Chapter 16

Question 1

Constraints in Portfolio Management

Answer 1

Liquidity
Investment Horizon
Regulatory Constraints

Question 2

Advantages of Institutional Investment

Answer 2

Economies of Scale - Reduced broker fees, Reduced costs in achieving diversification.
Professional Mgmt - Record Keeping, Risk Mgmt, Selection of mispriced securities, Market Timing and watching.

Question 3

Taxes on Investment companies

Answer 3

Companies distribute CG, Div and interest from holdings to avoid taxation on the fund.
Investor directed funds can be optimized for taxes, mutual fund cannot.

Question 4

Net Asset Value Definition and Equation

Answer 4

Basis of Valuation of investment company shares - Selling and Redeeming.
NAV = MV of Asset-Liabilities/Shares Outstanding

Question 5

“End” Type of Investment Companies

Answer 5

Closed-end: A specific number of shares are issued. Additional shares can only be purchased in the open market. Not common.
Open-End: Company stands ready at all times to issue or purchase its own shares at near NAV.
Other Types: Commingled Funds, Real Estate funds, Segregated Funds, Hedge Funds.

Question 6

Other types of investment companies

Answer 6

Fixed Income (Bonds) - Corporate, Government, Global, Index.
Common Stock Funds- Growth, Income
Balanced Funds
Speciality Funds - Money Market, mortgage, dividend, option, ethical, international.

Question 7

What is a fixed trust?

Answer 7

REIT - Real Estate Investment Trust

Unit Investment Trusts - Portfolio remans fixed for period of time. Low mgmt and broker fees.

Question 8

What is a segregated fund?

Answer 8

Subject to a maturity date. Principal is guaranteed to a percentage of the invested capital. Guarantee can be reset if the market value change.

Question 9

What is a labor sponsored investment fund?

Answer 9

Created by labor unions to invest in small and startup business. Very illiquid. Investor receives up to 30% tax credit. 15% fed up to 5,000$, 15% prov. 12,000$. Credit must be returned if not held for 8 years.

Question 10

What are rescricted transactions in mutual funds?

Answer 10

Diversification, Control, Illiquid assets, Derivatives.

Prohibited: Borrowing to invest, Margin trans, short sales, underwriting.

Question 11

Investment company structure

Answer 11

An Investment manager manages the assets. Paid based on the market value of the assets. Range from 0.25%-2.8% depending on the level of assets.

Question 12

Determinants of Mgmt Fees (Asset Mix)

Answer 12

Different Assets require different levels of management.

Question 13

Determinants of Mgmt (Investment Practices)

Answer 13

Some investment practices require special expertise that can increase expenses.

Question 14

Determinants of Mgmt (Size of accounts)

Answer 14

The smaller the size, the higher the admin costs and communication to process statements.

Question 15

Determinants of Mgmt (Distribution System)

Answer 15

Funds differ in their sales administration costs.

Question 16

Determinants of Mgmt (Economies of Scale)

Answer 16

As long as asset mix stays the same, mgmt costs do not increase proportionately with size.

Question 17

What percentage of NAV are administrative and custodial expenses?

Answer 17

Usually around .50%

Question 18

What are the determinants of Operating Costs?

Answer 18

Record Keeping, custodial fees, legal, audit. 
Brokerage costs (0-1%) - change based on Portfolio turnover - Active vs. Passive. Soft Dollar- the use of full service vs. discount brokers.

Question 19

What is the Management Expense Ratio (MER)

Answer 19

Total costs divided by average net monthly assets for the year. All fees except brokerage. Range is 2.1%-3.3%

Question 20

Load Funds- Front vs. Back-end

Answer 20

Front end load deducts before investment. Have gone down or eliminated recently. Usually 0-5%, Avg. 1-2%
Back-end load deducts from redemption before the investor receives the money. Decrease over holding period starting usually at 6% declining to 0%.
No-Load - Share sold at price equal to net asset value.

Question 21

What are Trailing commissions?

Answer 21

Paid to advisors by fund as compensation for servicing the account. 1% for equity, .5% for bonds.

Question 22

Various Mutual Fund scandals

Answer 22

Market Timing - Allowing investors to buy or sell on stale net asset values, time zones.
Late Trading - Allowing some investors to purchase or sell later than others.

Question 23

Findings from mutual fund studies include..

Answer 23

Little difference between performance of big vs. small firms.
Performance of load vs. no-load firms is similar.
No evidence that market timing caused higher returns.
Higher turnover = lower performance.

Question 24

Do funds outperform?

Answer 24

Sometimes. Uncertainty in individual funds. Good past does not mean strong future. Poor past does mean poor future.

Question 25

Mutual Fund evaluation services

Answer 25

Morningstar
Globefund
The Fund Library

Question 26

Differences between Hedge funds and mutual funds

Answer 26

Transpaprency - Hedge funds provide little info.
Investors - In hedge funds are wealthy and sophisticated.
Strategies - Much less restriction on the strategies used.
Liquidity - Hedge funds use lock-up periods.
Compensation structure - Hedge funds charge incentive fees as well as annual mgmt fees.

Question 27

What are the different Hedge Fund fees?

Answer 27

Incentive fees - Usually 20% on assets managed beyond a certain benchmark.
High-water mark - base level that may be well above current asset value following bad bets.
Annual Fee - 1-2% of managed assets.
Fund of Funds - Hedge funds will hold other hedge funds to minimize risk. Doubles fees.

Question 28

What are the strategies of Hedge funds?

Answer 28

Directional - bets that one sector will out perform others.
Non-directional - hedged with respect to interest rate or market changes
Relative value - exploit mispricing of related securities such as MBSs / Treasuries
Convergence Arbitrage - Exploit pricing differences and wait for correction in time horizon such as futures. In bonds, exploiting mispricing in convertible bonds.
Statistical Arbitrage - using relative value to identify misalignments.

Usually focused on mispricing, hedging against systemic risk.

Question 29

What is portable alpha?

Answer 29

Exploit underpriced stock in a falling market.

Buy stock and hedge market risk by selling futures. Move Beta to 0.

Question 30

What is Alpha transfer?

Answer 30

Hedge the alpha found in one sector by using sector indices to create alpha in another sector as the exposure in the first sector is neutralized.

Question 31

Hedge fund Bias

Answer 31

Backfill Bias - Hedge funds only publish reports if they choose.
Survivorship - Performance may seem higher because poor performing funds just disappear.

Question 32

What is an ETFs (Exchange traded fund)

Answer 32

Index Investments with low mgmt expenses, low turnover, fully invested and trade on major exchanges. Can be sold at anytime, can use stop-loss, can sell short. Its a stock.

Question 33

Index Funds vs ETFs

Answer 33

Index funds - Easy to buy from banks, reinvest dividends without cost, available on no-load. Can invest small.
ETF - Need a brokerage account, dividends accumulate in account. Have to pay commissions. TSX 60, US S&P, DOW, Global, Nations.

Question 34

What are the different ETFs?

Answer 34

Sector spiders: health care, consumer stables, financials.

Question 35

What are HOLDRs?

Answer 35

Baskets of stocks chosen by analysts at Merrill Lynch focussed on biotech, broadband, internet, B2B. No fees. Must be purchased in board lots.