Capital Funds Ebooks Catalog

Lessons From The Intelligent Investor

Lessons From The Intelligent Investor

If you're like a lot of people watching the recession unfold, you have likely started to look at your finances under a microscope. Perhaps you have started saving the annual savings rate by people has started to recover a bit.

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Lowest Cost No Load Mutual Funds And Etfs

This inexpensive ebook will help you in three main ways: It will improve your understanding of investing by summarizing what the research literature actually says does and does not work when investing. It conveniently provides a directory of the lowest cost, diversified no load mutual funds and Etfs available to US investors for direct investing. The book lists over 200 lowest cost, no load mutual funds in 30 global, international, and US stock, bond, real estate, and money market fund asset category tables. It also lists the over 200 lowest cost Etfs in 29 global, international, and US stock, bond, and real estate asset category tables. All these low cost funds are screened from the universe of available funds using objective factors supported by university research and discussed in this ebook. This ebook helps you to put your investing strategy on autopilot. Increase diversification, lower risks, and reduce investment costs, so that you can save a lot of money and time year after year after year.

Lowest Cost No Load Mutual Funds And Etfs Summary

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4.6 stars out of 11 votes

Contents: EBook
Author: Larry Russell
Price: $9.75

My Lowest Cost No Load Mutual Funds And Etfs Review

Highly Recommended

This ebook comes with the great features it has and offers you a totally simple steps explaining everything in detail with a very understandable language for all those who are interested.

My opinion on this e-book is, if you do not have this e-book in your collection, your collection is incomplete. I have no regrets for purchasing this.

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History Of Hedge Funds

This section details some of the important events in the history of hedge funds. Back in 1949, Alfred Winslow Jones, a former reporter for Fortune, started the first hedge fund with an initial capital of only US 100 000. Jones' core intuition was that by correctly combining two speculative techniques, i.e. using both short sales and leverage, it would be possible to reduce total portfolio risk and construct a conservative portfolio, featuring a low exposure to the general market performance. Jones also had two other major ideas to cater to investors, he had invested all his savings in the fund he managed, and his profit came from a 20 stake in the generated performance rather than from the payment of a fixed percentage of assets under management. This approach made it possible to bring the interests of manager and investor together. Today, the archetype described above characterizes only a small number of hedge funds the term is now used to refer to a vast realm of different...

Definition Of Hedge Fund

Definitions of hedge funds run into problems because it is exceedingly difficult to describe what a hedge fund is without running into trouble with funds that don't fit into the rules. There are investment pools that closely resemble hedge funds but are generally regarded as a different type of investment. Still other types of investments may contain characteristics that are generally associated with hedge funds. As a starting point, begin with a rather typical definition of a hedge fund A hedge fund is a loosely regulated investment company that charges incentive fees and usually seeks to generate returns that are not highly correlated to returns on stocks and bonds. Many traits of hedge funds aren't useful in defining what is and what is not a hedge fund.

Stock Selection Based on Mutual Fund Holdings

Academics have investigated whether individual investors should consider the weightings mutual fund managers place on the stocks held in their funds when making stock selection decisions (Weigand et al., 1973). Specifically, they compare the performance of the stocks that are most heavily weighted in mutual funds vs. the stocks that are most lightly weighted. These studies find that the heavily weighted stocks in mutual funds perform no better than, and sometimes significantly underperform, the most lightly weighted stocks. These results contradict the idea that individual investors can earn excess returns by following the implicit stock selection picks of mutual fund managers, particularly, short-term and momentum investors who trade large-cap stocks. These findings rather suggest that individual investors should be wary of investing in stocks that are the top holdings in general equity mutual funds.

Regulation and Hedge Funds

Chapter 8 describes the laws and regulations that control hedge funds. While hedge funds are not unregulated, as is sometimes asserted, they are more loosely regulated than mutual funds and common trusts run by bank trust departments. Other types of investments are also loosely regulated, though, including private equity partnerships, venture capital funds, and many real estate partnerships. Investors may feel they will know it (a hedge fund) when they see it, but there are no firm lines separating hedge funds from these other types of investments. Hedge funds may invest part of their assets in private equity, venture capital, or real estate. To further blur the distinction between hedge funds and regulated investment companies, there is increasing pressure from the Securities and Exchange Commission (SEC), bank regulators, auditors, and exchanges for hedge funds to disclose more information and to control permitted activities. Hedge funds may soon be required to disclose much of the...

The Growth Of The Hedge Fund Industry

Hedge Fund Research estimates that the number of hedge funds has gone from 610 in 1990 up to 7436 in 2004 (not including funds of hedge funds). Assets managed by hedge funds went from an estimated 38.9 billion in 1990 to approximately 973 billion in 2004. According to Tremont Capital Management Inc., at the end of 2004 the hedge fund industry reached 975 billion of assets, in addition to another 300 billion held in managed accounts, totaling 1275 billion of AuM. Various sources agree in estimating that the number of active hedge funds is running at about 9000, with approximately 3500 managers. A trillion dollars accounts for about 1.3 of the total capitalization of financial markets, excluding the leverage, or 3.5 including the leverage. Therefore the hedge fund industry can be considered a niche sector. Why then bother with an industry that accounts for only 3-4 of the assets of global financial markets First, because it is estimated that hedge funds make up 10 of market trade...

The Why and Hout of Mutual Funds

I take you through the investing basics. If you don't understand the different types of investments that funds are made of, such as stocks and bonds, you won't fully understand funds. Part I defines and demystifies what mutual funds are and discusses what funds are good for and when you should consider alternatives. Before you're even ready to start investing in funds, your personal finances need to be in order, so in Part I, I give you some financial house-cleaning tips. You also discover the importance of fitting mutual funds to your financial goals. After your finances are shipshape and you've identified your goals, you are ready to find out how to pick great funds, how to avoid losers, where and how to purchase funds, and how to read all those pesky reports (such as prospectuses and annual reports) that fund companies stuff in your mailbox. Part I touches all these bases.

Contrasting Mutual Funds With Hedge Funds

One definition of a hedge fund is that it is a mutual fund that doesn't have to follow any rules. This overly simple distinction may help the uninitiated get a rough idea of what a hedge fund can do. Of course, there are lots of rules that a hedge fund must observe, and hedge funds are organized differently from mutual funds. The distinction loses meaning as mutual funds have been given broader investment rules over time. Recently, U.S. regulators have been pressing to tighten the regulation of hedge funds. Nevertheless, there are some consistent differences between mutual funds and hedge funds.

Hedge Funds What Exactly Are They

Hedge funds are one sexy component of the buy side. Since the mid-1990s, hedge funds' popularity has grown tremendously. Hedge funds pool together money from large investors (usually wealthy individuals) with the goal of making outsized gains. Historically, hedge funds bought individual stocks, and shorted (or borrowed against) the S& P 500 or another market index, as a hedge against the stock. (The funds bet against the S& P in order to reduce their risk.) As long as the individual stocks outperformed the S& P, the fund made money. Nowadays, hedge funds have evolved into a myriad of high-risk money managers who essentially borrow money to invest in a multitude of stocks, bonds and derivative instruments (these funds with borrowed money are said to be leveraged). Essentially, a hedge fund uses its equity base to borrow substantially more capital, and therefore multiply its returns through this risky leveraging. Buying derivatives is a common way to quickly leverage a...

Mutual Funds An Investment

At their most basic, mutual funds are an investment. I know that, but please bear with me. I don't want to make the mistake that I see so many investment writers (and financial advisors) make starting with the more advanced stuff on the assumption that you know the basics. So often I hear from people reading about mutual funds and complaining that a writer starts throwing around terms such as small cap value stock fund and asset allocation without explaining them, and before you know it, you're lost in the weeds and frustrated. You have every right to be. If you already understand what stocks and bonds are, their risks and potential returns, terrific. You can skip this chapter. Most people, however, don't really understand the basics of investments, and that's one of the major reasons that people make investment mistakes in the first place. If you understand the specific types of securities that funds can invest in, you've mastered one of the important building blocks to understanding...

The Hedge Fund Manager

As has already been remarked, each hedge fund tends to be unique. Hedge funds are characterized by a strong entrepreneurship and the absence of a stringent regulatory framework. Every hedge fund has its unique organizational and legal structure, particular business culture, management style, and manager's professional experience, age and education. In every hedge fund it is the manager who sets the rules of the game in full latitude management style, investment time horizon, return and volatility objectives, target market and the fund's optimal capacity.

