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See all Premium member Presentation Transcript PORTFOLIO MANAGEMENT: PORTFOLIO MANAGEMENT B M NAMAZI S2 MTECH MACEWarren Buffet: Warren Buffet Warren Buffet (on 12th Dec 2006), the second richest man who has donated $31 billion to charity. Here are some very interesting aspects of his life He bought his first share at age 11 and he now regrets that he started too late! He bought a small farm at age 14 with savings from delivering newspapers. Warren Buffet: Warren Buffet He still lives in the same small 3-bedroom house in mid-town Omaha , which he bought after he got married 50 years ago. He says that he has everything he needs in that house. His house does not have a wall or a fence. He drives his own car everywhere and does not have a driver or security people around him. He never travels by private jet, although he owns the world's largest private jet company. Warren Buffet: Warren Buffet His company, Berkshire Hathaway, owns 63 companies. He writes only one letter each year to the CEOs of these companies, giving them goals for the year. He never holds meetings or calls them on a regular basis. He has given his CEO's only two rules. Rule number 1: do not lose any of your share holder's money. Rule number 2: Do not forget rule number 1. He does not socialize with the high society crowd. His past time after he gets home is to make himself some pop corn and watch Television. Warren Buffet: Warren Buffet Bill Gates, the world's richest man met him for the first time only 5 years ago. Bill Gates did not think he had anything in common with Warren Buffet. So he had scheduled his meeting only for half hour. But when Gates met him, the meeting lasted for ten hours and Bill Gates became a devotee of Warren Buffet. Warren Buffet does not carry a cell phone, nor has a computer on his desk. His advice to young people: "Stay away from credit cards and invest in yourself and Remember: Warren Buffet: Warren Buffet A. Money doesn't create man but it is the man who created money. B. Live your lives, as simple as you are. C. Don't do what others say, just listen to them, but do what you feel good. D. Don't go on brand name; just wear those things in which u feel comfortable. E. Don't waste your money on unnecessary things; just spend on them who really in need rather. F. After all it's your life then why gives chance to others to rule our life." Slide28: The Life of every man is a diary in which he means to write one story, and writes another; and his humblest hour is when he compares the volume as it is with what he vowed to make it. - J.M. BarrieOutline: Outline Introduction Part one: Background, Basic Principles, and Investment Policy Part two: Portfolio construction Part three: Portfolio management Part four: Portfolio protection and contemporary issuesIntroduction: Introduction Investments Security analysis Portfolio management Purpose of portfolio management Low risk vs. high risk investments The portfolio manager’s job The six steps of portfolio management Investments: Investments Traditional investments covers: Security analysis Involves estimating the merits of individual investments Portfolio management Deals with the construction and maintenance of a collection of investmentsSecurity Analysis: Security Analysis A three-step process The analyst considers prospects for the economy, given the state of the business cycle The analyst determines which industries are likely to fare well in the forecasted economic conditions The analyst chooses particular companies within the favored industries EIC analysis (a top-down approach) Portfolio Management: Portfolio Management Literature supports the efficient markets paradigm On a well-developed securities exchange, asset prices accurately reflect the tradeoff between relative risk and potential returns of a security Efforts to identify undervalued undervalued securities are fruitless Free lunches are difficult to find Portfolio Management (cont’d): Portfolio Management (cont’d) Market efficiency and portfolio management A properly constructed portfolio achieves a given level of expected return with the least possible risk Portfolio managers have a duty to create the best possible collection of investments for each customer’s unique needs and circumstancesPurpose of Portfolio Management: Purpose of Portfolio Management Portfolio management primarily involves reducing risk rather than increasing return Consider two $10,000 investments: Earns 10% per year for each of ten years (low risk) Earns 9%, -11%, 10%, 8%, 12%, 46%, 8%, 20%, -12%, and 10% in the ten years, respectively (high risk)Low Risk vs. High Risk Investments: Low Risk vs. High Risk InvestmentsLow Risk vs. High Risk Investments (cont’d): Low Risk vs. High Risk Investments (cont’d) Earns 10% per year for each of ten years (low risk) Terminal value is $25,937 Earns 9%, -11%, 10%, 8%, 12%, 46%, 8%, 20%, -12%, and 10% in the ten years, respectively (high risk) Terminal value is $23,642 The lower the dispersion of returns, the greater the terminal value of equal investmentsThe Portfolio Manager’s Job: The Portfolio Manager’s Job Begins with a statement of investment policy, which outlines: Return requirements Investor’s risk tolerance Constraints under which the portfolio must operateThe Six Steps of Portfolio Management: The Six Steps of Portfolio Management Learn the basic principles of finance Set portfolio objectives Formulate an investment strategy Have a game plan for portfolio revision Evaluate performance Protect the portfolio when appropriateThe Six Steps of Portfolio Management (cont’d): The Six Steps of Portfolio Management (cont’d) Learn the Basic Principles of Finance (Chapters 1 – 3) Set Portfolio Objectives (Chapters 4 – 