Transcript Evaluating Portfolio Performance

PROFESSIONAL ASSET
MANAGEMENT
1
Basic Categories
Private Management: Clients each have a separate
account {popular with institutions}
Investor 1
Account 1
$
$
Asset manager
Investor 2
$
$
Account 2
Account
2
Basic Categories
Investment Companies: Sell shares of the fund and
invest the proceeds in a portfolio of stocks, bonds, or
other assets
Fund Shares
Investor 1
$
$$
Asset manager
Fund
Portfolio
$
Investor 2
Fund Shares
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Professional Asset Management
vs. Individuals
1.
2.
3.
4.
Diversification
Record Keeping
Professional Management
Lower Transaction Costs
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Net Asset Value

T otalMarketValue of Portfolio  Fund Expenses
NAV 
T otalFund Shares Outstanding
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 = $11.24 / share
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Traditional Closed End Funds
 Shares of the fund trade like stock on an exchange
 Fund does not usually offer additional shares or repurchase
shares
 Fund is actively managed
 Market price is NOT NECESSARILY EQUAL to NAV
 Premium or discount reflects investors’ opinions of manager’s
ability to select good investments in future
 Poor history of long-run returns
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Open-End Funds
(Mutual Funds)
 Fund manager is always willing to buy back (redeem)
shares or sell additional shares at the NAV.
 Shares may not be bought from or sold to anyone
except the Fund.
 Shares of the fund are always valued at NAV
(calculated at the end of each day).
 Total number of shares outstanding will change as fund
sells/buys shares.
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Loads: Sales Charge
• Front End: Paid when shares are purchased.
• 3% of NAV is typical
• Back End: Paid when shares are redeemed
• 5-10% fee on sale. Typically drops by 1% every year.
 No-Load: No sales charge.
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12b-1 Fees
An alternative to a load to cover advertising & marketing
expenses. Can be found in both loaded and no-load funds
 Can deduct as much as .75% of assets annually to cover
fund advertising & marketing.
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Records Fees
 Funds can charge as much as .25% of
assets annually for records fees.
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Management Fees
 Range is typically .20% to 1.00%.
 Does not include trading commissions
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Expense Ratio
Expense Ratio =
Annual Expenses/$ Amt of Fund Assets
Annual Expenses are:
Management fees, 12b-1 fees, records fees
(NOT front or back-end loads and not trading commissions)
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Expense Ratio
 Studies find that funds with lower
expense ratios earn higher (net) returns
than those with higher expense ratios.
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Turnover & Taxes
 Turnover: Fraction of portfolio replaced each year.
 Studies indicate that funds with a lower turnover achieve
higher returns
 Mutual funds have pass-through-status which means
that taxes are paid only by the investor, not the mutual
fund.
 Investors can be taxed on gains they never received
 Not an issue if in a tax-deferred retirement account
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Performance
 Many Studies find active managers (on average)
underperform benchmarks after costs and fees by about
1% per year.
 Good performance is associated with low expense ratio.
 Very low correlation between top funds one year and top
funds the next year.
 Some positive correlation between bottom funds one year
and bottom funds the next year.
 Investors tend to put more money in funds that have
recently done well
 Investors in mutual funds tend to overweight growth stocks
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ETFs
 Exchange Traded Funds
 Close-end index funds
 Indexes for every sector, region and style
 Most trade on AMEX
 Low expense ratios
 Trade like stocks
 Can be shorted
 Can be purchased on margin
 More transparent than mutual funds
 Trade very close to NAV
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Hedge Funds
 Similar to Mutual Funds
 Lightly Regulated
 Only open to “Accredited” Investors
 Only recently allowed to advertise
 No secondary market
 Not regularly marked-to-market due to illiquid
investments
 Can be highly leveraged
 Often require a lockup period for investors
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Common Hedge Fund
Investment Strategies
 Long/Short – Market Neutral
 Convertible Arbitrage
 Merger Arbitrage
 Statistical Arbitrage
 Distressed Companies
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Compensation Structure
 Management Fee similar to mutual funds
 Usually 1-2% of AUM(assets under management)
 Performance Fee – typically 20% of profits
 Leads to emphasis on absolute return rather than
relative return
 May be a hurdle rate for performance fee
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Results
 Often difficult to know for sure
 Some appear to be very high
 Some studies say the industry averages are no better
than mutual funds
 Additional fees can cut into positive results –
Especially funds of funds
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Some Well-Known Hedge Funds
 Renaissance
 Citadel
 Millenium
 Paulson and Co.
 Maverick
 S.A.C. Capital Advisors
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