc. All rights reserved. Global Investment Companies Foreign funds –International funds –Global funds Fund categories, regions, countries

Copyright © 2000 by Harcourt, Inc. All rights reserved. Sources of Information About Mutual Funds The Wall Street Journal Barron’s - weekly and quarterly Investment Companies Mutual Funds Update Mutual Funds Report Closed-end Weekly Review FundEdge Management Results Forbes Business Week - “Mutual Fund Scoreboard” Morningstar Mutual Funds Value Line

Copyright © 2000 by Harcourt, Inc. All rights reserved. Ethics and Regulation in the Professional Asset Management Industry Agency - looking out for the interest of another Asset management industry is based on handling someone else’s money Investment Company Act of 1940 Securities Act of 1933 Securities Act of 1934 Investment Advisors Act of 1940 ERISA (1974) - Prudent man rule

Copyright © 2000 by Harcourt, Inc. All rights reserved. Ethics and Regulation in the Professional Asset Management Industry Association for Investment Management and Research (AIMR) has a Code of Ethics and Standards of Professional Conduct Chartered Financial Analyst (CFA) Compensation dilemma - incentives and risk Soft dollars

Copyright © 2000 by Harcourt, Inc. All rights reserved. Performance of Investment Companies Below average returns for actively managed equity and bond funds Do a fund’s objectives matter? –Positive relationship between stated objectives and risk measures Do managers generally outperform the market? –Results are more consistent in shorter time periods

Copyright © 2000 by Harcourt, Inc. All rights reserved. Your Portfolio Manager 1. Determine your risk-return preferences and develop a portfolio that is consistent with them 2. Diversify your portfolio to eliminate unsystematic risk 3. Maintain your portfolio diversification and your desired risk class while allowing flexibility so you could shift between alternative investment instruments as desired 4. Attempt to achieve a risk-adjusted performance that is superior to aggregate market performance 5. Administer the account, keep records of costs, provide timely information for tax purposes, and reinvest dividends if desired

Copyright © 2000 by Harcourt, Inc. All rights reserved. The Internet Investments Online

Copyright © 2000 by Harcourt, Inc. All rights reserved. End of Chapter 26 –Professional Asset Management

Copyright © 2000 by Harcourt, Inc. All rights reserved. Future topics Chapter 27 Composite Portfolio Performance Measures Performance Attribution Analysis Evaluation of Bond Portfolio Performance

Copyright © 2000 by Harcourt, Inc. All rights reserved.