Characteristics of Wall Streets Best Mutual Fund Managers

Unlike most portfolio managers, the Winner's Circle mutual fund managers stick to their disciplines, and never stray. Franklin Templeton's Jeff Everett, a disciple of legendary investor Sir John Templeton, maintains Sir John's disciplines, and when new circumstances arise does not hesitate to talk through situations with his mentor. Using hundreds of metrics, AXA Rosenberg's quantitative models follow strict instructions, never deviating from Bill Ricks and team's investment approach. Interestingly, each manager thinks independently. They are never coerced by current sentiments or newspaper headlines. They are trained to think differently for most of them, when the crowds are heading in one direction, they are going the other way. I recall a conversation with David Dreman in mid-2002 where he seemed excited at the opportunity to buy Tyco in the low teens, after falling from around 60 a share. While the newspapers and market commentators were predicting the company would go belly-up,...

How Large Funds Adapted to Decimalization

A large fund has the dual advantage of size and power, but it also has limitations. Funds provide liquidity to the markets, and the system is designed to allow them some flexibility. The decimalization rule served them this flexibility on a silver platter. This rule was initially conceived as a way to attract private investors and lower the spread costs, but it was in fact an implicit authorization for large funds to manipulate markets. Indeed, before decimalization, if a fund wanted to lower the price of a stock, it had to sell at the bid enough shares to take out all the outstanding buy orders. Since the spread cost was high, all players entered their order in advance (first come, first served), and it was easy to see what large players wanted to do. Market manipulation at that time was quite costly. (For example, you had to sell perhaps 10,000 shares at a spread cost of 0.0625. This meant that if in fact you wanted to lower the price in order to buy a larger quantity at a lower...

Size And Growth Of Hedge Funds

Because hedge funds avoid most of the registration requirements of traditional money managers, no business or governmental agency has precise knowledge of the number of hedge funds in existence. Businesses that collect performance data on large numbers of hedge funds maintain estimates of the number of hedge funds. Fortunately, the estimates are fairly close. For example, in Figure 1.1, Van Hedge Fund Advisors International has estimated the number of hedge funds worldwide at 8,100. Other estimates are generally within about 10 percent of this estimate. The number of hedge funds has risen by about 12.6 percent annually since 1988.3 This total represents the new funds created and the funds that shut down. Hedge fund professionals believe that the average hedge fund has been in existence for about eight years. The lack of hard data on hedge fund assets means that this average life is uncertain but if it is true, each year many more hedge funds are created and a large number of funds...

Investing in Hedge Funds to Increase Return

With thousands of hedge funds in existence, it is difficult to generalize much about the expected return. Funds can experience higher returns or lower returns than traditional assets, including stocks and bonds. Nevertheless, some hedge fund managers seek to make very high returns and are willing to accept substantially more risk in their portfolios to achieve that return. In the late 1980s and early 1990s, a number of global macro hedge funds (see Chapter 2 for a description of this and other hedge fund styles) caught the public's attention. This group of funds made levered investments in U.S. and international stocks, bonds and foreign currencies. Despite the name, they were generally not hedged, although the variety of their positions may have provided some risk control in the form of diversification. Chapter 11 demonstrates that the typical hedge fund is not as risky as a buy-and-hold investment in the Standard & Poor's 500 stock index. For some investors, hedge funds serve a...

Qualitative Factor Determinants for Hedge Funds

Quantitative factors that can be attributed as determinants of hedge fund return and volatility are identified in Chapter 11. In addition to quantitative factors, there are unique qualitative factors that contribute to the performance, volatility, and correlation of hedge funds. Although these qualitative factors are numerous and not easily quantified, they may at times contribute heavily to the total return of individual funds operating in this realm. The qualitative influences on hedge funds are described through examples for each individual hedge strategy described in this chapter.

Parallels Between the Development of Microfinance Institutions and the Development of Microfinance Investment Funds

This section explores the way in which investment funds follow a pattern that is similar to that of the MFIs as they gradually become more commercial. While a large number of MFIs and some investment funds will continue to focus on social aspects, institutions of both types which are ready for a more sustained growth should do so through a broader participation in the general financial markets. Similarly, the first financial structures put in place to lend to MFIs were established by private donors and development agencies, again with a development objective in mind. Even Profund, which could arguably be considered as the first microfinance investment fund established with the objective of obtaining a financial return, was initiated and essentially owned by development agencies. Many lessons were learnt from this early initiative that invested mainly in equity participations in MFIs. This was seen as quite risky when the fund was launched in 1995. Probably only a few of the original...

Investing in Hedge Funds to Reduce Risk

Hedge fund investors face many risks. These risks include the risks introduced by the securities and currencies held by the fund the use of leverage, which may concentrate risks present in the positions the risk of financing positions and other risks (see Chapter 11). However, many hedge funds are considerably less risky (by several risk measures) than the S& P 500, and many funds are less risky than the more conservative Lehman Brothers Aggregate Bond Index.

Primary Investment Categories Of Hedge Funds

Although more than 80 percent of the total assets under management in the industry are invested in the equity markets, the investment disciplines used are diverse and distinct. Tremont and TASS have defined 10 primary investment categories in the hedge fund industry

Hedge Fund Strategies

Hedge funds and their strategies are heterogeneous. However, they can be divided into a number of categories. Four chief categories are long short equity, relative value, event-driven approaches, and tactical trading. Long short equity includes the substyles of long-biased and short-biased. The relative value category incorporates the subcategorizations of market-neutral equity, convertible bond arbitrage, and fixed-income arbitrage. Event-driven components consist of merger arbitrage, event arbitrage, and distressed debt. The tactical trading area encompasses global macro, commodity trading advisers, and statistical arbitrage. This is not meant to be a comprehensive discussion of all hedge fund styles, but rather a general overview of some of

Investing in Hedge Funds to Increase Diversification

Diversification can significantly lower portfolio risk, compared to the risk of individual assets. Many hedge funds do not track stock or bond returns closely so they are more effective in reducing risk through diversification than simply splitting the debt and equity investments over more securities in a portfolio. One of the most popular measures of risk is the standard deviation of returns. This measure is used by academic writers, traditional investors, and hedge fund investors. The standard deviation of return is shown in equation (1.2) and can be found in almost any introductory statistics textbook

Analysis of Microfinance Investment Funds

Microfinance investment funds are vehicles or institutions that channel funds to the microfinance sector. The term covers a diversified range of vehicles with different missions, objectives and types of shareholders. MFIFs' sponsors range from NGOs or development agencies to commercial players. A useful definition is that microfinance investment funds are vehicles which have been specifically set up to invest in microfinance assets (in some cases with trade finance investments) in which social or commercial, private or institutional investors can invest. Foundations would not qualify as investment funds, but they would qualify as investors in microfinance and take stakes in microfinance investment funds. The results of a survey of investment funds are summarised in this section, with additional details in appendices to this paper. The survey, as noted previously, was conducted jointly by CGAP, The MIX and the author, on behalf of ADA in Luxembourg, between July and October 2004. It...

Other Hedge Fund Provisions

Funds allow entry into or exit out of the hedge fund at a limited number of times per year. Restricting flows to month-end, quarter-end, or year-end greatly simplifies the tax-reporting burden on the hedge fund administrator. Funds sometimes require investors to advise the manager in advance of withdrawing funds. Some managers require 10 to 90 days' notice to redeem hedge fund interests. These provisions, along with lockup provisions, seek to make hedge fund investments more sticky (investors remain in a hedge fund for a longer period of time).

Index fund investing the relatively new passive investment strategy

An alternative passive investment policy would be holding index funds. This happens to be the most prominent investment strategy at present. In this approach, money managers do not attempt to identify undervalued or overvalued stocks. Nor do they attempt to forecast general movements in the stock market and then structure the portfolio to take advantage of those movements. In this scenario, the only choice for investors is which index fund provides suitable portfolio diversification at the best price. The motivation for investing via index funds dates back to the early work of Treynor (1965), Sharpe (1966), and Jensen (1968).12 The findings of each of these writers are well summarized by Jensen, who concluded that there is little evidence that any individual fund was able to do significantly better than that which we expected from mere random chance. What these early writers highlighted was that a randomly selected benchmark portfolio could consistently outperform the average active...

