Investment Property - How Mutual Funds and ETFs Work

Transcription

1 411 NW Park Ave., Suite 402 Portland, OR USA Toll Free: 877-WITH-ACG Main Line: White Paper: Overview of Mutual Funds and Exchange-Traded Funds (ETFs) in Russia, Singapore, and the European Union Date: November, 2011 Aginsky Consulting group Page 1 of 26

2 Table of Contents MUTUAL FUNDS ETFS 3 4 COMPARISON OF MUTUAL FUNDS AND ETFS FROM AN INVESTOR S PERSPECTIVE 6 MUTUAL FUND AND ETF MARKETS IN RUSSIA, SINGAPORE AND EUROPE RUSSIA SINGAPORE EUROPE Page 2 of 26

3 Mutual Funds General A mutual fund is an entity that pools money from many investors and invests the money in stocks, bonds, short- term money-market instruments, other securities or assets, or some combination of these investments. The combined holdings the mutual fund owns make up its portfolio, and each share represents an investor s proportionate ownership of the fund s holdings and the income those holdings generate. Investors purchase mutual fund shares from the fund itself (or through a broker for the fund) instead of from other investors on a secondary market, such as a stock exchange. The price that investors pay for mutual fund shares is the fund s per share net asset value (NAV) plus any shareholder fees that the fund imposes at the time of purchase (such as sales loads). Most mutual funds are actively managed, seeking to outperform market indexes. Most mutual funds are either open-end or closed -end funds. Open-end funds issue and redeem shares on demand, whenever investors put money into the fund or take money out. This means that the more investors that buy an open-end fund, the more shares there will be since there is no limit to the number of shares the fund can issue. Further, the value of each individual share is not affected by the number of shares outstanding, since the NAV is determined solely by the change in prices of the securities the fund owns, and not by the size of the fund itself. Closed-end funds issue a set number of shares only once in an initial public offering and trade on an exchange. Share prices of these funds are determined not by the total value of the assets they hold, but by investor demand for the fund. Mutual fund share redemption Mutual fund shares are redeemable, meaning investors can sell their shares back to the fund (or to a broker acting for the fund). Investors are entitled to receive on demand, or within a specified period after demand, an amount computed by reference to the value of the investor s proportionate interest in the net assets of the mutual fund. This means that the owner of mutual fund shares can cash in or redeem his or her shares at any time. Mutual funds, therefore, are considered a liquid investment. The investor s selling (redemption) price may be higher or lower than the purchase price depending on the performance of the fund s portfolio. Mutual fund prices The method by which the purchase and redemption prices of mutual fund shares are determined is known as forward pricing. Each mutual fund computes and reports its shares NAV only after the stock markets close each day, and there is no continuous pricing of fund shares throughout the trading day. When an investor places an order to buy or sell a fund s Page 3 of 26

4 shares, the order is executed based on the NAV calculated at the end of that trading day, regardless of what time during the day the order was placed. On the other hand, if the investor were to check the price of his or her fund shares during the course of the business day, the price quoted would be the previous day s NAV because that was the last time the fund calculated and reported the value. Forward pricing is used in the mutual fund market due to the constantly changing nature of the basic product. The prices of the securities in the fund s portfolio fluctuate continuously throughout the day; in addition, the fund is taking buy orders and redemption requests throughout the day. Because of this ongoing activity, the number of shares that the fund has outstanding changes every trading day. After the close of trading, each fund must calculate its NAV. First, the fund will mark to market its portfolio, which means that it calculates the total value of securities and cash equivalents held in the portfolio based on their closing prices. From the total are subtracted any ongoing expenses, fees, and trading costs. Finally, this net amount is divided by the number of shares outstanding (based on the quantity of buy orders and redemption requests received during that day). The resulting figure is the fund s net asset value per share. These values are then distributed to the public. ETFs General An ETF is an investment vehicle that combines key features of traditional mutual funds and individual stocks. Like index mutual funds, ETFs represent diversified portfolios of securities that track specific indexes. Like stocks, they can be bought and sold (long or short) on an exchange throughout the trading day through a broker-dealer. In addition, ETFs are typically broadly diversified since they usually hold all or many of the securities within the index. In contrast to a mutual fund share, the price of an ETF share is continuously determined on a stock exchange. Consequently, the price at which investors buy and sell ETF shares may not necessarily equal the NAV of the portfolio of securities in the ETF. In addition, two investors selling the same ETF shares at different times on the same day may receive different prices for their shares, both of which may differ from the ETF s NAV. Most ETFs are passively managed, in that they seek to track a market index, before fees and expenses, and do not attempt to outperform during rising markets or to take defensive positions in declining markets. Some ETFs, however, are actively managed. These funds have a manager or team making decisions on the underlying portfolio allocation or otherwise not following a passive investment strategy. An actively managed ETF will generally have a benchmark index, but managers may change sector allocations, markettime trades or deviate from the index as part of their strategy to outperform the index. Page 4 of 26

