1. © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 24: Professional Money Management Alternative Assets, and Industry Ethics

2. The Asset Management Industry: Structure and Evolution Two Organization Forms –Contract directly with a management and advisory firm –Combining investment capital of several clients in an investment company Differences between These Two Forms –Private management and advisory firms develop a personal relationship with clients –An Investment company offers a general solution See Exhibit 24.1 24-2 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

3. Exhibit 24.1 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 24-3

4. The Asset Management Industry: Structure and Evolution Contract directly with a management and advisory firm –Relationship with client –Separate accounts –Customized Combining investment capital of several clients in an investment company –Invest a pool of funds belonging to many individuals in a single portfolio of securities –Issue new shares representing the proportional ownership of the fund. 24-4 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

5. Private Management and Advisory Firms The majority of private management and advisory firms are still much smaller More narrowly focused on a particular niche of the market Investment Strategy –Each client’s assets are held in a separate account –The security portfolio are likely to be guided by the firm’s overall investment philosophy –While the specific stock allocations might vary, the same fundamental orientation toward stock selection will be applied to all accounts Example 24-5 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

6. Organization and Management of Investment Companies Investment Companies –They are the financial intermediaries that pool the assets of individual investors and invest the fund in securities or other assets –Major Duties  Investment research  Management of the portfolio  Administrative duties –The management fee is generally stated as a percentage of the total value of the fund –Family of funds helps achieve economies of scale 24-6 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

7. Organization and Management of Investment Companies Fund Management Fees –Charge annual management fees to compensate professional managers of the fund –The fee typically is a percentage of the average net assets of the fund varying from about 0.25 to 1.00 percent –Management fees are a major factor driving the creation of new funds –Mutual fund fees decline with the size of the fund –More assets under management generate more fees 24-7 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

8. Organization and Management of Investment Companies The nature of assets held in a mutual fund define its Investment objectives –Equity funds: They invest almost exclusively in common stocks –Bond funds: These funds concentrate on various types of bonds to generate high current income with minimal risk –Balanced funds: They diversify outside a single market by combining common stock with fixed income securities 24-8 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

9. Organization and Management of Investment Companies Money market funds: They invest in diversified portfolios of short-term securities, such as T-bills and commercial papers. Which of these funds provide current income and safety of principle? when investors are bullish about stocks, where do they invest? © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 24-9

10. Organization and Management of Investment Companies Global Investment Companies –Funds that invest in non-Saudi securities are generally called either international funds or global funds –International funds often hold only non-Saudi stocks from other countries, such as Asia and Europe. For example, “Al-ahli Europe Trading Equity Fund” –Global funds contain both Saudi and non-Saudi securities. For example, “Global Property Fund” in Riyadh Capital Company 24-10 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

11. Investing in Alternative Asset Classes Basic Concepts –Alternative Assets  Hedge funds  Private equity  Real estate  Natural resources and commodities –Management Structure  Structured as a limited partnership rather than as a mutual fund to manage the commingled assets –The Fund “alpha” (See Exhibit 24.14)  Excess returns generated by the fund, implying the superior performance by the fund management 24-11 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

12. Exhibit 24.14 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 24-12

13. Hedge Funds The Development –One of the most significant developments in the professional asset management industry over the past 20 years has been the hedge fund investing –Hedge fund investing is not new and can be traced back to 1949, structured as a partnership structure with an incentive fee for superior performance –With both long and short positions and financial leverage, it is able to produce superior returns than traditional investment structures, such as mutual funds –See Exhibit 24.15 24-13 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

14. Exhibit 24.15 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 24-14

15. Hedge Funds The Characteristics –As a private partnership, hedge funds are generally less restricted in how and where they can make investments –Less correlated with traditional asset class investments, providing diversification benefits –Hedge fund investments are far less liquid than mutual fund –There are severe limitations on when and how often investment capital can be contributed to or removed from a partnership –Performance allocation and high-watermark –See Exhibit 24.16 24-15 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

16. Exhibit 24.16 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 24-16

17. Private Equity Basic Concepts –Refers to any ownership interest in an asset (or assets) that is not tradable in a public market  Typically fund either new companies or established firms that are seeking to change their organizational structure or are experiencing financial distress  Generally far less liquid than public stock holdings and are therefore considered to be long-term positions within an investor’s overall portfolio –Characteristics  Higher return and low liquidity  Good sources of diversification –See Exhibit 24.21 24-17 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

18. Exhibit 24.21 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 24-18

19. Private Equity Development and Organization –Organized private equity investing began in the United States back in 1946 –The common investment strategies in private equity include:  Venture Capital  Leveraged Buyouts (LBO)  In an LBO transaction, a private-equity firm controls the majority of an existing or mature firm. While in a venture-capital, the investors invest in young, growing companies, and usually don’t obtain a majority of control. 24-19 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

20. Exhibit 24.22 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 24-20

21. Private Equity –Private equity investment is mostly done through institutional investors and accredited investors, who can invest large amount of money for long period of time –The venture capital firm will ultimately want to liquidate their equity holdings in order to create a return on their investment through:  Buyout  IPO 24-21 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

22. Private Equity Returns to Private Equity Funds –Private equity commitments should be viewed as long-term, highly illiquid investments –The return pattern known as the “J-curve effect”  Average annual returns for these investments tend to be quite high over time  The initial years of a new private equity commitment usually produce negative returns –In addition to its higher overall risk level, there exists a huge dispersion in fund returns, that is, good performance vs. bad performance managers –See Exhibit 24.25 24-22 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

23. Exhibit 24.25 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 24-23

24. Ethics and Regulation in the Professional Asset Management Industry Agency Problem Examples of Ethical Conflicts –Incentive Compensation Schemes –Soft Dollar Arrangements –Marketing Investment Management 24-24 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

25. Ethics and Regulation in the Professional Asset Management Industry The Capital Market Authority (CMA) had Issued an Implementing Regulations that Manages the Asset Management Industry Such as the: Investment Funds Regulations http://www.cma.org.sa/en/Pages/Implementing_Regul ations.aspx Authorized Persons Regulations http://www.cma.org.sa/En/Documents/AUTHORISED %20PERSON.pdf 24-25 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

26. What Do You Want from a Professional Asset Manger? Help determine your investment objectives and develop a portfolio that is consistent with them Diversify your portfolio to eliminate unsystematic risk Maintain your portfolio diversification and your desired risk class while allowing flexibility so you could shift between alternative investment instruments as desired Attempt to achieve a risk-adjusted performance level that is superior to that of your relevant benchmark Administer the account, keep records of costs and transactions, provide timely information for tax purposes, and reinvest dividends if desired Maintain ethical standards of behavior at all times 24-26 © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

27. The Internet Investments Online 24-27 http://www.morningstar.com http://www.lipperweb.com http://www.brill.com http://www.mfea.com http://www.investorguide.com/funds.html http://www.ici.org http://www.hedgefundresearch.com http://www.privateequity.com © 2012 Cengage Learning. All Rights Reserved. May not scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.