Business Case A Hedge Fund Startup

Let us consider as an exemplification the start-up of a hedge fund. Let's try and estimate the profit of a fund management company, whose fee structure is 1.5 management fee and 20 performance fee. To make things simple, let's say that fees are collected at year-end, capital follows a linear growth, management fees are collected first, followed by performance fees, and that management fees are calculated based on the average asset value. We won't consider income taxes. Let's assume also that overhead costs, namely personnel costs, office rents and the depreciation of IT equipment, like servers and PCs, amount to 1.5 million per year (Table 1.4). Initial capital of the hedge fund in million dollars

Main Benefits of Microfinance Investment Funds

Since the early to mid-1990s, microfinance investment funds have increasingly been used to channel funding to MFIs and to scale up the microfinance industry. Regardless of the different types of investment funds and of the players involved, there are a number of benefits from continuing to use and expand MFIFs Risk diversification investors and donors are able to diversify their risks through investment funds by allocating resources to a wider and more diversified group of MFIs. Investor and donor coordination and harmonisation microfinance investment funds are an effective tool to promote coordination by their various participants. Harmonisation is difficult without a common structure. Wide range of financial and social objectives investment funds can be tailored to a wide range of objectives. They can fund sustainable MFIs and be targeted to commercial investors, they can assist greenfield MFIs and be funded by development agencies or private donors, they can focus on loans or on...

Costs Of Investing In Mutual Funds Fee Structure

An individual investor choosing a mutual fund should consider not only the fund's stated investment policy and past performance, but also its management fees and other expenses. Comparative data on virtually all important aspects of mutual funds are available in the annual reports prepared by Wiesenberger Investment Companies Services or in Morningstar's Mutual Fund Sourcebook, which can be found in many academic and public libraries. You should be aware of four general classes of fees. Operating expenses Operating expenses are the costs incurred by the mutual fund in operating the portfolio, including administrative expenses and advisory fees paid to the investment manager. These expenses, usually expressed as a percentage of total assets under management, may range from 0.2 to 2 . Shareholders do not receive an explicit bill for these operating expenses however, the expenses periodically are deducted from the assets of the fund. Shareholders pay for these expenses through the...

The Construction Of A Segregated Portfolio Of Hedge Funds

Hedge strategies can be used in a portfolio of diversified assets or in a portfolio that is dedicated only to hedge funds. In a blended portfolio of all types of assets, the inclusion of hedge strategies can provide performance enhancement as well as risk reduction through diversification. There are numerous factors that determine the returns and volatility in hedge strategies and that also are present in traditional asset classes, which is discussed in more detail in Chapter 11. When considering the use of only hedge strategies in an optimized portfolio, some of the same principles are present as is the case in other asset optimizations. For instance, the use of constraints for the maximum allowable allocations to any one hedge strategy generates an efficient frontier that is optimized in its risk and return output. As illustrated in Figure 3.2, a lack of constraints in an optimizer using these strategies provides an efficient frontier that has an extended risk spectrum relative to...

Taxation Of Mutual Fund Income

Investment returns of mutual funds are granted pass-through status under the U.S. tax code, meaning that taxes are paid only by the investor in the mutual fund, not by the fund itself. The income is treated as passed through to the investor as long as the fund meets several requirements, most notably that at least 90 of all income is distributed to shareholders. In addition, the fund must receive less than 30 of its gross income from the sale of securities held for less than three months, and the fund must satisfy some diversification criteria. Actually, the earnings pass-through requirements can be even more stringent than 90 , since to avoid a separate excise tax, a fund must distribute at least 98 of income in the calendar year that it is earned. The pass through of investment income has one important disadvantage for individual investors. If you manage your own portfolio, you decide when to realize capital gains and losses on any security therefore, you can time those realizations...

Who Categorizes Hedge Funds

Many types of organizations label hedge funds according to the style or investment philosophy they follow. Hedge funds frequently categorize themselves in their disclosure documents and marketing literature. Hedge fund data providers such as Evaluation Associates Capital Markets (EACM), CSFB Tremont, Hennessee, Hedge Fund Research (HFR), and the Center for International Securities and Derivatives Markets (CISDM) track thousands of hedge funds and assign most of them to 10 or 15 styles. (Data from these providers can be used to study the characteristics of the types of hedge funds discussed here.) A growing industry of hedge fund indexers begins by creating a benchmark that can be replicated then the indexers invest in individual funds to create a portfolio that tracks their benchmarks. The media often classifies hedge funds, sometimes without regard to the facts. Finally, analysts and academic researchers may categorize hedge funds based on their actual performance, explaining returns...

Mutual Fund Investment Performance A First Look

We noted earlier that one of the benefits of mutual funds for the individual investor is the ability to delegate management of the portfolio to investment professionals. The investor retains control over the broad features of the overall portfolio through the asset allocation decision Each individual chooses the percentages of the portfolio to invest in bond funds versus equity funds versus money market funds, and so forth, but can leave the specific security selection decisions within each investment class to the managers of each fund. Shareholders hope that these portfolio managers can achieve better investment performance than they could obtain on their own. What is the investment record of the mutual fund industry This seemingly straightforward question is deceptively difficult to answer because we need a standard against which to evaluate performance. For example, we clearly would not want to compare the investment performance of an equity fund to the rate of return available in...

Personalized Mini Mutual Fund

Instead of agonizing over which stock will outperform in a certain sector, you can use ETFs as an investment vehicle that has certain stocks in a basket as one unit, listed as a sector fund. This allows individual investors to invest in a group of stocks in a sector, rather than relying on a mutual fund to do it for them. Moreover, many mutual funds charge management fees and at times do not fully invest all an investor's cash in the market. Because ETFs trade like a stock, the price of which fluctuates daily, an ETF does not have its net asset value (NAV) calculated every day like a mutual fund. By owning an ETF, you get the diversification of an index fund plus the ability to sell short, buy on margin, and purchase as little as one share. Another advantage of an ETF is that the expense ratios for most ETFs are lower than that of the average mutual fund. When buying and selling ETFs, you have to pay the same commission to your broker that you'd pay on any regular order. ETFs allow...

Inconsistency of Hedge Fund Categorizations

Regardless of how and why hedge funds are classified, the results are occasionally inconsistent. Sometimes categories overlap, so the choice of strategy is a bit arbitrary. Sometimes a fund will shift strategies gradually (called style drift) one data provider might classify the fund by the current strategy and another might include it in the style previously followed. Some funds may be tough to categorize because the manager deviates from the announced strategy. Other funds may follow multiple strategies so can't fit into a single category. Finally, some funds may be erroneously classified either because of human error or because there aren't enough categories to match all hedge funds.

International index funds versus actively managed international funds

Of course, the debate surrounding index funds that invest abroad is not completely devoid of passion. Active managers might privately concede that, overall, index funds could indeed be better choices, if all else is equal in the most established of the world's financial markets however, they contend that this is far from being the case in the less well-known markets. They claim that inefficiencies such as poor research in many foreign markets, and illiquidity of some of the stocks contained in the indexes, give their funds certain advantages passively run index funds must invest in these stocks, whereas active managers can shun them. This is certainly BNGI typically charges an annual fee of 14 basis points for a 10 billion domestic equity portfolio geared to the Topix. That compares with 26 basis points charged by IACs that manage active portfolios and 32 basis points levied by trust banks. Another selling point Some trust banks are in fact using indexing techniques to handle a...

Hedge Funds The Dark Side

I explore the world of hedge funds in fuller detail later in the book (most specifically in Chapter 7), but on a purely factual basis, let's explore the dark side before getting carried away on a sea of alternative investment media hype. Hedge funds by definition would have us assume that they are hedging us from risk. Most retail investors have only a vague idea of what hedge funds actually do to make money, or why hedge fund managers are able to charge fees that would be seen as obscene by those in the mutual fund industry. (Factually, hedge fund fees are far cheaper than mutual fund or brokerage fees in years they fail to make profits.) Retail investors hear that hedge funds are hot, and they are for the superrich. Some of them blow up and go to zero, but others make big profits in bull markets and bear markets alike. And they wield enormous power over the financial markets and the companies whose stocks they invest in. Successful hedge fund managers receive sizable salaries by...