5 ETF share creation and redemption While ETF trading occurs on a stock exchange like stocks, the process by which their shares are created is significantly different. Unless a company decides to issue more shares, the supply of shares of an individual stock trading in the marketplace is finite. When demand increases for shares of an ETF, however, authorized participants have the ability to create additional shares on demand. Through an in kind transfer mechanism, authorized participants create ETF shares in the primary market by delivering a basket of securities to the fund equal to the current holdings of the ETF. In return, they receive a large block of ETF shares (typically 50,000), which are then available for trading in the secondary market. This ETF creation and redemption process helps keep ETF supply and demand in continual balance and provides a layer of liquidity not evident by looking at trading volumes alone. This process also works in reverse. If an investor wishes to sell a large block of shares of an ETF, even if there seems to be limited liquidity in the secondary market, authorized participants can readily redeem a block of ETF shares by gathering enough shares of the ETF to form a creation unit and then exchange the creation unit for the underlying securities. ETF prices The price of an ETF share on a stock exchange is influenced by the forces of supply and demand. While imbalances in supply and demand can cause the price of an ETF share to deviate from its underlying value (i.e., the market value of the underlying instruments, also known as the Intraday Indicative Value or IIV), substantial deviations tend to be short-lived for most ETFs. Two primary features of an ETF s structure promote trading of ETF shares at a price that approximates the ETF s underlying value: portfolio transparency and the ability of authorized participants to create or redeem ETF shares at NAV at the end of each trading day. The transparency of an ETF s holdings enables investors to observe discrepancies between the ETF s share price and its underlying value during the trading day and to attempt to profit from them. ETFs contract with third parties (typically market data vendors) to calculate an estimate of an ETF s IIV using the portfolio information an ETF publishes daily. IIVs are disseminated at regular intervals during the trading day (typically every 15 to 60 seconds). If the ETF is trading at a discount to its underlying value, investors may buy ETF shares and/or sell the underlying securities. The increased demand for the ETF should raise its share price and the sales of the underlying securities should lower their share prices, narrowing the gap between the ETF and its underlying value. If the ETF is trading at a premium to its underlying value, investors may choose to sell the ETF and/or buy the underlying securities. These actions should reduce the ETF share price and/or raise the price of the underlying securities, bringing the price of the ETF and the market value of its underlying securities closer together. Page 5 of 26

6 The ability of authorized participants to create or redeem ETF shares at the end of each trading day also helps an ETF trade at market prices that approximate the underlying market value of the portfolio. When a deviation between an ETF s market price and its underlying value occurs, authorized participants may engage in trading strategies similar to those described above, but will purchase or sell creation units directly with the ETF. For example, when an ETF is trading at a premium, authorized participants may find it profitable to sell short the ETF during the day while simultaneously buying the underlying securities. At the end of the day, the authorized participant will deliver the creation basket of securities to the ETF in exchange for ETF shares that they use to cover their short sales. When an ETF is trading at a discount, authorized participants may find it profitable to buy the ETF shares and sell short the underlying securities. At the end of the day, authorized participants return ETF shares to the fund in exchange for the ETF s redemption basket of securities that they use for their short positions. These actions by authorized participants, commonly described as arbitrage opportunities, help keep the market-determined price of an ETF s shares close to its underlying value. Comparison of Mutual Funds and ETFs from an Investor s Perspective Investment in mutual funds and ETFs each carry certain advantages and disadvantages for investors. The following is a general description that outlines several main factors that influence an investor s decision to invest in a mutual fund or an ETF. Advantages of Mutual Funds Over ETFs No trading commissions In most cases, investors can invest in a no-load mutual fund without incurring a trading fee. While there may be a minimum initial investment, investors can make purchases without being charged a trading commission as they would when buying or selling a stock or ETF. Dividend reinvestment Unlike ETFs, dividends paid out by mutual funds can be automatically reinvested into the fund. This can be a significant benefit for funds that pay out regular and sizable dividends. Breakpoints and share classes With different share classes including front -load, back-load, and institutional shares, there is more flexibility in how mutual funds are purchased compared with ETFs. There are also breakpoints on fees for having a certain amount invested with one particular fund company. Fewer pricing fluctuations Since funds are priced once at the end of each trading day, price fluctuations occur less Page 6 of 26

