Mutual Funds and Other Investment Companies Hedge Funds

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1 Mutual Funds and Other Investment Companies Hedge Funds Chapter 4 & 26 McGraw-Hill/Irwin Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Lecture outline Introduction of investment companies and funds Fund fees Mutual funds Hedge funds Funds in Vietnam 4-2 Investment companies Collecting funds from individuals Investing in a big portfolio How it works Investment company forms portfolio Sells investors shares in the portfolio investors have claim to the portfolio, proportional to their number of shares 4-3

Lecture outline Introduction of investment companies and funds Fund fees Mutual funds Hedge funds Funds in Vietnam 4-2 Investment

2 Services of Investment Companies Administration & record keeping Diversification & divisibility Professional management Reduced transaction costs 4-4 Net Asset Value Used as a basis for valuation of investment company shares. Selling new shares Redeeming existing shares Calculation Market Value of Assets - Liabilities Shares Outstanding 4-5 Types of Investment Organizations Unit Trusts: pool of money invested in portfolio; its portfolio is fixed, unmanaged. Fixed portfolio for the life of the fund unmanaged. Brokerage firm buys and forms portfolio Sells shares in that trust called units or redeemable trust certificates All money from portfolio is distributed to share holders by trustee, i.e. company which manages portfolio 4-6

Selling new shares Redeeming existing shares Calculation Market Value of Assets - Liabilities Shares Outstanding 4-5 Types of Investment Organizations Unit Trusts: pool of money

3 Types of Investment Organizations Managed Investment Companies Portfolio is managed Board of directors, elected by shareholders, hires management company for fee of 0.2 to 1.5% of assets value Open-End (or mutual funds) vs Closed-End 4-7 Open-End and Closed- End Funds: Key Differences Open-End (called mutual funds) Open-end: shares redeemed, new shares issued at NAV; shares outstanding change when new shares are issued or old shares are redeemed Priced at Net Asset Value(NAV) 4-8 Open-End and Closed- End Funds: Key Differences Closed-End Not redeemed, no new share issue No change in shares outstanding Shares traded on organized exchanges and can be sold and bought at market price (unlike open-end mutual funds shares) May be priced at Premium or discount to NAV 4-9

NAV; shares outstanding change when new shares are issued or old shares are redeemed Priced at Net Asset Value(NAV) 4-8 Open-End and Closed- End Funds: Key Differences Closed-End Not redeemed,

4 4-10 Open-End and Closed- End Funds: Key Differences Shares Outstanding Closed-end: no change unless new stock is offered. Open-end: changes when new shares are sold or old shares are redeemed. Pricing Open-end: Net Asset Value(NAV) Closed-end: Premium or discount to NAV 4-11 Other investment organizations Commingled funds (partnership of investors pooling their funds together) REITs (similar to closed end funds investing in real estate market) Hedge funds 4-12

Pricing Open-end: Net Asset Value(NAV) Closed-end: Premium or discount to NAV 4-11 Other investment organizations

5 Hedge funds Like mutual funds but private partnership so under minimal SEC regulation can make heavy use of risky, profitable assets very often initial lock-ups 4-13 Mutual fund - Investment Policies Money Market Fixed Income Equity Balance & Income Asset Allocation Indexed Specialized Sector

initial lock-ups 4-13 Mutual fund - Investment Policies Money Market Fixed

6 How funds are sold Direct-marketed funds; mails, phone, internet etc. Sales force distributed: brokers, advisers on commission Revenue sharing on sales force Potential conflicts of interest Financial Supermarkets; sell shares of many funds 4-16 Costs of Investing in Mutual Funds Fee Structure Front-end load: when you buy a share Back-end load: when you redeem a share Operating expenses: cost of operating portfolio, inc. administration and advisory cost 12 b-1 charges distribution costs paid by the fund (authorized by SEC, up to 1% of average NAV per year) Alternative to a load Fees and performance Rate of return = change in NAV (%) + income distributions (%) 4-17 Example of fees Class A Class B Class C Front end % 0 0 Back end 0 0-4% 0 1% 12b % 1% 1% Expense 1.25% 1.25% 1.25% 4-18

Mutual Funds Fee Structure Front-end load: when you buy a share Back-end load: when you redeem a share Operating expenses: cost of operating portfolio, inc.