Face Off Mutual Funds Versus individual Securities

According to a recent slew of books, newsletters, and magazine articles, (stock) mutual funds are not the place to be. They're boring, conservative, and totally unsexy. An amateur who devotes a small amount of study to companies in an industry he or she knows something about can outperform 95 percent of the paid experts who manage mutual funds, plus have fun in doing it. - Peter Lynch, Beating the Street

The Virtues of Index Funds

Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. ith more than 5 trillion indexed globally by the end of 2006, growing by at least a half trillion a year, it is safe to say that indexing has caught on all over the world. And for many compelling reasons. In this chapter, we present the many merits of index funds and show why this simple investment strategy has become such a valuable tool for investors. To properly frame its many benefits, we compare the index fund with its primary competition the legions of actively managed funds.

Fixed Income Hedge Funds

Fixed Income Arbitrage Fixed income arbitrage funds rely primarily on debt instruments. Sometimes the group is called just fixed income fund to recognize that some of these funds retain substantial risks, albeit typi Fixed income arbitrage funds have very effective hedges because interest rates tend to move up and down together (to a lesser extent when hedges span international borders or involve significantly different default risks). Because these hedges remove much of the day-to-day portfolio risks, arbitrage funds or arb funds usually have the highest leverage of all hedge fund strategies. Fixed income arb funds may have sizable positions in foreign currencies but the currency exposure is usually hedged away. Similarly, the funds frequently buy individual issues that have considerable interest rate risk. However, this category of hedge fund would hedge away most of this risk. As a group, fixed income funds have produced the lowest returns over time. However, the returns are rather...

Hedge Fund And Mutual Fund Taxesbuyers Beware

Hedge funds and funds of funds (limited partnerships in general) can have some very complex tax structures. Few of them are tax efficient simply because few strategies can succeed by simply buying and holding their investments. It is normal for a hedge fund, or fund of funds, to have a tax flow-through of 100 percent short-term gains or ordinary income. I find that acceptable if the trade-off for paying the taxes as you go offers less risk and higher returns than traditional investments over typical 5-to-10-year periods. However, there are some extremely tax-inefficient strategies that can wreak havoc with your tax bottom line. You, your adviser, and or your fund of funds manager must be held to the fire about doing proper tax analysis with any hedge fund manager you may be directly (or indirectly through a fund of funds) invested with. The question is, What is the net (after all fees) after-tax performance of this investment You may put individual retirement accounts (IRAs) into...

Other Hedge Fund Strategies

With 8,000 or more hedge funds in existence, it is not surprising that they do not fit neatly into a few categories. Other categories are important not so much because of the assets committed to these strategies but rather because they extend the range of investment opportunities. Global Macro The global macro hedge funds brought the concept of hedge fund trading to the attention of many investors for the first time. These funds generally started out as equity portfolios but the managers also traded debt and foreign currency. Despite being called hedge funds, these funds generally take speculative, directional positions in stocks, bonds, and currencies worldwide, based on macroeconomic forecasts. Global macro hedge funds have some of the highest returns of all hedge fund strategies. Nevertheless, the volatility of returns is (at least as a group) lower than stock market volatilities but considerably higher than most hedge fund strategies. Because these funds may take either long or...

The Positive Side of Hedge Fund Taxes versus Mutual Fund Taxes

Many mutual funds have unrealized gains hidden in their portfolios, so that when you take money out, or when one of your mutual funds sells those positions while you are still invested, massive amounts of realized gains (far beyond what you have personally gained in your account) may need to be reported on your taxes, leaving you with a potentially enormous tax burden. These types of unfair realized gains tax flow-throughs rarely, if ever, occur with hedge fund investing. Many investors from 2000 to 2002 lost huge sums of money in their mutual funds and also ended up with outrageous tax bills. But it can happen at other times as well. For instance, suppose you are invested in a mutual fund, and were even losing money in your account. If the fund then sells long-held stock positions that had made great profits for the fund before you invested, you would be held responsible for a percentage of the long- or short-term capital gains tax from the sale of the stock. In other words, you...

Managed Investment Alternatives to Mutual Funds

The unbelievably wide variety of mutual funds enables you to invest in everything from short-term money market securities to corporate bonds, U.S. and international stocks, precious metals companies, and even real estate. Although mutual funds can fill many investing needs as I discuss in Chapter 1 you may be interested in and benefit from directly investing in things such as real estate, your own business, and many other investments. Other types of privately managed investment accounts exist that have some things in common with mutual funds.

Return Compression In Hedge Funds Has Led To An Increased Interest In Investing In Commodities

Over the past 10 years, not only has the number of hedge funds quadrupled but also the assets under management have grown exponentially. There are currently an estimated 8,000 hedge funds, which in aggregate manage about 1 trillion. As hedge fund assets grow, one wonders whether the inefficiencies that initially brought them success will still be available to exploit. Performance in general seems to be deteriorating. In the late 1990's, no one would touch a fund that did not claim to be able to make 15 a year. Now investors seem happy with a promise of high single-digit returns, noted the Economist (2004). Exhibit 1 illustrates how in general hedge funds have underperformed the U.S. equity market and, for that matter, commodities over the 2-year timeframe, March 2003 through March 2005. The high fees available to hedge fund managers have caused traditional managers to migrate to the hedge fund space. Unfortunately for existing hedge fund managers, those moving into hedge funds are the...

Figure 66 Mutual Fund Shareholder Accounting Example

How dramatic can this injustice between shareholders be To answer this question we need to look back to 1987- During the correction of 1987, stocks rose significantly during the summer and early fall, but then they hemorrhaged in the third week of October. Many mutual funds h ave October 31 as their fiscal year-end. Therefore, there were cases where ind ividual inves tors p urchased shares in equity mutual funds, saw their investment drop 20 percent or so in value, and then got hit with a sizable capital gains distribution. Fortunately, the market gradually rebounded, but many of those investors were forced to sell shares at unfavorable prices to cover the ir tax bill the following year.

Figure 67 Mutual Fund Example Profit vs Capital Gains Distributions

Each individual an annual deduction from capital gains distributions.11 Also, Congressman Paul Ryan has introduced legislation (H.R. 1989) that would require individuals to pay taxes on capital gains only when they s ell fun d shares. 12 Both proposals are intended to make things easier fo r mutual fund investors. However, what is often ignored is that these bills would only exacerbate the problem of portfolio managers ignoring the impact of taxes . Moreover, as we will discover in chapter 9, there are already free market solutions that have solved this issue. Unfortunately, tax-aware s olu tions do not vote and the shareholders who use them still represent a small portion of the market. If Congress really wants to pro-vid e inves tors with a meaningful change, it should change the accounting co nvention for mutual funds to allow losses to flow through to investors. I t may take several years, if ever, for a fund manager to take advantage of the 1 oss position, whereas individual...

Types of Hedge Fund Investors

The individuals and institutions that invest in hedge funds are surprisingly different in terms of risk tolerance, investment horizon, investment objectives, and investment restrictions. (See Figure 3.1.) Many of the differences between investors involve the way they are taxed (if they are taxed at all). This chapter includes a discussion of the tax treatment of these investor types. (Hedge funds usually pay little or no tax but must flow through the taxable amounts to investors in many countries, including the United States. For a description of how a partnership calculates the tax consequences of the hedge fund investments, see Chapter 10.) FIGURE 3.1 Hedge Fund Investors, December 31, 1999 Source Tass Research. FIGURE 3.1 Hedge Fund Investors, December 31, 1999 Source Tass Research.

Index Fund Advantages

The index fund 's long-term return advantage is impressive, even overwhelming. The problem is not that active managers lack talent. The superiority of the index is - tructural the advent of the mutual fund and the growth in the professional asset management industry has led this hard-working group of investment professionals to, for all intents and purposes, become the market. The total market is capitalization-weighted, as are the indexers. Take away the index funds, and what 's left is essentially the same portfolio. The aggregate portfolio that active managers collectively own give or take a little wiggle room is that selfsame index So the average active manager dollar weighted should have the same returns as the index funds before costs. But active managers ' costs and fees are higher, so their average net returns to investors must be lower. So, how long would it take to determine whether a typical manager has skill For a manager with an information ratio of 0.3 the median for...

