1. PROFESSIONAL ASSET MANAGEMENT

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

3. Basic Categories Investment Companies: Sell shares of the fund and invest the proceeds in a portfolio of stocks {popular with individuals} Investor 1 Investor 2 Asset manager Fund Portfolio $$$$ $$ Fund Shares

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

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

6. Types of Investment Companies Closed-end funds Open-end funds (a.k.a. mutual funds)

7. Closed End Funds Stock of the fund trades on the regular secondary market Fund does not usually offer additional shares or repurchase shares NAV computed twice daily Market price is NOT NECESSARILY EQUAL to NAV

8. Open-End (Mutual Fund) Buy back (redeem) shares or sell additional shares at the NAV. May be a sales charge (load) when the fund sells the shares to customers. May charge a redemption fee when the customers sell their shares back to the fund.

9. Mutual Funds Equity funds invest primarily in stocks. Most hold some money market instruments to provide liquidity regarding redemptions. May also hold fixed income or other securities.

10. Income Funds: Bonds and High Dividend yield stocks. Growth Funds: Forego dividend yield for capital gains. Invest in well-established firms. Aggressive Growth: Seek maximum capital growth by investing in smaller, younger companies. Mutual Funds

11. Loads: Sales Charge Front End: Paid when shares are purchased. Load: 3% of NAV is typical No-Load: No sales charge.

12. Back-End Loads 5-10% fee on sale. Typically drops by 1% every year.

13. 12b-1 Fees An alternative to a load to cover advertising & marketing expenses. Some No-Load and Low-Load funds use these. Can deduct as much as.75% of assets annually to cover fund advertising & marketing.

14. Sales & Marketing Fee Choice Some funds give you a choice as to how you want to pay your share of the expenses. Offer alternatives called choices “A”, “B” or “C” for example.

15. Sales & Marketing Fee Choice A: front-end load B: 12b-1 & rear-end load that decrease the longer you hold shares. C: Perpetual 12b-1 fees

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

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

18. 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)

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

20. Examples Vanguard 500: Expense Ratio =.18%, no- load, Mgmt fee is.16%. Janus 20: Expense Ratio =.87%, no-load, Mgmt fee is.65%. Fidelity Magellan: Expense Ratio =.74%, 3% front load, Mgmt fee =.57%.

21. Turnover & Taxes Turnover: Fraction of portfolio replaced each year. Mutual funds have pass-through-status which means that taxes are paid only by the investor, not the mutual fund. Not an issue if in a tax-deferred retirement account

22. Performance Many Studies find active managers underperform benchmarks after costs and fees by about 1% per year. Risk does increase as stated objectives become more aggressive. Some evidence of short run persistence in performance particularly for high expense funds (may be due to momentum strategies)

23. Performance 1. Less than half outperform a broad market index after costs and fees. 2. Good performance associated with low expense ratio. 3. Lack of consistency in performance of funds over time except for poor funds. Poor funds show persistence. 4. Recent data shows some persistence for growth style managers (momentum style)

24. ETFs Exchange Traded Funds Close-end index funds Most trade on AMEX SPDR – S&P 500 QQQQ – Nasdaq 100 Diamonds – Dow Jones Ind. Ave. Low expenses

25. Hedge Funds Similar to Mutual Funds Lightly Regulated Only open to Qualified Investors Not allowed to advertise No secondary market Not regularly marked to market Often require a lockup period for investors

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

27. Compensation Structure Management Fee similar to mutual funds Performance Fee – typically 20% of profits

28. 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