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Indirect Investing
(see Ch. 3 Jones)
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Indirect Investing
Alternative to direct investment in or
ownership of securities
 Refers to buying and selling the shares of
intermediaries that hold securities in portfolio
- Shares are ownership interest in portfolio entitled
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to portfolio income
Shareholders also pay expenses
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Investment Companies
An investment company invests a pool of funds belonging to
many individuals in a portfolio of individual investments such as
stocks and bonds
Financial firm that sells shares to the public and uses the proceeds
to invest in marketable securities
Benefits:
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Diversification
Professional management
Low capital requirement
Reduced transaction costs
Access to illiquid markets
Access to non-traditional trading strategies
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Types of Investment Organizations
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Mutual funds
- Open-End
- Closed-End
(Stock trades on secondary market; Net asset value (NAV) is
determined daily, but market price determined by supply and demand)
- ETFs (Exchange Traded Funds)
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Hedge Funds
Private equity/venture capital funds [Not covered in text]
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Mutual Funds
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An investment company that issues its portfolio shares to investors.
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Money from shareholders are pooled and invested in a wide range of stocks,
bonds, or money market securities.
- Managed by professional managers
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Each investor shares proportionately in the income and investment gains
and losses, as well as the brokerage expenses and management fees.
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Open end fund: # of shares issued solely depends on investor demand
- Bought and sold directly through the investment company (not an exchange)
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Net Asset Value
Used as a basis for valuation of mutual funds.
- Selling new shares
- Redeeming existing shares
Calculation:
Market Value of Assets – Fund Expenses - Liabilities
Shares Outstanding
A mutual fund has $100 mil in assets and $3 mil in short term liabilities.
10.765 mil shares outstanding. What is the NAV?
Solution
($100 mil - $3 mil) / 10.765 mil = $9.0107 per share
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Sources of Information
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Lipper Inc.: leading provider of data and analysis on the
investment company business ( www.lipperweb.com )
Morningstar.com: provide unbiased data and analysis and
candid editorial commentary (www.morningstar.com)
Vanguard Group: providing competitive investment
performance and lowest operating expenses (
www.vanguard.com )
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Mutual Funds: Investment Policies
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Money Market
Fixed Income
Equity
Balance & Income
Asset Allocation
Indexed
Specialized Sector
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Mutual Fund Organization
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Mutual fund shareholders: own mutual
funds, elect the board of directors
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Majority of the directors must be
independent directors
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Investment advisor: manages the day-today operations
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Principal underwriter, administrator,
transfer agent, custodian, and independent
public accountant
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Direct Costs of Investing in Funds
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Sales charge (loads)
- Front-end load
- Back-end load
Redemption fee
Exchange fee
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Indirect Costs of Investing in Funds
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Account maintenance fee (Operating expenses)
12 b-1 charges
- distribution costs paid by the fund
- Alternative to a load
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Mutual funds: Performance
It’s not conclusive
 Most of the studies suggest that the average MF underperforms its
benchmark
 There is some evidence of short-term performance persistence
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 The evidence show that it’s not easy to find funds that outperform
for a long period of time
 Nonetheless, “hot” funds receive a disproportionately amount of
new money
Benchmarks
Survivorship bias
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Closed-End Funds
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Issues a fixed number of shares at a given point in time
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Collect money from investors through and IPO and use this money to invest in
securities.
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# of shares are fixed at the time of IPO.
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When the market price exceeds its NAV, selling at a premium, otherwise,
selling at a discount (closed-end funds typically sell at a discount)
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Suited to specialized investing in small or illiquid markets
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Exchange Traded Funds
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Are similar to closed-end funds: traded securities; entails
commission costs
Each ETF is a claim on a trust that holds a specified pool of assets
(e.g. S&P500 index components)
Examples:SPDRS,ishares,HOLDERS
Advantages:
 Liquidity
 Taxes
 Can be purchased on margin or sell short
ETF are appropriate for short-term investors and the ones who buy
in large lots
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Morningstar rating
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Created in 1984 to provide comprehensive assessment of mutual
funds
The star system was not meant to predict future performance
5* - the top 20% of the funds
1* the bottom 20%
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Hedge Funds
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Considerable confusion exists concerning hedge funds –
what they are (and are not) and how they work
Hedge funds are privately organized, pooled investment vehicle
with no restrictions in terms of investment strategies, asset classes
and use of leverage
Many of them registered off-shore for tax and regulatory reasons
Can’t have more than 100 “accredited” investors or 500 “superaccredited” investors
Accredited investor: net worth > 1 million or income of $200,000
in each of the past two years
Super-Accredited investor: net worth > 5 million
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Hedge Funds
Are not allowed to advertise broadly and engage in
“ general solicitation” to the investing public
 Charge 1-2% of assets under management and 20-25% of profits
 First hedge fund on record, Jones Hedge Fund, was established in 1949
 He hedged the US equity market risk and focused on stock selection
 By 2011, more than 10,000 funds in existence world-wide
 Common features:
- shorting
- leverage
- concentration
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Do they all hedge?
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Learning objectives
-Discuss the advantages and disadvantages of mutual funds
-Know how to calculate NAV
-Define and Discuss the differences between open end, closed end and ETFs
- Briefly discuss the costs, loads and fees of investing in mutual funds
-Morningstar and Style boxes
-Benchmarks
-Survivorship bias and Chasing the Hot funds (p. 73-74)
-Hedge Funds
End of chapter questions 3.1 to 3.13
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