7 frequently. With an ETF, the underlying share price may change minute to minute, and fluctuate a few percentage points throughout the day. While not a significant concern for the long-term investor, an ETF investor could lose 1-2% on a trade due to market conditions being out of the investor s control. Advantages of ETFs Over Mutual Funds ETFs can be traded like a stock Because ETFs can be traded intraday like traditional stocks and bonds, they provide an opportunity for short-term investors to bet on the direction of shorter-term market movements through the trading of a single security. For example, if a market index is experiencing a steep rise in price through the day, investors can try to take advantage of this rise by purchasing an ETF that mirrors the index, hold it for minutes or hours while the price continues to rise and then sell it at a profit before the close of business. Investors in a mutual fund that mirrors the same market index do not have this capability. Because of the way it is traded, a mutual fund does not allow short-term investors to take advantage of the daily fluctuations of its basket of securities. In addition, unlike mutual funds, ETFs can also be used for short-term trading strategies, such as short selling and trading on margin. In this way, the ETF allows investors to trade the entire market as though it were one single stock. Lower cost of ownership All mutual funds incur expenses. Generally, the expenses are deducted from income before distributions to shareholders or deducted in the calculation of NAV. Some mutual funds also charge a sales fee (a "load"), which is added to the NAV after purchasing new securities or deducted from the NAV when selling. Because of their efficient structure that tracks an index rather than pay investment managers to create a portfolio, the recurring expenses for most ETFs are very low. Most mutual funds still have internal costs well over 1%, whereas most ETF funds will have an internal expense ratio typically under 1%, with some as low as 0.30%. Tax efficiency ETFs are generally more tax-efficient than mutual funds. Mutual funds typically have capital gain payouts at year-end, due to redemptions throughout the year. ETFs minimize capital gains by doing in-kind exchanges of stock, thus shielding the fund from any need to sell stocks to meet redemptions. Therefore, such actions are not treated as a taxable event. No minimum investment With an ETF, investors are not required to invest a minimum amount into the fund. Many mutual funds require thousands of dollars as a minimum before investors can buy shares in Page 7 of 26

8 a fund. ETFs therefore have a much lower barrier to entry. Mutual Fund and ETF Markets in Russia, Singapore and Europe The Company plans to market and/or license the patented technology in Russia, Singapore and Europe. The success of their efforts depends, in part, on the degree to which their technology is received in these jurisdictions and the prospects for growth of the mutual fund and ETF markets. The following is a discussion of the mutual fund and ETF markets in Russia, Singapore and Europe. Russia Introduction The Russian mutual fund market has experienced significant growth since its inception in The popularity of mutual funds as an investment vehicle has generally tracked the overall macroeconomic situation of the country, and the mutual fund industry has benefited from strong growth in the Russian economy over the last decade. Currently, it is estimated that 50 million people in Russia accumulate savings and that half of those are willing to consider collective investments as an investment vehicle. Less than 2% of the adult population in Russia is currently a shareholder in a mutual fund. However, with one of the highest concentrations of high net worth individuals as well as a rapidly growing economy, the outlook for the collective investment and mutual fund industry in Russia appears promising. In Russia, there are two types of investment funds: mutual investment funds (MIFs) and stock investment funds. MIFs are similar to mutual funds used in other countries in that they are professionally managed collective investments that pool funds from many investors and purchase different securities and assets with the goal of meeting certain investment objectives. Investors are issued shares in the MIFs depending on the size of their investments. Among the BRIC economies, Russia has the highest annual disposable income as well as the most rapid growth in terms of US$ per capita. Types of MIFs There are three types of MIFs in Russia: open-end, interval, and closed-end. Open-end: in an open-end fund, investors can buy or sell shares at any time. The price of shares is calculated daily. The minimum amount required to form an open-end fund is 10 million rubles. Page 8 of 26

9 Interval: in an interval fund, investors can buy or sell shares only during certain periods or intervals. The interval is called at least once a year (usually 2-4 times a year) for a period of two weeks. The opening and closing dates of each interval are pre-determined. All of the terms are prescribed in the fund trust management regulations and are communicated to investors in advance. The price of shares for interval funds is calculated at the end of each month. In compliance with Russian legislation, interval fund managers can purchase certain less liquid securities, which are riskier, but that have the potential to generate higher tangible returns in the long term. The minimum amount required to form an interval fund is 15 million rubles. Closed -end: closed-end MIFs are established for a certain term (usually 1-15 years). The shares cannot be redeemed until the expiration of the term and the fund is terminated. Closed-end funds are typically created for direct investments into specific projects. This category of MIF is well-suited for passive investors that want higher returns and can tolerate more risk, as these funds are allowed to invest in securities that are often deemed less safe. The minimum amount required to form a closed-end fund is 25 million rubles. A MIF falls into one of the following categories depending on the composition and structure of the fund s assets: Equity fund, including an index fund; Money market fund; Bond fund; Mixed investment fund; Venture investment fund; Direct investment fund; Mortgage coverage fund; Fund of funds (investing in MIFs); Real estate fund; Private equity fund; Loan fund; Commodities market fund; and Hedge fund. Different types of funds have different asset composition rules and requirements. For example, hedge funds and commodities market funds can only be closed-end or interval MIFs. How MIFs in Russia operate In Russia, the Federal Service for the Financial Markets regulates MIFs. Several entities participate in the operations of a MIF. Management company: The management company manages the assets of the mutual fund. The shareholder and the management company interact on the basis of a trust management Page 9 of 26