5) Formulate an Investment Strategy (Chapters 6 – 14) Have a Game Plan for Portfolio Revision (Chapters 15 – 18) Protect the Portfolio When Appropriate (Chapters 21 – 25) Evaluate Performance (Chapters 19 - 20)Mutual Funds: Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 4 Mutual FundsMutual Funds: Mutual Funds Our goal in this chapter is to understand the different types of mutual funds, their risks, and their returns. Around 1980, 5 million Americans owned mutual funds. However, by 2001, 93 million Americans in 55 million households owned mutual funds. In 2001 investors added $505 billion in net new funds to mutual funds. In 2001, mutual fund assets totaled $7 trillion. Mutual Funds: Mutual Funds Mutual funds are simply a means of combining or pooling the funds of a large group of investors. The buy and sell decisions for the resulting pool are then made by a fund manager, who is compensated for the service provided. Like commercial banks and life insurance companies, mutual funds are a form of financial intermediary.Investment Companies and Fund Types: Investment Companies and Fund Types An Investment company is business that specializes in pooling funds from individual investors and making investments. An Open-end fund is an investment company that stands ready to buy and sell shares in itself to investors, at any time. A Closed-end fund is an investment company with a fixed number of shares that are bought and sold by investors, only in the open market.Investment Companies and Fund Types: Investment Companies and Fund TypesInvestment Companies and Fund Types: Investment Companies and Fund Types Net asset value (NAV) is the value of the assets held by a mutual fund, divided by the number of shares. Shares in an open-end fund are worth their NAV, because the fund stands ready to redeem their shares at any time. In contrast, share value of closed-end funds may differ from their NAV. Mutual Fund OperationsOrganization and Creation: Mutual Fund Operations Organization and Creation A mutual fund is simply a corporation. It is owned by shareholders, who elect a board of directors. Most mutual funds are created by investment advisory firms (say Fidelity Investments), or brokerage firms with investment advisory operations (say Merrill Lynch). Investment advisory firms earn fees for managing mutual funds.Mutual Fund OperationsTaxation of Investment Companies: Mutual Fund Operations Taxation of Investment Companies A “regulated investment company” does not have to pay taxes on its investment income. To qualify, an investment company must: Hold almost all its assets as investments in stocks, bonds, and other securities, Use no more than 5% of its assets when acquiring a particular security, and Pass through all realized investment income to fund shareholders Mutual Fund OperationsThe Fund Prospectus and Annual Report: Mutual Fund Operations The Fund Prospectus and Annual Report Mutual funds are required by law to supply a prospectus to any investor who wishes to purchase shares. Mutual funds must also provide an annual report to their shareholders.Mutual Fund Costs and FeesTypes of Expenses and Fees: Mutual Fund Costs and Fees Types of Expenses and Fees Sales charges or “loads” Front-end loads are charges levied on purchases. Back-end loads are charges levied on redemptions. 12b-1 fees. SEC Rule 12b-1 allows funds to spend up to 1% of fund assets annually to cover distribution and marketing costs. Management fees: Usually range from 0.25% to 1.00% of the funds total assets each year. Are usually based on fund size and/or performance. Trading costs Not reported directly Funds must report "turnover," which is related to the amount of trading. The higher the turnover, the more trading has occurred in the fund. The more trading, the higher the trading costs.Mutual Fund Costs and FeesExpense Reporting: Mutual Fund Costs and Fees Expense Reporting Mutual funds are required to report expenses in a fairly standardized way in their prospectus. Shareholder transaction expenses - loads and deferred sales charges. Fund operating expenses - management and 12b-1 fees, legal, accounting, and reporting costs, director fees. Hypothetical example showing the total expenses paid by investors through time per $10,000 invested.Example: Fee Table: Example: Fee TableMutual Fund Costs and FeesWhy Pay Loads and Fees?: Mutual Fund Costs and Fees Why Pay Loads and Fees? After all, many good no-load funds exist. But, you may want a fund run by a particular manager. All such funds are load funds. Or, you may want a specialized type of fund. Perhaps one that specialized in Italian companies Loads and fees for specialized funds tend to be higher, because there is little competition among them.Short-Term Funds, I.: Short-Term Funds, I. Short-term funds are collectively known as money market mutual funds. Money market mutual funds (MMMFs) are mutual funds specializing in money market instruments. MMMFs maintain a $1.00 net asset value to make them resemble bank accounts. Depending on the type of securities purchased, MMMFs can be either taxable or tax-exempt.Short-Term Funds, II.: Short-Term Funds, II. Most banks offer what are called “money market” deposit accounts, or MMDAs, which are much like MMMFs. The distinction is that a bank money market account is a bank deposit and offers FDIC protection.Long-Term Funds: Long-Term Funds There are many different types of long-term funds, i.e., funds that invest in long-term securities. Historically, mutual funds were classified as stock funds, bond funds, or income funds. Nowadays, the investment objective of the fund is the major determinant of the fund type. Stock Funds, I.: Stock Funds, I. Some stock funds trade off capital appreciation and dividend income. Capital