1. PROFESSIONAL ASSET MANAGEMENT 1

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

3. Basic Categories Investment Companies: Sell shares of the fund and invest the proceeds in a portfolio of stocks, bonds, or other assets Investor 1 Investor 2 Asset manager Fund Portfolio $$$$ $$ Fund Shares 3

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

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 5

6. Closed End Funds Stock of the fund trades on the regular secondary market Fund does not usually offer additional shares or repurchase shares Fund is actively managed NAV computed twice daily Market 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 6

7. Open-End (Mutual Fund) 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. 7

8. 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. 8

9. 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. 9

10. Records Fees Funds can charge as much as.25% of assets annually for records fees. 10

11. Management Fees Range is typically.20% to 1.00%. Does not include trading commissions 11

12. 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) 12

13. Expense Ratio Studies find that funds with lower expense ratios earn higher returns than those with higher expense ratios. 13

14. Turnover & Taxes Turnover: 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 14

15. Performance Many 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 15

16. ETFs Exchange Traded Funds Close-end index funds Indexes for every sector, region and style Most trade on AMEX SPDR – S&P 500 QQQQ – Nasdaq 100 Low expense ratios Trade like stocks More transparent than mutual funds Trade very close to NAV 16

17. Hedge Funds Similar to Mutual Funds Lightly Regulated Only open to “Accredited” Investors Not allowed to advertise No secondary market Not regularly marked-to-market due to illiquid investments Can be highly leveraged Often require a lockup period for investors 17

18. Investment Strategies Long/Short – Market Neutral Convertible Arbitrage Merger Arbitrage Statistical Arbitrage Distressed Companies 18

19. Compensation Structure Management Fee similar to mutual funds Performance Fee – typically 20% of profits Leads to emphasis on absolute return rather than relative return 19

20. 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 20