Advanced Portfolio Management
ADMS 4501 – Winter 2012 – Lois King
Lecture 4 – Chapter 17 – Money Management & Alternative Investment – Jan 26
The Asset Management Industry: Structure & Evolution
- Two organization forms:
o Private management and advisory firms
Clients contract directly with a management and advisory firm.
Private management and advisory firms develop a personal
relationship with clients.
o Investment (fund) companies
Commingling of investment capital of several clients in an
Investment company offers a general solution
Private Management and Advisory Firms
- Clients contract directly with a management and advisory firm
o Relationship with client
o Assets under management (AUM)
o Separate accounts
- Majority of private management and advisory firms are still much smaller.
- More narrowly focused on a particular niche of the market.
- Investment strategy
o Each client’s assets are held in separate account.
o Security portfolio guided by the firm’s overall investment philosophy.
o While the specific stock allocations might vary, the same fundamental
orientation toward stock selection will be applied to all accounts.
Investment (Fund) Companies
- Commingling of investment capital of several clients in an investment company.
o Invest a pool of funds belonging to many individuals in a single portfolio of
o Issue new shares representing the proportional ownership of the fund.
o Financial intermediaries that pool the assets of individual investors and
invest the fund in securities or other assets.
o Major duties
Management of the portfolio
o Management fee is percentage of total value of the fund.
o Family of funds achieve economies of scale
- Valuating investment company shares o Net asset value (NAV) for an investment company is analogous to the
share price of a corporation’s common stock.
o NAV of the fund shares will increase as the value of the underlying assets
(the fund security portfolio) increases.
Closed-End vs. Open-End Investment Companies
- Closed-end investment company
o Functions like any other public firm and its stock trades on the regular
o Fund generally doesn’t issue or redeem shares once it is established.
o Price of fund is different from its NAV.
o Puzzle for modern finance why closed-end funds often sell at a discount
o Often a means of investing in a pool of assets from a foreign country.
- Open-end investment companies
o Company continues to sell and repurchase shares after their initial public
o Fund stands ready to issue or redeem shares at the net asset value
o Investors who buy or sell the shares may have to pay sales charges (the
o Normally called mutual funds.
- Open-end mutual fund – load versus no load
o Load fund
Offering price for a share = NAV of the share plus a sale charge.
o No load fund
No initial sales charge, so it sells shares at a price = NAV
o Several variations exist between full load and pure no load fund
Funds have contingent, deferred sales loads.
- Fund management fees
o Charge annual management fees to compensate professional managers
of the fund.
o Fee typically is a percentage of the average net assets of fund varying
from about 0.25 to 1.00%.
o Management fees are a major factor driving the creation of new funds.
o Mutual fund fees have been declining due to the industry consolidation
and the huge growth in ETFs.
- Investment company portfolio objectives
o Equity funds – invest almost exclusively in common stocks.
o Bond funds – concentrate on various types of bonds to generate high
current income with minimal risk. o Balanced funds – diversify outside a single asset class by combining
common stock with fixed income securities.
o Money market funds – invest in diversified portfolios of short-term
o Flexible portfolio (hybrid) funds – invest in a mix of stocks, bonds, and
- Breakdown by fund characteristics
o By major means of distribution
Direct purchase from the fund.
Direct institutional marketing.
o By investment objective
Money market funds
- Global investment companies (funds that invest in foreign securities)
o International funds – often hold only foreign stocks from U.S., Germany,
Japan, Singapore, and Korea.
o Global funds – contain both Canadian and foreign securities.
o Foreign investment companies – offer both domestic and global products
in their local markets.
- Basic concepts
o Alternative assets
Include a wide variety of investments: hedge funds, private equity,
real estate and commodities.
Structure can be either through separate accounts or though
comingled funds but if commingled funds it is usually set up as a
o Limited partnership
One or more general partners run the business (and assume its
legal obligations) and the remaining limited partners are liable for
only the amount of their investment.
Hedge Funds and Private Equity
- The development
o A significant development in professional asset management industry over
the past 20 years was emergence of global market for hedge fund
o Hedge fund investing traces back to 1949.
o Structured as a partnership structure with an incentive fee for superior
- Hedge fund portfolio o Combines both long and short position in equity market.
o Uses of financial leverage to enhance return.
o Better able to produce superior returns than traditional investment
structures, such as mutual funds.
o Management fee plus performance fee is paid to the manager.
- Hedge funds – other characteristics