Closedend Mutual Funds

Closed-end mutual funds are somewhat similar to corporations because they issue fixed numbers of shares. This doesn't fluctuate, with the exception of when a new stock may be issued. The funds may issue bonds or preferred stock to support the common shareholders' positions. They then use their capital and other resources to invest in other companies' securities. Closed-end funds are not nearly as common as open-end funds. Closed-end funds' shares are bought and sold at market like other mutual fund shares and shares of stock. Their prices are dependent Net asset value The true value of a share of a mutual fund. It is calculated by taking the total value of all assets and other securities of the fund, less any of the fund's liabilities, and dividing that number by the number of the fund's outstanding shares. NAV is valued on a daily basis. Breakpoint The dollar amount at which the investor is entitled to a lesser sales charge. Rights of accumulation Amount of money already invested in...

Figure 610 Sample Mutual Fund Accounting Format

Mutual fund dends are distributed, there is very little income left, if any, after the fund uses it to offset expenses. The groups of shareholders receiving almost all o f the b enefit o f the favorab le tax l egisl at i o n are thos e investe d in low-fe e ind ex-orien ted mutual or exchange-traded funds. For a shareholder in a fund with a fee of 0.2 percent, the lower tax on dividends resulted in an enhancement in after-tax return of 0.33 percent ( 1.6 - 0.2 x 38.5 - 15.0 ) annually versus 0.02 percent ( 1.6 - 1.5 x 38.5 15-0 ), or almost nothing for the average actively managed equity fund. Once again, this example shows how important fees and a basic understanding of the tax code can be. When this legislation came about, the author was interviewed by a major financial services magazine and made this his number one point. Do you think it was included when the s tory went to press Of course not, because low-fee funds don't support advertising budgets This occurrence supports the...

History Of The First Hedge Fund

As already said in Chapter 1, Alfred Winslow Jones (1923-1989) is considered the father of the first hedge fund. During World War II he was a writer and editorfor Fortune magazine covering a variety of topics from finance, to politics, to the war effort. By 1948 he had left Fortune but was working on a freelance article for the magazine entitled Fashions in Forecasting. It was while researching this piece that he interviewed the most successful money managers of the time and began to formulate ideas for a new type of fund. Jones was not convinced of his ability to predict the direction of the market consistently. He thought he had good stock picking skills but admitted that he was not able to predict the direction of market trends. The realization that one could use speculative techniques to conservative ends was the most important step in forming the hedge fund. In 1949, Jones formed a general partnership with four friends, became the Managing Partner, and started a long short equity...

Harald Mcpike Hedge Fund Nassau

Paul Samuelson

Members of (A) include Ed Thorp (Princeton Newport and later funds), Bill Benter (the Hong Kong racing guru), Blair Hull, Harry McPike, Jim Simons (Renaissance hedge fund), Jeff Yass (Susquehanna Group), David Swensen, Nikolai Battoo (a private trader with unique criterion applications) and me. Blowouts occur more in hedge funds that do not focus on not losing and true diversification and over-bet when a bad scenario hits them, they get wiped out, such as LTCM, Niederhofer, and Amaranth see Chapters 11-13 and the June 2007 Bear Stearns hedge fund blowout bond blow up see our forthcoming column in Wilmott that discusses this typical hedge fund blowup and the wider August 2007 sub-prime world wide equity, banking and bond market crisis. My idea of using scenario dependent correlation matrices, see Chapter 21 is very important here.

Figure 42 Average Turnover Rates for Morningstar Categories versus Representative Index Funds 2002 through 2006

Turnover is average of five calendar years ending 2006. Representative index funds include Schwab S& P 500 Index Investor Class for Large Blend, Schwab Small Cap Index for Small Blend, and Vanguard Developed Markets Index for International Large Blend. Source Research Affiliates, LLC. that subsequently increase to their fair value, these stocks are sold, often for a sizable, realizable gain. New stocks are purchased to replace the sales, resulting in much higher turnover than the indexers have. This fact is evident from a quick comparison of annual turnover rates of different mutual fund categories versus representative index funds in Figure 4.2. The gap between index funds and active managers only widens when taxes are taken into consideration. A 2000 study by Arnott, Berkin, and Ye found that only 14 percent of actively managed equity mutual funds managed to outperform the Vanguard 500 Index Fund after capital gains and dividend taxes over a...

Accomplishing Goats With Mutual Funds

Mutual funds can help you accomplish various financial goals. The rest of this chapter gives an overview of some of these more common goals saving for retirement, buying a home, paying for college costs, and so on that can be tackled with the help of mutual funds. For each goal, I mention what kinds of funds are best suited to it, and I point you to the part of the book that discusses that kind of fund in greater detail. You'll start to see how important goal identification is in the mutual fund selection process. In most cases, only a few fund categories are appropriate for a specific financial goal. Once you've got your fund category, simply peruse Chapters 7 through 9 to find the best individual funds in that fund category. fund is appropriate. If you need to tap into the money within two or three years or less, a money market or short-term bond fund may fit the bill. If your time horizon falls between three and seven years, you want to focus on bond funds. For long-term goals,...

Table 51 General Surrender Charges for Class B Mutual Funds

When an investor purchases Class B shares of a mutual fund, he or she does so at NAV thus ensuring that the entire amount of money is invested. However, if the shares are redeemed within the first six years, the investor will pay a surrender charge. The shares will be redeemed at NAV but then the applicable load will be subtracted. The surrender charge schedule for Class B shares is a declining one. After nine years, Class B shares revert to Class A shares, although no front-end sales load will be assessed at that time. Table 5.1 shows a sample of the surrender charges for Class B mutual funds. Although this is the standard for surrender charges, some mutual fund companies may charge on a different scale. The time frame will remain the same, but the initial CDSC may be less, and the corresponding years and CDSC rates may be different than what is listed above. Although investors are charged a surrender charge for redeeming their shares prior to holding the fund for seven years, if...

Why Foundations Invest in Hedge Funds

Foundations invest in hedge funds for many of the same reasons that other types of investors incorporate hedge funds into their portfolios. A foundation that earns high returns can increase the funding of projects consistent with its objectives. Because of the 5 percent distribution requirement, a foundation needs to earn a substantial real return to preserve the size of the foundation relative to inflation. A foundation may also invest in hedge funds to get the benefit of lower risk, either by incorporating hedge funds with low volatility of returns or by investing in hedge funds with low correlation to other assets in the foundation portfolio. All investors like to lower the risk in their portfolios if this is possible with little reduction in expected return. Foundations may be particularly sensitive to the effects of a short-term loss in a portfolio because the combination of the loss and the commitments the foundation has made to make distributions may shrink the size of the...

Foundations as Hedge Fund Investors

Because of the threat of unrelated business income tax (UBIT), foundations tend to avoid investing in highly leveraged hedge funds. As a result, foundations are less likely to invest in convertible bond strategies and fixed income arbitrage strategies, which can have leverage of 6 1 up to 40 1, unless the hedge fund is located offshore and organized as a corporation so that the foundation is not allocated significant interest expenses. Foundations often invest in hedge funds by hiring consultants to aid in determining a portfolio strategy, suggest individual funds within a strategy, and perform due diligence analysis of alternatives. Foundations may also invest in funds of hedge funds and rely on the fund of funds manager for asset allocation, due diligence, and so on.

Why Endowments Invest in Hedge Funds

Many endowments have been long-term investors in alternative assets, including real estate, venture capital, and hedge funds. Endowments may be motivated by higher returns, lower risk, or low correlations, much like other investors. The endowments of Harvard University and Yale University along with other prominent university endowments have earned spectacular returns from these alternative assets. Other endowments may feel a degree of peer pressure to include some alternative assets in their portfolios.

In your recent letters to clients youve been surprisingly critical of some mutual fund managers

What is happening now May 1999 in the fund industry is not only dangerous but it's also downright insidious. Many of the largest public funds that individual investors believe are being actively managed, with stocks presumably being selected based on fundamental merits, are actually closet index funds. What do you mean Take Fidelity Magellan as an example. When Peter Lynch managed the fund, he typically held one thousand to two thousand stocks. He picked stocks based on value and earnings expectations, and his performance was exemplary. During his thirteen-year stewardship, the fund averaged a 29 percent return, nearly doubling the S& P 500 gains of 16 percent. Now the fund holds only about three hundred stocks, with most of the money concentrated in about twenty-five core positions, even though assets have mushroomed from 12 billion to 90 billion since Peter Lynch's departure. The fact that their portfolio is composed almost entirely of the highest capitalization S& P 500...