10 agreement under which the investors transfer property to the management company. The management company is not permitted to engage in any activity beyond the management of the assets. Other responsibilities of the management company include the development and registration of the mutual fund itself and the prospectus for the investment shares, organizing the placement of investment shares to investors, redeeming investment shares according to the rules of the particular investment fund, and publishing information relating to the activities of the fund, its investment programs, information relating to balance sheet assets, and other operating activities of the fund. The management company is also responsible for concluding agreements with a specialized depository, specialized registrar, auditor, share replacement and repurchase agents and independent appraisers. Specialized depository: The specialized depository is responsible for providing custody of the securities in the MIF, keeping a record of title to the securities and other assets that belong to the MIF, transferring rights to the security to other owners when shares in the management company are sold, ensuring the transmission of information and documents from the issuers of the securities to the management company and vice versa, receiving dividends, interest and other income payable on the MIF s securities and transferring them to a separate account of the management company, and maintaining a register of holders of investment shares if the management company does not have an agreement in place with the specialized registrar. The specialized depositary is also responsible for ensuring that the investments and allocations made by the management company are compliant with applicable regulations. Specialized registrar: A special registrar is responsible for keeping a register of MIF shareholders, which includes a transaction history for each shareholder. It is further responsible for inputting all of the information relating to each shareholder s share in the MIF asset pool, and recording all purchases, exchanges, transfers and repurchases of shares. Auditor: The auditor is responsible for performing an independent appraisal of the records of the management company. The appraisal includes audits of business accounting, net asset value calculations, and the validity of performed transactions, etc. Agent: Investors can purchase shares in a MIF either through the management company or agents representing the management company. The agents may offer MIFs to investors that are managed by several different management companies. For investors, this mechanism gives them more investment options than a single management company would be able to provide. This system also allows management companies to extend their geographical reach. Independent appraiser (for closed -end and interval funds): When a MIF is managing assets such as real estate properties or unlisted securities, appraisers provide an independent assessment of the value of the assets. This provides shareholders with additional assurance that the value of their shares or their income is not understated. The involvement of several organizations in the operation of a MIF in theory allows for the minimization of infrastructural risk and also enhances public trust in MIFs as an investment vehicle. Page 10 of 26

11 Current state of the mutual fund market The Russian MIF market has grown at a tremendous rate since its inception in Currently, the total NAV of MIFs, not including qualified investors, is over $ 11 billion, down from over $20 billion at its peak in The following table provides a snapshot of the current value, number of funds, net inflow, and returns of the MIF industry as a whole as well as of for each type of MIF. NAV, total (Mil. USD)* NAV of open-funds (Mil. USD) 11, , NAV of interval funds (Mil. USD) NAV of close-end funds (Min. USD) , Number of funds, total 1,270 Number of open-end funds 443 Number of interval funds 68 Number of close-end funds 759 Net inflow, open-end funds (Mil. USD) Net inflow, open-end and interval funds (Mil. USD)* Net inflow, close-end funds (Mil. USD)* ** Deposits, total (Mil. USD) 364, Weighted deposit rate (% p/a) 5.20 Weighted return of open-end equity funds (YTD, % p/a) 7/29/ Weighted return of open-end fixed income funds (YTD, %p/a) 7/29/ Weighted return of open-end miscellaneous funds (YTD, % p/a) 7/29/ * Funds for qualified investors are not included ** As of March 2011 The Russian MIF market, as demonstrated in the figure below, is deeply fragmented, with the top 20 funds controlling approximately half of the total market share with hundreds of other funds having a market share each well below 1%. Trends in the Russian MIF market As shown in the graph below, the total NAV of MIFs in Russia has grown at a very strong rate. Total NAV stood at $330 million in 2001, $16 billion in 2006, $20 billion at its peak in 2008 and this figure currently stands at more than $11 billion. Over the last five years alone, NAV grew approximately 76% despite the market crash in The number of funds increased from 51 in 2001 to 600 in 2006 and finally to 1,270 in Page 11 of 26

12 Figure 2: Total net asset value of Russian MIFs Despite this impressive growth, the industry in Russia is still at the very early stages of development. In the United States, approximately 50% of families invested in mutual funds in 2006 compared to 6% in In Russia, less than 1% of families had invested in MIFs as of the end of Total assets under management in MIFs in Russia are still below 1% of GDP compared to approximately 90% of GDP in Australia and 70% of GDP in the United States. Moreover, open-end funds represent only 35% of the total number of funds and only 26.5% of the overall NAV of MIFs in Russia. Given this relatively low level of participation by investors in MIFs, there is opportunity for tremendous growth of the MIF market in Russia in the future. The market composition of MIFs over the last several years has changed quite significantly. The share of open-end funds has declined while the capital inflow into closed-end funds has increased. The main advantage of closed-end funds is that management companies of these funds are allowed to invest in higher risk and often-illiquid assets that potentially can generate significantly higher returns. Real estate funds alone have 140 billion rubles worth of assets under management, which is almost half of the total assets under management in MIFs in Russia. Another growing category of MIF that is limited to closed-end funds is venture investment funds. Assets under management for venture investment funds increased by 112% in 2008 to approximately 26.8 billion rubles; however, due to the market crash in the same year, this figure fell to 4.7 billion rubles by the beginning of The current segmentation of funds according to fund type is shown in the following chart. Page 12 of 26