appreciation Growth Growth and Income Equity income Some stock funds focus on companies in a particular size range. Small company Mid-cap Some stock fund invest internationally. Global International Region Country Emerging marketsStock Funds, II.: Stock Funds, II. Sector funds specialize in specific sectors of the economy, such as: Biotechnology Internet Energy Other fund types include: Index funds Social conscience, or “green,” funds “Sin” funds (i.e., tobacco, liquor, gaming) Tax-managed fundsBond Funds: Bond Funds Bond funds may be distinguished by their Maturity range Credit quality Taxability Bond type Issuing country Bond fund types include: Short-term and intermediate-term funds General funds High-yield funds Mortgage funds World funds Insured funds Single-state municipal fundsStock and Bond Funds: Stock and Bond Funds Funds that do not invest exclusively in either stocks or bonds are often called “blended” or “hybrid” funds. Examples include: Balanced funds Asset allocation funds Convertible funds Income fundsMutual Fund Objectives: Recent Developments, I.: Mutual Fund Objectives: Recent Developments, I. A mutual fund “style” box is a way of visually representing a fund’s investment focus by placing the fund into one of nine boxes:Mutual Fund Objectives: Recent Developments, II.: Mutual Fund Objectives: Recent Developments, II. In recent years, there has been a trend toward classifying a mutual fund’s objective based on its actual holdings. For example, the Wall Street Journal classifies most general purpose funds based on the market “cap” of the stocks they hold, and also on whether the fund tends to invest in “growth” or “value” stocks (or both).Mutual Fund Objectives: Mutual Fund ObjectivesMutual Fund Performance: Mutual Fund Performance Mutual fund performance is very closely tracked by a number of organizations. Financial publications of all types periodically provide mutual fund data. The Wall Street Journal is particularly timely print source. www.morningstar.com has a “Fund Selector” that provides performance informationMutual Fund Performance: Mutual Fund PerformanceMutual Fund Performance: Mutual Fund PerformanceMutual Fund Performance: Mutual Fund Performance While looking at historical returns, the riskiness of the various fund categories should also be considered. Whether historical performance is useful in predicting future performance is a subject of ongoing debate. Some of the poorest-performing funds are those with very high costs.Closed-End Fund Performance: Closed-End Fund Performance A closed-end fund has a fixed number of shares. These shares are traded on stock exchanges. There are about 450 closed-end funds that have their shares listed on U.S. Stock Exchanges. There are about 7,000 long-term open-end mutual funds. Mutual Fund Performance: Mutual Fund PerformanceThe Closed-End Funds Discount: The Closed-End Funds Discount Most closed-end funds sell at a discount relative to their net asset values. The discount is sometimes substantial. The typical discount fluctuates over time. Despite a great deal of academic research, the closed-end fund discount phenomenon remains largely unexplained.Exchange Traded Funds: Exchange Traded Funds An exchange traded fund, or ETF, Is basically an index fund. Trades like a closed-end fund (without the discount phenomenon). An area where ETFs seem to have an edge over the more traditional index funds is the more specialized indexes. A well-known ETF is the “Standard and Poor’s Depositary Receipt” or SPDR. This ETF mimics the S&P 500 index. It is commonly called “spider." A list of ETFs can be found at www.amex.com. Hedge Funds: Hedge Funds Like mutual funds, hedge funds collect pools of money from investors. However, Hedge funds are not required to register with the SEC. Hedge funds are not required to maintain any particular degree of diversification or liquidity. Hedge fund investors must qualify as “financially sophisticated” investors. Hedge fund managers have considerable freedom to follow various investment strategies, or styles. Hedge fund fees: General management fee of 1-2% of fund assets Performance fee of 20-40% of profitsUseful Internet Sites: Useful Internet Sites www.ici.org (reference for mutual fund facts and figures) www.vanguard.com (example of major fund family website) www.fidelity.com (website of largest investment advisory firm in US) www.ipsfunds.com (reference for “plain language” risk disclosure) www.mfea.com (reference for info on thousands of funds) www.morningstar.org (reference for one of the best mutual fund sites) www.vicefund.com (reference for “vice” funds) www.socialinvest.org (reference for “social conscience” funds) www.hedgefundworld.com (reference for hedge fund information) www.turnkeyhedgefunds.com (reference to start your own hedge fund) Chapter Review, I.: Chapter Review, I. Investment Companies and Fund Types Open-End versus Closed-End Funds Net Asset Value Mutual Fund Operations Mutual Fund Organization and Creation Taxation of Investment Companies The Fund Prospectus and Annual Report Mutual Fund Costs and Fees Types of Expenses and Fees Expense Reporting Why Pay Loads and Fees? Short-Term Funds Money Market Mutual Funds Money Market Deposit AccountsChapter Review, II.: Chapter Review, II. Long-Term Funds Stock Funds Taxable and Municipal Bond Funds Stock and Bond Funds Mutual Fund Objectives: Recent Developments Mutual Fund Performance Mutual Fund Performance Information How Useful are Fund Performance Ratings? Closed-End Funds and Exchange Traded Funds Closed-End Funds Performance Information The Closed-End Fund Discount Mystery Exchange Traded Funds You do not have the permission to view this presentation. In order to view it, please contact the author of the presentation.