Corporations And Hedge Fund Investments

Corporations (including U.S. companies and foreign businesses) invest in hedge funds for a variety of reasons. For example, some corporations invest in hedge funds with low-volatility, nondirectional strategies to improve the return on cash balances that aren't required for the company's cash management needs. Other corporations invest in hedge funds to increase the company return on assets or to reduce the company's sensitivity to volatile operating results. Corporations pay corporate income tax on hedge fund returns. When these returns are eventually distributed to shareholders as dividends, shareholders pay ordinary income tax on the same returns. It would seem to make more sense for such cash-rich companies to distribute cash to shareholders, who could decide to invest the cash in hedge funds or other financial assets or reinvest the dividends back in the company by buying more shares. The situation is complicated because any distribution to shareholders would likely be taxed as a...

Pension Fund As Hedge Fund Investors

Individually directed plans are discussed earlier in this chapter along with other types of individual investments in hedge funds. This section discusses traditional company-sponsored pension plans. Like the IRA and Keogh plan, it makes sense for highly taxed workers who can qualify based on their incomes, net worth, and investment knowledge to invest their defined contribution balances in hedge funds. These investments would benefit from the tax deferral on the investment returns of the hedge funds. However, individuals can elect to invest in hedge funds only if the plan sponsor (usually the employer) offers that as an option. Yet most group defined contribution plans have been replaced by individually directed 401(k) plans, so company defined contribution plans are not a source of funding for hedge funds. In a defined benefit plan, an employer makes a commitment to fund a retirement benefit at a particular level. It is typical to guarantee some percent of salary upon retirement...

Specialized Longshort Equity Funds

We can find hedge funds with geographical focus by country (United States, United Kingdom, Japan, etc.), as well as by geographical region (Europe, Asia, etc.). Among the geographical specializations, emerging markets are particularly important, such as Brazil, Russia, India, China, Korea, etc. In the 1990s, there was a mushrooming of hedge funds specialized in high-growth sectors, like technology, telecommunications, biotechnologies, financial services, natural resources, etc. Based on this specialization, the manager offers a focused sector exposure, trying to put his past working experience in a given field to work. Typically, these managers set up the hedge fund portfolio along a bottom-up approach, and compared to generalist hedge funds, they often have a greater concentration in single positions, are more aggressive and have a long bias on a single industry or a single geographical area. Technology gives access to a series of new applications that open up new investment...

Varieties Of Mutual Funds

Just as you can categorize common stocks, you can classify mutual funds. Each individual fund has a specific objective or specialty however, many funds may all have some of the same underlying stocks as their investments. When choosing mutual funds in which to invest, it's important to do some research so you don't wind up buying four different mutual funds that each have the same companies' stock inside. That would defeat the purpose of diversifying your portfolio. Mutual funds don't have to invest just in common stock from corporations there are many funds that are bond funds, international funds, and hybrid funds. Equity Funds These are mutual funds that invest their assets in the common stock of corporations. There are different types of equity funds. Equity mutual funds are the most common type of fund traded and held. Growth Funds. Primarily, growth funds hold the common stock of more proven, larger growth-oriented corporations. These funds are akin to growth stocks. The goal of...

Insurance Companies As Hedge Fund Investors

Insurance companies in the major financial centers of the world control large amounts of financial assets but they are not large investors in hedge funds. Insurance companies themselves have two sources of funds that might be invested in hedge funds. First, insurance companies have capital, much like any other kind of business. This capital is generally called surplus. The second source of investment dollars is the deferred amounts set aside to pay future claims, called reserves. The payments are delayed for a variety of reasons. In many cases, the amount payable will be determined by a lawsuit that has not yet worked through the judicial system. Insurance companies invest the money set aside to pay claims and use the investment returns to help pay the settlement amount. All of these balances could arguably be invested in hedge funds. Insurance companies can invest a limited amount of their funds in common stocks, real estate, and other potentially risky assets. With the average hedge...

Consultants And Hedge Fund Investing

Many new hedge fund investors hire consultants to assist in the decisionmaking processes. Although the consultants do not invest their own money in hedge funds, they can influence on how moneys are invested. Large institutional investors are more likely to hire consultants to review their hedge fund investments. Pension funds, endowments, and foun dations are more likely to employ consultants than other types of hedge fund investors. Consultants are more sophisticated than the typical hedge fund investor. Consultants are generally not impressed with high-risk high-reward strategies. In general, they focus on funds that deliver consistent, high returns relative to the amount of risk involved with the strategy.

The Double Standard in Mutual Funds

Writing in Fortune magazine late in 1997, Joseph Nocera pointed out the obvious inconsistencies between what mutual fund managers recommend to their shareholders buy and hold and The obvious question becomes If investors are counseled to wisely buy and hold, why do managers frenetically buy and sell stocks each year The answer, says Nocera, is that the internal dynamics of the fund industry make it almost impossible for fund managers to look beyond the short term.2 Why Because the business of mutual funds has turned into a senseless short-term game of who has best performance, measured totally by price. Today, there is substantial pressure on portfolio managers to generate eye-catching short-term performance numbers. These numbers attract a lot of attention. Every three months, leading publications such as the Wall Street Journal and Barron's publish quarterly performance rankings of mutual funds. The funds that have done best in the past three months move to the top of the list, are...

Money Market Mutual Funds

One of the more widely held investment vehicles, money market mutual funds, or money market funds, provide the investor with a highly secure, liquid account that earns interest. These funds are gen erally used to stabilize a portfolio, as well as be the cash portion of the asset allocation. Money market funds are thought of as cash investments because the mutual fund company usually sells shares for 1 apiece, as well as usually redeeming the shares for 1 each. These accounts may also offer the investor check-writing privileges. While these accounts do earn interest, it's usually a far cry from what the investor may earn if the money were invested in the stock market or in bonds. However, the interest rates on money market funds are much higher than a regular savings account at a bank. These accounts are designed to be liquid, safe, and convenient. They, therefore, make an excellent choice to hold cash reserve money. Be aware, though, that the mutual fund companies may not redeem the...

Index Funds Demands for Stock

We will see shortly that index funds play an important role in portfolio selection, so let's see how an index fund would derive its demand for shares. Suppose that 130 million of investor funds in our hypothesized economy are given to an index fund named Index to manage. What will it do Index's demand curve for BU shares is plotted in Figure 7.2 next to Sigma's demand, and in Figure 7.3 for TD shares. Index's demand is smaller than Sigma's because its budget is smaller. Moreover, the demand curve of the index fund is very steep, or inelastic, that is, demand hardly responds to price changes. This is because an index fund's demand for shares does not respond to expected returns. Index funds seek only to replicate market proportions. As the stock price goes up, so does its proportion in the market. This leads the index fund to invest more in the stock. Nevertheless, because each share costs more, the fund will desire fewer shares.

Hedge Fund Investment Techniques

Despite the mystery surrounding hedge funds, they employ investment techniques that are also used in traditional portfolio management, in broker-dealers, or in commodity pools. In fact, many hedge fund managers gained their expertise working in broker-dealers, mutual funds, or futures funds. Therefore, the description of hedge fund techniques that follows includes discussion of methods that are not unique to hedge funds. Hedge funds differ from other types of trading entities in many ways, though, and, not surprisingly, have adapted techniques to their unique needs. For example, a hedge fund can use leverage and has very few restrictions on applying risk management techniques. Hedge funds are able to take either long or short positions in securities. Hedge funds face few restraints on the size of positions, characteristics of those positions, or issues of investment style or strategy. Finally, hedge funds are free to apply a wide range of techniques to create investment portfolios.