13 Among open-end funds, equity funds are the most popular investment choice followed by mixed investment funds and bond funds, respectively. It is worth noting that a third of all new mutual funds are industry specific funds. Due to the lower income generated from index funds or broader market funds, management companies have sought alternative ways to attract investors. While industry specific funds are generally more risky than index or market funds, they also typically generate higher returns. Prospects for development of the mutual fund industry Growth in the overall stock market, competition between different mechanisms of distribution and marketing of MIF shares, and a development of an exchange infrastructure for MIFs are all prerequisites for increasing growth in the MIF market. Both the Russian economy and the stock market have grown at a significant rate over the past decade and these growth rates are expected to continue in the coming years. The BRIC equity markets have far outperformed their counterparts from more developed markets and among the BRICs, Russia s equity markets have shown the most growth, up 15% over the first three months of Page 13 of 26

14 Figure 4: Global equity performance ETF market and outlook Actively managed ETFs have slowly begun to become more prominent in more developed exchanges like the NYSE. As of February 2011, actively managed ETFs in the US had $1.2 billion in assets under management according to figures from BlackRock. Actively managed ETFs are not yet available in the Russian markets, however. Although there are a number of ETFs focused on Russian equities, a majority of them are traded on much more developed exchanges like the NYSE. Troika Dialog launched one of the first passively managed ETFs in 2010, which trades on the RTS and had a NAV of 212 million rubles as of October Although ETFs are only in the nascent stage for Russian investors, Troika reports strong interest in these products. Additionally, Russian equity markets are generating significant inflow from foreign investors investing in Russia-focused ETFs on stock exchanges outside of Russia. An exchange infrastructure in Russia to buy and sell MIF shares could tremendously increase the inflow of assets into mutual funds. While providing the same liquidity and transparency that an ETF would, a system for selling mutual fund shares on Russian exchanges could encourage much more trading activity of mutual funds than is currently possible. With good prospects for growth in the equity markets, a fast growing economy, and increasing investor sophistication, the outlook for the MIF market in Russia is positive Page 14 of 26

15 Singapore Introduction The global financial crisis of 2008 paved the way for a golden age in Asia in the fund management industry. According to a report released by Strategic Insight in 2009, Asia is now considered by many investors to be a more stable market than Europe, gathering $1 trillion in long term inflows since 2005 as opposed to $430 billion gathered by Europe in the same period. As a result of slower economic growth and growing debt problems in Europe, as well as higher volatility of Western stock markets, a significant amount of international capital is being diverted to Asian markets, with Singapore at the epicenter of this investment activity. A financial hub in the Asia -Pacific region, Singapore has a very developed asset management industry. Aggressive government policy, incentives such as tax breaks and a simplified regulatory framework designed to spur growth in the fund management industry, transparency, and a strong financial infrastructure have made Singapore an attractive destination for asset managers and investors. Assets under management in Singapore reached a new high of $1.13 trillion as of the end of 2010, recording average growth of 16% over the previous five years. The Singapore economy continues its strong growth with real GDP projected to grow at approximately 4.5% in 2011 and Because Singapore is a major financial center in the Asia-Pacific region, the health of its fund management industry is closely correlated to the economic health of the overall region. Over 80% of the assets under management in Singapore were from international sources and 60% of the total assets were invested in the Asia-Pacific region as of Successful companies that is unable to obtain a stock market listing in their home countries because of an underdeveloped corporate legal framework often transfer their shares into an offshore vehicle and list the offshore vehicle s shares on a foreign stock exchange. The Singapore Exchange is one of only four exchanges that list shares of such offshore vehicles. The strong economic recovery in Asia following the financial crisis in 2008 has helped the Singapore fund management industry to recover relatively quickly from the slight downturn it experienced in According to the World Wealth Report 2010 compiled by Capgemini for Merrill Lynch, the number of millionaires in the Asia-Pacific region surpassed Europe s for the first time in Household net wealth in Singapore grew from 666,009 million SGD to 1,089,699 million SGD in 2009, representing a CAGR of 8.6%. Financial assets over the same period grew at a CAGR of 7.7%. Mutual fund assets in Asia s six key markets rose to $1 trillion in 2009, boosted by strong market performance, and are expected to continue their growth trajectory to Mutual fund operations Retail funds in Singapore can be classified into open-end retail funds or closed-end funds. The open-end retail funds market in Singapore is well developed. These funds are offered as collective investment schemes (CISs) for investment by the public (Singapore retail investors). A closed-end fund is defined by the Monetary Authority of Singapore (MAS) as a collective Page 15 of 26