7 Class example Initial NAV = $20 Income distributions of $.15 Capital gain distributions of $.05 Ending NAV = $20.10 $ $ $.15 + $.05 Rate of Return = = 1.5% $ Impacts of costs on investment performance 4-20 Exchange Traded Funds Allow investors to trade funds based on indexes like stock. Traded continuously during the day Can be sold short or traded on margin Prices can depart from NAV. Examples SPDRS WEBS HOLDERS Allow sector specialization 4-21

00 4-19 Impacts of costs on investment performance 4-20 Exchange Traded Funds Allow investors to trade funds based on

8 A First Look at Fund Performance Benchmark: Wilshire 5000 Results Most funds underperform Not fair comparison because of costs Adjusted Benchmark: Wilshire 5000 with passive management costs considered. The majority of funds still under-perform Consistency of Fund Performance Do some mutual funds consistently outperform? Evidence suggests that some funds show consistent stronger performance. Depends on measurement interval Depends on time period Evidence shows consistent poor performance. 4-24

4-22 4-23 Consistency of Fund Performance Do some mutual funds consistently outperform?

9 Sources of Information on Mutual Funds Wiesenberger s Investment Companies Morningstar Investment Company Institute Popular press Investment services 4-25 Hedge funds 4-26 Main investment strategies of hedge funds Long/short equity Global macro and emerging markets Event driven Mergers Distressed securities Relative value strategies Convertible arbitrage Fixed income arbitrage Equity market neutral 4-27

of hedge funds Long/short equity Global macro and emerging markets Event driven Mergers Distressed

10 Hedge funds 4-28 Hedge funds vs. mutual funds during market contractions 4-29 Sources of returns of mutual funds and hedge funds 4-30

11 Average yearly performance of FOFs vs. hedge funds 4-31 Funds in Vietnam Mixed FTSE Vietnam Index ETF PXP Vietnam Fund Vietnam Dragon Fund Vietnam emerging market fund Vietnam Equity holding Vietnam Lotus fund VinaCapital Vietnam Opportunity Fund Fixed income Dragon capital Vietnam Debt fund A and B class VinaCapital Vietnam Fixed Income fund 4-32 Funds in Vietnam (cont) Local (about 46 local IFs) Manulife Progressive Fund Prudential balanced Fund VF1 Vietnam securities VF4 Vietnam bluechips Fund Private equity Mekong Enterprise Fund PCA Vietnam Vietnam resource investments Property JSM Indochina Vietnam Property Fund VinaLand Limited 4-33

Lotus fund VinaCapital Vietnam Opportunity Fund Fixed income Dragon capital Vietnam Debt fund A and B class VinaCapital Vietnam Fixed Income fund 4-32 Funds in

12 A case study: Mekong Enterprise Fund II Percent Ownership Minimum and Maximum Investment Size Stage of Development Regional focus Corporate Governance and Transparency Fund's Policies and Restrictions Dividend Policy Exit strategy Fund's Representation on Board of Directors 4-34 Case cont. The investment process Initial Meeting Appraisal Agreement in principle Investment Committee Approval Audited Financial Statements Implementation Completion 4-35 VFMVF1 4-36

Fund's Representation on Board of Directors 4-34 Case cont.

13 VFMVF Funds in Vietnam 4-38

Mutual Funds and Other Investment Companies. Chapter 4

Mutual Funds and Other Investment Companies Chapter 4 Investment Companies financial intermediaries that collect funds from individual investors and invest in a portfolio of assets shares = claims to portfolio