Differential Source Of Returns To Managed Futures Hedge Funds And Traditional Assets

The real benefit of managed futures is the provision of sources of returns that are uniquely different from traditional stock or bonds or even hedge funds. For instance, hedge funds have been marketed as offering unique risk and return properties that are not easily available through traditional investment securities or investment products. These return opportunities stem from the expanded universe of securities available to trade and to the broader range of trading strategies. One reason for the supposedly low correlation and potential diversification benefit is that hedge funds often describe themselves as employing skill-based investment strategies that do not explicitly attempt to track a particular index. Because their goal is to maximize long-term returns independently of a proscribed traditional stock and bond index, they emphasize absolute returns and not returns relative to a predetermined index. It is important to realize, however, that although hedge funds do not emphasize...

Common Hedge Fund Techniques

Chapter 2 describes the most popular hedge fund strategies. This chapter reviews some of the most popular hedge fund investment techniques, organized according to the type of hedge fund strategy mostly closely associated with the technique. Hedge funds are free to adopt more than one of the methods listed. Hedge funds of a particular style may also develop techniques that differ from the following methods to improve return or to modify the types of risks to the investor. Hedge funds use the investment techniques found in traditional investment textbooks and portfolio management textbooks. These traditional methods are often divided into fundamental and technical techniques. Funda Like traditional asset managers, hedge funds may be organized as top-down or bottom-up investors. A top-down investment organization begins by making macroeconomic forecasts, then makes forecasts for returns on broad classes of assets. Next, the firm makes asset allocation decisions among stocks, bonds,...

Mutual Funds And Other Investment Companies

The previous chapter introduced you to the mechanics of trading securities and the structure of the markets in which securities trade. Increasingly, however, individual investors are choosing not to trade securities directly for their own accounts. Instead, they direct their funds to investment companies that purchase securities on their behalf. The most important of these financial intermediaries are open-end investment companies, more commonly known as mutual funds, to which we devote most of this chapter. We also touch briefly on other types of investment companies such as unit investment trusts and closed-end funds. We begin the chapter by describing and comparing the various types of investment companies available to investors. We then examine the functions of mutual funds, their investment styles and policies, and the costs of investing in these funds. Next we take a first look at the investment performance of these funds. We consider the impact of expenses and turnover on net...

Gamblers As Hedge Fund Managers

I have been fortunate to work and consult with seven individuals who used investment market anomalies and imperfections and hedge funds ideas to turn a humble beginning with essentially zero wealth into hundreds of millions or billions. Each had several common characteristics a gambling background usually obtained by playing blackjack professionally and a very focused, fully researched and computerized system for asset position selection and careful attention to the possibility of loss. These individuals focus more on not losing rather than winning. Three were relative value long short managers consistently eaking out small edges who extensively used derivatives. One was a futures trader taking bets on a large number of liquid financial assets based on favorable trends (interest rates, bonds and currencies were the best). The fifth was a Hong Kong horse race bettor see Benter's paper in Hausch, Lo and Ziemba (1994). The sixth, James Simons of Renaissance, was in 2005 the top hedge...

Finding Information About Mutual Funds

As with common stocks, there are a number of places to find accurate, reliable information about mutual funds. The best place to look is the mutual fund's prospectus. A prospectus is a legal document prepared by the mutual fund company. It is filed with the Securities and Exchange Commission and lists the most recent information about the fund. These are produced once a year. However, some fund families put out revised prospectuses throughout the year. A prospectus will include an expense summary for the fund, the fund's investment strategy and risks, any minimum purchase restrictions, financial highlights of the fund, and many other useful bits of information. The prospectus will also disclose the different types of securities and assets that the particular fund is allowed to invest in. Each mutual fund has its own prospectus. Another good source of information is a mutual fund's semiannual or quarterly report. Often times, this is included in the prospectus booklet, but it can also...

Investing Through A Fund Of Hedge Funds

Unlike traditional investments, hedge funds require a distinct due diligence process that is usually best undertaken by professionals with specific expertise in alternative investments. Because of the complexity involved, investors are increasingly availing themselves of the opportunity to make alternative investment allocations through a pooled vehicle managed by a hedge fund expert, namely a fund of hedge funds (FOHF). These portfolios of hedge funds can offer the most attractive risk-adjusted rates of return with low to zero correlation to most traditional portfolios and far less volatility. (See Figure 1.2.) For those who do not meet the definition of an accredited investor, investing in a fund of hedge funds is currently the only way to gain access to absolute return strategies in any form. Thanks to an increas- Single Hedge Fund Minimum investment 1 million per hedge funda FIGURE 1.2 Two Primary Approaches to Investing in Hedge Funds. aTo achieve the diversification for managing...

Discount Brokers Mutual Fund Supermarkets

For many years, you could only purchase no-load mutual funds directly from mutual fund companies. If you wanted to buy some funds at, say, Vanguard, Fidelity, T. Rowe Price, and USAA, you needed to call these four different companies and request each firm's application. So you ended up filling out four different sets of forms and mailing them with four envelopes, four stamps, and four separate checks. Soon, you received separate statements from each of the four fund companies reporting how your investments were doing. (Some fund companies make this even more of a paperwork nightmare by sending you a separate statement for each individual mutual fund that you buy through them.) Now suppose that you wanted to sell one of your USAA funds and invest the proceeds at Fidelity. This was also a time-consuming pain in the posterior, because you contacted USAA to sell, waited days for them to send you a check for the sales' proceeds, and then sent the money with instructions to Fidelity. It...

Reinventing the Investment Fund

It's not hard to find strong, consistent, and well-reasoned criticism of investment products and services. From insider industry critics like John Bogle, founder of the Vanguard Group, to crusading journalists and high-profile politicians, proponents of change in the financial-services industry in general and fund management in particular are everywhere. Most reform rhetoric focuses on eliminating conflicts of interest and extracting large financial settlements from alleged offenders. Ironically, few of the changes wrought or even proposed will improve the efficiency or effectiveness of the investment process very much. The changes we propose will reduce costs substantially, improve the use of research information in the fund-management industry, and ultimately improve investor performance. We describe how to build a better pooled investment fund product the self-indexing fund (SIF) by improving the structure of contemporary fund products. We measure, at least in an approximate way,...

The Failure Of The Top Hedge Fund Team Ever Assembled

There have been many hedge fund failures but LTCM stands out as a particularly public one. The firm started with the talents of the core bond traders from John Merriwether's group at the Salomon Brothers who were very successful for a number of years. When Warren Buffett came on board at Salomon the culture of this group clashed with Buffett's apparently more conservative style. In truth Buffett's record is Kelly like and not all that Such losses occur from time to time in various markets and hedge funds which overbet can be very vulnerable to it. The problem for LTCM was that they had 1.25 trillion of positions in notional value (that's about 1 of the December 2006 value of the world's derivatives and even more in 1998) and 125 billion of borrowed money. Although the trades were all over the world and hence it seemed they were diversified, they in fact were not. What happened was a scenario dependent correlation situation like that modeled in the Innovest pension application...

Investing in Investment Funds

One course open to the defensive investor is to put his money into investment-company shares. Those that are redeemable on demand by the holder, at net asset value, are commonly known as mutual funds (or open-end funds). Most of these are actively selling additional shares through a corps of salesmen. Those with nonredeemable shares are called closed-end companies or funds the number of their shares remains relatively constant. All of the funds of any importance are registered with the Securities & Exchange Commission (SEC), and are subject to its regulations and controls.* The industry is a very large one. At the end of 1970 there were 383 funds registered with the SEC, having assets totaling 54.6 billions. Of these 356 companies, with 50.6 billions, were mutual funds, and 27 companies with 4.0 billions, were closed-end.t There are different ways of classifying the funds. One is by the broad division of their portfolio they are balanced funds if they have a significant (generally...

Figure 92 Expense Ratio and Transaction Cost Differences Silent vs Benchmark Index Funds

Net benchmark index fund disadvantage licensing arrangement, most of their license fees fall in the range of 1.5 5 basis points, with most of the fund assets above the midpoint of that range. Most other large benchmark index ETFs pay annual license fees of 3 6 basis points, with one large fund apparently paying an effective license fee significantly above that range. Actively managed funds usually pay no index license fees. Like benchmark indices, silent indices for self-indexing funds incur some market-impact transaction costs when a portfolio is changed, even if market impact is not exacerbated by publication of the index change before the fund has an opportunity to trade. Our estimates, based on the assumed annual expenses in FiGuRE 9.2, show a minimum net disadvantage for large-cap benchmark index ETFs of 20 basis points (0.20 percent) and a maximum net disadvantage on small-cap index funds (for example, Russell 2000) of 190 basis points (1.90 percent). Other numbers in Figure 9.2...