16 investment scheme under which units issued are exclusively or primarily non-redeemable at the option of the investor. As long as redemption is allowed during the life of a fund rather than only on its maturity date, the fund will generally be classified as open-end. Certain closed- end funds formed as entities or trusts are specifically excluded from the CIS definition, and are funds that both invest in real estate and real estate-related assets and are listed on the Singapore Stock Exchange. There are no known closed-end retail funds offered in Singapore. Fund managers typically offer shares in closed - end funds to accredited investors or institutional investors through a private placement. Foreign funds constitute a third type of fund in Singapore. A foreign retail fund is not subject to the investment guidelines set out in the CIS code. However, the MAS will only recognize a foreign retail fund if it is subject to investment guidelines in its home jurisdiction that are substantially similar to those of Singapore. Marketing: An open-end retail fund can be marketed by an offeror that holds a capital markets services (CMS) license for fund management (or is exempted from holding a CMS license) or a distributor licensed under the Financial Advisers Act as a financial adviser. Open -end funds can be marketed to any Singapore retail investor, subject only to prospectus filing requirements. A distributor with a CMS license for dealing in securities can market closed-end funds. Managers and operators: For a CIS constituted in Singapore, the manager must hold a CMS license for fund management and be considered fit and proper for the role by the MAS. The MAS must approve a trustee for a CIS if the CIS is constituted as a trust (which is invariably the market practice in Singapore). The trustee should be independent of the manager and must conduct all transactions with or for a CIS at arm's length. The trustee has certain operational requirements, including that it must: 1) inform the MAS of any breach of the CIS financial requirement and criteria set out by the Securities and Futures Act and the MAS; 2) send to participants certain semi-annual and annual reports; and 3) submit to the MAS a statement within two weeks of the termination or maturity of the CIS. For a CIS constituted outside of Singapore, the laws and practices of that jurisdiction must afford investors in Singapore protection at least equivalent to that provided by the Singapore laws and regulations. The MAS would consider, for example, whether there is: 1) a legal requirement for the manager to manage the CIS in the interest of investors; 2) independent adequate safekeeping of the assets of the CIS; and 3) an independent party which exercises oversight over the manager, such as an independent trustee in the case of a unit trust or independent directors in the case of a mutual fund company. Reporting requirements: the manager is required to prepare certain information for openend fund investors. This includes semi-annual financial statements and audited financial statements for the semi-annual report and the annual report. The manager must also prepare quarterly reports. The semi-annual report and annual report, based on a CIS s financial year, contain a large amount of information. Some of the information these reports contain includes: Investments at market value and as a percentage of NAV as at the end of the period Page 16 of 26

17 under review classified by country, industry and asset class; The top ten holdings at market value and as a percentage of NAV as at the end of the period under review and a year ago; The performance of the CIS and where applicable, the performance of the benchmark, in a consistent format, covering the following periods of time: three months, six months, one year, three years, five years and ten years since inception of the CIS; and Any material information that will adversely affect the valuation of the CIS such as contingent liabilities of open contracts. Current state of the mutual fund market The Singapore mutual fund market is one of the most well developed fund markets in the world. In a Morningstar report release in early 2011, Singapore and the US markets were covaledictorians, earning an A grade on a report card that measured the overall experience of mutual fund investors based on a variety of factors including taxation, transparency and investor protection. The current assets under management (AUM) in Singapore reached a new high of $ 1.13 trillion in 2010, up 13% from the previous year and recording a 16% growth average over five years. The total CIS AUM amounted to $25.77 billion at the end of 2009, an increase of 35% from Although the fund industry is quite developed, it is still in its early growth stage. The current mutual fund penetration rate in Singapore is only 15%, about a quarter of the US market, which has a penetration rate of 60%. The CIS AUM is only 14% of GDP while the same ratio is 70% of GDP for the US and 90% of GDP for Australia. There are currently 51 fund management companies and 364 funds authorized as a CIS. Most of the top global asset management companies already have a presence in Singapore and these asset managers mainly manage equity and fixed income portfolios. The 20 largest asset management companies account for approximately 42% of the total AUM in Singapore. Trends in the Singapore fund industry Growth of funds/aum: The AUM of CIS s has increased from S$19.8 billion in 2005 to reach S$31 billion in 2009, a CAGR of 9.38% over five years. The number of funds has largely remained the same 379 in 2004 and 364 in The asset allocation of the funds has not deviated substantially either, with equities being the dominant asset class and Asia-Pacific the dominant geographical region for investment. Asset allocation: Equity is the dominant asset class for funds managed in Singapore and this trend is likely to continue. Investment into equity funds experienced its highest year over year growth in 2009, with a 72% increase. Asian exposure: In terms of geographical allocation, Asia-Pacific markets accounted for 77% of CIS investments in 2010, compared to 71% in 2009, reflecting continued robust interest in Page 17 of 26

18 the region. According to the latest report of Cerulli Associates, mutual fund assets in the six key Asian markets (Singapore included) are expected to grow at a CAGR of 14% between 2010 and Figure 5: Investment of CIS by Region According to PwC s See the Future report, Singapore is predicted to be the premier destination for asset management in the future due to its advanced financial infrastructure, tax policies, regulatory environment, transparency and human capital. The following graphs depict the growth trajectory of the Singapore mutual fund market and Singapore s projected growth as an asset management center, respectively. Figure 6: Projected growth of mutual funds Figure 7: Future asset mgmt. clusters According to Peter Ong, Permanent Secretary for Finance at IMAS, there are several trends that will continue to drive the fund management industry in Asia and Singapore, including Page 18 of 26

