1. Economics 71a: Spring 2007 Mayo 17, Malkiel 8 Lecture 4.8
Investment Companies
Economics 71a: Spring 2007
Mayo 17, Malkiel 8
Lecture 4.8

2. Goals History Closed and open funds Performance and fees
Types of funds
Index funds
ETF’s
Hedge funds
How well do funds perform?

3. History First funds, March 1924 Boston is key location Growth
State Street Research
Massachusetts Investment Trust
Massachusetts Financial Services
now owned by Sun Life of Canada
Boston is key location
Growth
Recently phenomenal
Increase in total capital between times since 1980
Number of funds has also exploded
1980 = 468 funds in U.S
1997 = 5,765
Today around 10,000

4. Closed versus Open Funds
Closed end fund
Traded like regular stock (price)
Fixed number of shares
Basically a corporation whose only assets are its portfolio
Open end fund
New shares issued for each buyer
Valued at current market value of the fund portfolio
Net asset value (NAV)

5. Net Asset Value (NAV) Total net worth of fund NAV/share
Assets - Liabilities
Assets: Stocks, bonds
Liabilities: Borrowing
NAV/share

6. More on Closed versus Open
Most funds are Open-End
Closed-end funds occasional trade differently from their asset values (NAV)
P<NAV, or P>NAV

7. Performance (open end) (Reported numbers often exclude fees.)
NAV = Net asset value
I, CG = Income + Capital gain distributions

8. Performance (closed end)
P = Market price
I, CG = Income + Capital gain distributions

9. Costs and Fees Loading fees (paid at start, 3-6 percent)
12b-1 fees (sales expenses)
Continue over years
Management fees
Paid to investment advisor
Between 0.25 and 1.5%
Fund expenses (legal, admin)
Trading costs

10. Benefits
Diversification
Stock selection skills
Bookkeeping

11. Types of Funds
Stocks
Bonds
Money Market

12. Stock Funds Index (see next slide) Growth Value Sector Market neutral
Green and socially responsible funds
International
Country
Emerging markets

13. Index Mutual Funds Designed to match (but not beat) the market
Examples
Track S&P 500
Country funds
Why?
Market efficiency
Cost

14. Other Index Instruments Exchange Traded Funds (ETF)
Traded on regular exchanges
Can be short sold
Types
Standard and Poors Depository Receipts (SPDRS)
World Equity Benchmarks (WEBS)
Diamonds (Dow)
Qubes (NASDAQ) (QQQ)

15. More ETF Info (See Economist)
Growing fast
Expanding into new areas
Gold
Nanotechnology
“Ultrashort QQQ”
Goes down 2% when NASDAQ up 1%
Advantages
Easy to trade long or short indices
Disadvantages
May encourage short run trading
Liquidity for some may be low

16. Hedge Funds Small numbers of large investors (> $1.5 million)
Not SEC regulated (registered)
More flexible in strategies
May hold derivatives
Short sales
Leveraged (borrowing)
Performance based fees
2% of total assets and then
20% of profits
(2 and 20)
Limit withdrawals

17. Other Managed Funds Funds of hedge funds Pension funds
Insurance companies
Endowments/foundations

18. Mutual Fund Performance
Malkiel Chapter 8
Good data experiment
Do mutual funds out perform the rest of the market?

19. Mutual Funds vs. Market 10 years ending December 31, 2001
S&P 500: % per year
Stock mutual funds: %
Rankings: 70’s -> 90’s
Twentieth century growth
1 -> 176
Templeton growth
2 -> 126

20. More on rankings Average return in 70’s Average return in the 80’s
Top 20 funds in 70’s
+19%
All funds
+10.4%
Average return in the 80’s
Top 20 funds in the 70’s
11.1%
11.7%

21. More on rankings Average return in 80’s Average return in the 90’s
Top 20 funds in 80’s
+18%
S&P
+14%
Average return in the 90’s
Top 20 funds in the 80’s
13.7%
14.9%

22. The Problem of Size and Success for Mutual Funds
As funds get bigger size gets in the way
Difficult to buy stocks
50 stock fund
1 billion in assets
Control <5% in each stock
Universe = 1850
20 billion in assets
<5% in each stock
Universe = 182
Transaction costs and “price impact”

23. Gurus: Luck Versus Chance
Appear to be some people who do well consistently
Peter Lynch: Michael Jordan of mutual funds (retired ahead)
Generates consistent performance
Is he smart or lucky?
Statistically, we should see some people do well for long periods of time do to chance
“Survivorship Bias”

24. Summary Mutual funds are convenient way to diversify portfolios
Index funds are a powerful tool
Performance of the industry in general is not great