1. PROFESSIONAL ASSET MANAGEMENT 1

2. Basic Categories Private Management: Clients each have a separate account {popular with institutions} Investor 1 Investor 2 Asset manager Account 1 $ $ $ 2 Account Account 2 $

3. Basic Categories Investment Companies: Sell shares of the fund and invest the proceeds in a portfolio of stocks, bonds, or other assets Investor 1 Investor 2 Asset manager Fund Portfolio $$$$ $$ Fund Shares 3

4. Professional Asset Management vs. Individuals 1. Diversification 2. Record Keeping 3. Professional Management 4. Lower Transaction Costs 4

5. Net Asset Value 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 5

6. 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. 6

7. 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. 7

8. 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. 8

9. Records Fees Funds can charge as much as.25% of assets annually for records fees. 9

10. Management Fees Fees are higher for actively managed funds than index funds Fees are higher for international funds than domestic funds Fees are higher for stock funds than bond funds Does not include trading commissions 10

11. 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) 11

12. Expense Ratio Studies find that funds with lower expense ratios earn higher (net) returns than those with higher expense ratios. 12

13. 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 itself. Investors can be taxed on gains they never received when the fund distributes capital gains at end of year Best not to buy into a taxable mutual fund near year-end Not an issue if in a tax-deferred retirement account 13

14. 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 14

15. 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 15

16. 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 16

17. Hedge Fund 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 17

18. 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 18