19 strong economic growth in Asia, wealth accumulation as a result of such growth, and demographic trends that will generate demand for retirement planning. Further, as investors become increasingly savvy and more aware of risks, they are demanding greater transparency from their fund managers and are placing greater focus on the managers abilities to manage risks, particularly counter-party credit risk and liquidity risk. Tighter global regulations in the financial markets are also expected in the future. Based on its track record, the Singaporean fund industry is well positioned to capitalize on the growth of the Asian economies and adapting to the challenges of the investment environment in the future. Future development Although Singapore s fund market is one of the most developed financial markets in the world, the Singapore government is constantly implementing new measures and revising regulations to adapt to the ever-changing global financial atmosphere. The Singapore government is taking a number of steps to support the asset management industry s longterm development. First, it is making efforts to build up the talent pool in the financial industry with initiatives such as the Financial Training Scheme, which co-funds training costs for industry professionals to pursue recognized accreditation programs such as CAIA and other technical training. Second, the MAS is continually reviewing the regulatory framework to ensure that it is relevant and implementing necessary revisions. Third, it is enhancing its financial research capabilities. Finally, Singapore has been actively involved in various regional projects and initiatives including efforts to link regional stock exchanges and develop bond markets and work with the World Bank to promote public-private partnerships. ETF market and outlook ETFs have grown at a fast pace in Singapore over the past decade, growing from just 13 ETFs listed on the Singapore Exchange in 2001 to 84 ETFs listed currently. The average volume of ETF trades is currently 68.2 million per month and the average turnover per month is S$845.5 million. ETFs offer investors a way to invest into a fund at a lower liquidity risk than a traditional mutual fund. They also offer more transparency and lower fees. Innovative ETFs such as actively managed ETFs are increasing in global financial markets, with this category of funds expected to continue to grow. Traditional mutual funds compete directly with ETFs for the investor s money. A mechanism to buy and sell mutual fund shares on the exchange would allow traditional mutual funds to offer their services to a wider audience as well as reduce the liquidity risks associated with them. The future of the Singapore fund management industry overall is a very promising one because of its pro-business environment, excellent infrastructure, cost-competitiveness, a highly skilled and cosmopolitan labor force, proactive government and a strategic location in a region of increasing growth. Europe Page 19 of 26

20 Introduction The mutual fund industry in Europe has experienced significant growth in the past decade. At the end of 2001, the European mutual fund industry stood at $4.2 trillion in assets under management. By the end of the first quarter of 2011, this figure has grown to almost $8trillion. Growth in the industry has come largely from new products, as approximately 43% of assets (or $3.5 trillion) are currently managed in funds launched in the past nine years. The European mutual fund industry has its own framework that differs from other countries. In 1985 the European Union adopted a set of directives known as the Undertakings for Collective Investment in Transferable Securities (UCITS). The aim of the directives was to establish investor protection through strict investment limits, capital and disclosure requirements and independent oversight procedures. The directives also allow a UCITS to operate under a passport system, whereby it can be offered for sale throughout the EU once it has been authorized in one member state. The number of new UCITS that are launched continues to grow at a fast pace across Europe. Since the initial UCITS initiative, many amendments have been implemented, leading ultimately to the UCITS IV regulations approved by the European Parliament and implemented as of July UCITS IV aims to make the investment fund market in the EU less fragmented and improve its efficiency by removing the administrative barriers to the cross-border distribution of UCITs and creating a framework for mergers between UCITS funds. Management company passport A UCITS fund management company must be authorized by the home member state of the management company. Once permission has been granted to the management company to carry out its activities, those activities can be carried out for funds domiciled in any member state. The management company must comply with the rules of the UCITS home member state relating to: the establishment and authorization of UCITS; the issuance and redemption of units and shares; investment policies and limits, including the calculation of total exposure and leverage; restrictions on borrowing, lending and uncovered sales; the valuation of assets and the accounting of UCITS; the calculation of the issue price and/or the redemption price, and rules regarding errors in the calculation of the net asset value and the related investor compensation; the distribution or reinvestment of the income; the disclosure and reporting requirements of UCITS, including the prospectus, the key investor information and the periodic reports; the arrangements made for marketing; the relationship with unit holders; Page 20 of 26

