Goals. Investment Companies. History. Closed versus Open Funds

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1 Goals Investment Companies Economics 71a: Spring 2007 Mayo 17, Malkiel 8 Lecture 4.8 History Closed and open funds Performance and fees Types of funds Index funds ETF s Hedge funds How well do funds perform? History First funds, March 1924 State Street Research Massachusetts Investment Trust Massachusetts Financial Services now owned by Sun Life of Canada Boston is key location Growth Recently phenomenal Increase in total capital between times since 1980 Number of funds has also exploded 1980 = 468 funds in U.S 1997 = 5,765 Today around 10,000 Closed versus Open Funds Closed end fund Traded like regular stock (price) Fixed number of shares Basically a corporation whose only assets are its portfolio Open end fund New shares issued for each buyer Valued at current market value of the fund portfolio Net asset value (NAV) 1

History First funds, March 1924 State Street Research Massachusetts Investment Trust Massachusetts Financial Services now owned by Sun Life of Canada Boston is key location Growth Recently phenomenal

2 Net Asset Value (NAV) Total net worth of fund Assets - Liabilities Assets: Stocks, bonds Liabilities: Borrowing NAV/share More on Closed versus Open Most funds are Open-End Closed-end funds occasional trade differently from their asset values (NAV) P<NAV, or P>NAV Performance (open end) (Reported numbers often exclude fees.) NAV = Net asset value I, CG = Income + Capital gain distributions Rt +1 = NAV t +1! NAV t + CG t +1 + I t +1! Fees NAVt R t+1 = Value change + Capital gain yield + Income yield - Fees Performance (closed end) P = Market price I, CG = Income + Capital gain distributions Rt +1 = P t +1! P t + CG t +1 + I t +1! Fees Pt R t+1 = Price change + Capital gain yield + Income yield - Fees 2

) NAV = Net asset value I, CG = Income + Capital gain distributions Rt +1 = NAV t +1! NAV t + CG t +1 + I t +1!

3 Costs and Fees Loading fees (paid at start, 3-6 percent) 12b-1 fees (sales expenses) Continue over years Management fees Paid to investment advisor Between 0.25 and 1.5% Fund expenses (legal, admin) Trading costs Benefits Diversification Stock selection skills Bookkeeping Stocks Bonds Money Market Types of Funds Stock Funds Index (see next slide) Growth Value Sector Market neutral Green and socially responsible funds International Country Emerging markets 3

5% Fund expenses (legal, admin) Trading costs Benefits Diversification Stock selection skills Bookkeeping Stocks

4 Index Mutual Funds Designed to match (but not beat) the market Examples Track S&P 500 Country funds Why? Market efficiency Cost Other Index Instruments Exchange Traded Funds (ETF) Traded on regular exchanges Can be short sold Types Standard and Poors Depository Receipts (SPDRS) World Equity Benchmarks (WEBS) Diamonds (Dow) Qubes (NASDAQ) (QQQ) Growing fast More ETF Info (See Economist) Expanding into new areas Gold Nanotechnology Ultrashort QQQ Goes down 2% when NASDAQ up 1% Advantages Easy to trade long or short indices Disadvantages May encourage short run trading Liquidity for some may be low Hedge Funds Small numbers of large investors (> $1.5 million) Not SEC regulated (registered) More flexible in strategies May hold derivatives Short sales Leveraged (borrowing) Performance based fees 2% of total assets and then 20% of profits (2 and 20) Limit withdrawals 4

(WEBS) Diamonds (Dow) Qubes (NASDAQ) (QQQ) Growing fast More ETF Info (See Economist) Expanding into new areas Gold Nanotechnology Ultrashort QQQ Goes down 2% when NASDAQ up 1% Advantages Easy to

5 Other Managed Funds Funds of hedge funds Pension funds Insurance companies Endowments/foundations Mutual Fund Performance Malkiel Chapter 8 Good data experiment Do mutual funds out perform the rest of the market? Mutual Funds vs. Market 10 years ending December 31, 2001 S&P 500: % per year Stock mutual funds: % Rankings: 70 s -> 90 s Twentieth century growth 1 -> 176 Templeton growth 2 -> 126 More on rankings Average return in 70 s Top 20 funds in 70 s +19% All funds +10.4% Average return in the 80 s Top 20 funds in the 70 s 11.1% All funds 11.7% 5

Market 10 years ending December 31, 2001 S&P 500: +12.94 % per year Stock mutual funds: +10.

6 More on rankings Average return in 80 s Top 20 funds in 80 s +18% S&P +14% Average return in the 90 s Top 20 funds in the 80 s 13.7% S&P 14.9% The Problem of Size and Success for Mutual Funds As funds get bigger size gets in the way Difficult to buy stocks 50 stock fund 1 billion in assets Control <5% in each stock Universe = stock fund 20 billion in assets <5% in each stock Universe = 182 Transaction costs and price impact Gurus: Luck Versus Chance Appear to be some people who do well consistently Peter Lynch: Michael Jordan of mutual funds (retired ahead) Generates consistent performance Is he smart or lucky? Statistically, we should see some people do well for long periods of time do to chance Survivorship Bias Summary Mutual funds are convenient way to diversify portfolios Index funds are a powerful tool Performance of the industry in general is not great 6

stock fund 20 billion in assets <5% in each stock Universe = 182 Transaction costs and price impact Gurus: Luck Versus Chance Appear to be some people who do well consistently Peter Lynch: Michael

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