21 the merging and restructuring of UCITS; the content of the unit-holder register; the licensing and supervision fees regarding the UCITS; and the exercise of unit holders voting rights and other unit holders rights in general. Types of UCITS funds Money market funds invest in money market instruments (e.g. short-term debt instruments and time deposits), the prices of which are less at risk from price fluctuations and which generally have high ratings. They generally carry lower risks than other types of investment funds. They pay returns that largely reflect short-term interest rates, which tend to be higher than the interest offered by bank savings accounts. Bond funds invest primarily in fixed-interest securities (e.g. bonds and other types of debt securities). Depending on its investment objective a bond fund may concentrate on a particular type of bond such as government bonds, corporate bonds, convertible or zerocoupon bonds. Bond funds typically pay higher returns than money market funds and usually carry lower risks than equity funds. Equity funds invest in the shares of companies listed on public stock exchanges or traded on other regulated markets. Equity funds can invest in a very wide spectrum of assets, and are usually distinguished from one another on the basis of four characteristics: company size, investment style, geographic region and sector. A fund can also generate income from dividends received from the companies in which the fund invests. Equity funds can be actively managed through stock selection and asset allocation or designed to track a specific stock market index. Balanced (mixed) funds invest in a selection of equities, bonds and other fixed-income instruments. Mixed funds or balanced funds aim to deliver good growth and income while reducing risk. As a rule, the ratio of equities to fixed income will drive the degree of growth to be expected of the fund. The higher the equity component of a mixed fund, the greater the potential for higher returns it offers, but, likewise, the greater the risk. Exchange Traded Funds (ETFs) typically track the movements of a particular index or a selected basket of assets. Because ETFs are traded on stock exchanges in the same way as shares, their price constantly fluctuates during a given day. Investors can buy and sell shares in an ETF during trading hours on the stock exchanges where they are listed. There are also actively managed ETFs that are listed on stock exchanges. Maturity funds are designed to mature at a specified time and therefore have a fixed end date. Maturity funds can invest either in other investment funds or directly in assets such as bonds. The securities will be sold or, in the case of bonds, will have matured by the specified target date at the latest. The proceeds will then be paid out to the investor. Guaranteed funds and capital protection funds aim to ensure that the whole or a certain proportion (for instance 90%) of the investor s original investment is returned at the end of a pre -defined investment period. Guaranteed and capital protection funds sometimes rely on Page 21 of 26

22 the use of complex financial mechanisms to achieve their goals. Funds of funds offer a way of increasing diversification and a way of gaining access to a wider range of fund management skills and specialization through a single investment. Rather than investing directly in financial assets like shares and bonds, funds of funds buy shares in other investment funds. These can be different funds that cover the same sector, or funds offering a wide range of asset types, regions and markets. Asset allocation funds are funds whose investment strategy is driven by broader decisions on the relative performance of different types of assets, such as fixed income securities as opposed to shares. The investment fund s allocation to different assets may vary by sector, country, region or other considerations. Page 22 of 26

23 Mechanism of UCITS operations The figure below captures the relationship between the main entities involved in the regulation and management of a UCITS in Europe. Figure 8: The UCITS landscape under UCITS IV 1) The supervisory authority of UCITS host member state authorizes the management company. 2) The supervisory authority of the UCITS home member state receives attestation from the supervisory authorities of UCITS host member state that the management company has been authorized. Page 23 of 26

24 3) The supervisory authority of the UCITS home member state authorizes the UCITS. 4) The management company provides investment management, administration and marketing services to the UCITS. These services may in turn be outsourced to 3rd parties. 5) The UCITS may be distributed (passported) into any EU member state, including the management company home member state. If a UCITS wants to distribute into another member state then it needs to notify its home supervisory authority that in turn will notify the supervisory of the host member state. 6) The depositary acts independently and in the interest of shareholders to safeguard the fund s assets. Master-feeder structure As defined by the UCITS IV directive, a feeder fund is a fund approved to invest at least 85% of its assets in another UCITS. The remainder of the assets may be invested in cash, derivatives or property for its own use. A master fund is a fund that must have a feeder as a unit-holder, cannot be a feeder, and does not hold units of a feeder fund. Master-feeder structures were introduced by the UCITS IV directive and enable strategies relating to pooling funds assets and achieving economies of scale. In a master-feeder structure, the feeder is the collection fund in the target distribution country in which retail and/or institutional investors may be allowed to invest. The feeder invests the cash received from its own investors in the master, becoming its unit-holder. UCITS masterfeeder structures are only allowed between European-domiciled coordinated UCITS, meaning that both the feeder and the master must be subject to the UCITS directive. At the level of the master UCITS, besides the feeder s investment, other investors could be present such as institutional or retail investors, other funds of funds, and even other feeders. If both the master and feeder funds have different depositories and auditors, then those entities must enter into an information sharing agreement. Current state of the market Currently, the European countries with the highest levels of direct ownership by individuals in investment funds are Germany, Sweden and Belgium. German individual investors own 11.9% of the total assets in its investment funds, Swedish individual investors own 11.6% and Belgian individual investors own 10.9%. The average for European countries is 8.1%. UCITS NAV, total (Trillion USD) (2011) 7.8 Number of funds, total (2010) 62,812 Net inflow into UCITS (Million USD) (2010) According to the European Fund and Asset Management Association (EFAMA), Europe had net inflows into UCITS during 2010 totaling $227 billion, or 3% of total UCITS net assets. This figure takes into account the outflows experienced by Italy, Spain and France of over $180 billion due primarily to large outflows from money market funds. UCITS domiciled in Luxembourg, Ireland and the United Kingdom alone attracted inflows amounting to $368 Page 24 of 26