Example 46 Conditional Probabilities and Predictability of Mutual Fund Performance

The purpose of the Kahn and Rudd (1995) study, introduced in Example 4-2, was to address the question of repeat mutual fund winners and losers. If the status of a fund as a winner or a loser in one period is independent of whether it is a winner in the next period, the practical value of performance ranking is questionable. Using the four events defined in Example 4-2 as building blocks, we can define the following events to address the issue of predictability of mutual fund performance

Who Bears the Loss in a Hedge Fund Default

Hedge funds often invest more than their capital in assets and may have short positions. For either reason, hedge funds may lose more than the capital invested in the fund. If a hedge fund loses more than the investors' cap When hedge funds lose more than 100 percent of their capital, the loss is shared by the secured and unsecured creditors. The secured creditors have the benefit of collateral, which may greatly reduce the chance of loss due to the bankruptcy of a hedge fund customer. The losses in excess of paid-in capital are generally shared by the unsecured creditors and the secured creditors (to the extent that their security is insufficient).

Silence Is Golden The Stealth Index Fund

A silent index fund should outperform an index fund based on a benchmark index because, as noted earlier, benchmark index funds incur unnecessarily large transaction costs.21 The multiple fund licensees of some benchmark indices, together with speculators and other investors, who acquire full (and costless) knowledge of benchmark index changes, impose a transaction cost penalty on funds using benchmark indices. Benchmark index funds are forced to make portfolio changes amid a flurry of market activity caused by the announcement of changes to an index and often buy high and sell low during the blizzard of rebalancing and related speculation. Transaction costs associated with high-profile index changes are increasingly embedded in benchmark index performance. A silent index is based on many of the same kinds of rules as a good benchmark index, but the specific silent index rules are not subject to use by multiple funds (or by speculators attempting to front-run trades by funds using the...

Figure 93 Traditional Mutual Fund Process

A tax st andpoint, the open-end mutual fund is very susceptible to daily shareholder purchase and redemption activity. with the lowest cost basis. This causes the average cost of the securities co mprising the portfolio of the ETF to trend upward over time. In ess ence, the in-kind transfer is a substitute for the tax-loss harvesting trade, that is, the ETF manager lowers the amount of embedded capital gains in the fund through the in-kind transfer, whereas the mutual fund manager takeslosses when availabletooffsetgains. Like index funds, ETFs have very low expense ratios. Unless the buyer is an authorized participant, ETFs are purchased in the secondary market through a b roker, who receives a commission. Since ETFs are traded intraday, the underlying securities need to be somewhat liquid. Although there are more than 100 ETFs available to investors and new ETFs are being launched almost weekly, the structure is not suitable for all asset class es . Unfortunately, as a result of...

Hedge Funds and Mutual Funds

AIM 76.2 Compare hedge funds with mutual funds. Hedge funds and mutual funds are both investment companies that have the same economic function. They both are businesses where investors entrust money with managers, and the investors hope to be able to withdraw the money in the future plus a return. Mutual funds offer two basic choices (1) active funds and (2) passive (or index) funds. Passive funds track a benchmark such as the Dow Jones Industrial Average (DJIA) or Standard & Poor's 500 stock index (S& P 500). Most mutual funds are actively managed, and the investors hope the manager's skill will earn a return higher than a passive strategy. All hedge funds are active. The major point where hedge funds and mutual funds differ is that hedge funds deliver complex strategies that mutual funds either cannot offer, because of regulation, or choose not to offer. In contrast to hedge funds, for example, mutual funds generally do not take short positions, do not borrow, and make...

You Manage An Equity Fund With An Expected Risk Premium Of 10 And An Expected Standard Deviation Of 14 . The Rate On

You manage an equity fund with an expected risk premium of 10 and an expected standard deviation of 14 . The rate on Treasury bills is 6 . Your client chooses to invest 60,000 of her portfolio in your equity fund and 40,000 in a T-bill money market fund. What is the expected return and standard deviation of return on your client's portfolio 27. What is the reward-to-variability ratio for the equity fund in problem 26

Figure 95 Before and After Tax Returns of Similar Tax Managed and Exchange Traded Funds For the 10Year Period Ending

Exchange-traded or mutual fund Vanguard Tax-Managed G & Vanguard 500 Index Vanguard 500 Index Fund. These three funds were chosen for this com-p ariso n exercise because they all use the S& P 500 stock index to construct the underlying portfolio of stocks. Over extended periods of time, there are two key factors that dictate whether the mutual fund or ETF format is better for managing the unrealized gain position. Manageable redemption activity benefits the remaining shareholders of the exchange-traded fund, whereas reasonable price volat ility of individual securities benefits the tax-managed mutual fund. Extremes in either case may result in a cascade of redemption activity that co uld force the sale or distribution of shares, with a meaningful capital gaindistribution to follow. The results shown thus far are all net of fees, which is customary with mutual and exchange-traded funds. Now let's examine the results on a gross o f fee basistotheactual returnofthe S& P 500 (see...

Registered Hedge Funds

Finally, registered hedge funds are closed-end funds that allocate money to a variety of underlying hedge funds and are registered with the SEC under the Investment Company Act of 1940 (the 1940 Act). (See Figure 2.4.) Registration with the SEC allows a fund to exceed 100 investors and avoid limitations on commodity investments, hot issues, and the number of Employee Retirement Income Security Act (ERISA) clients that pose significant compliance issues for traditional unregistered hedge funds. Funds now can attract less affluent investors by offering lower minimums. They also may become more marketable to pension funds and other institutional investors as they are no longer subject to the restrictions of ERISA, which limits the amount of money that unregistered funds can attract from retirement plans to 25 percent of total assets. However, with these benefits comes increased regulatory oversight. The SEC has successfully sought and imposed significant fines on and sanctions against...

Hedge Fund Diversification

Since hedge funds often have concentrated and unique risk exposures, diversification is especially important. Furthermore, since hedge funds usually require a large commitment, an investor should make sure there is some diversification to counter the risk associated with that large investment. As mentioned, hedge funds usually require a large investment. Hedge funds often require an initial investment of 1 million or more, for example, and some require several million dollars. To achieve a diversified hedge fund portfolio, an investor would have to make several such investments. The necessary capital to achieve diversification could easily be in the tens of millions of dollars. Such an allocation to hedge funds would require the total portfolio of all assets to be many times as large, and relatively few investors have portfolios of that size. However, simply investing in several funds may not be sufficient to achieve diversification. The investor needs to make sure the risks of the...

Savings Rate Money Market and Mutual Fund Indicators

Money placed in mutual funds is not spent on consumerism. It is hoped to be deferred spending, but does little to boost immediate consumption. With change comes new terms of art. Although we do not see invested money enter the mainstream of Main Street or mall shopping, the Fed has identified the wealth effect that states people will allocate more income as disposable if their investments provide the perception of greater wealth. If I have 1 million in the stock market, I may feel more comfortable taking on a 500,000 mortgage because I feel wealthy. So even investing creates transaction velocity.

Mutual Funds and Commissioned Sales

MUTUAL FUND Mutual fund taxed at 15 Net after-tax mutual fund (if liquidated) Mutual fund estimated after-tax income (if the mutual fund performs as assumed) a myriad of rules and regulations in providing suitable mutual funds for their clients in taxable accounts. Some funds cost the consumer more and make the representative more money. As a result, a few representatives put their personal interests ahead of those of their clients. Regulators, fulfilling their duty to protect the consumer, write regulations and create forms and administrative procedures to try to make sure that registered representatives put their clients' interests first and sell only what's suitable and appropriate rather than what results in unwarranted sales charges or expenses. In selecting mutual funds for their clients, it's not unusual for advisers to consult Morningstar Principia for independent research, as well as whatever material they're able to obtain. There were 16,513 funds in the Morningstar...

Hedge Fund Considerations

AIM 76.1 Describe the emergence of hedge funds. AIM 76.5 Discuss consideration that should be made when evaluating hedge fund performance and risk. During the period from 1994 to 2006, the Credit Suisse Tremont Hedge Fund index had a slightly higher average return when compared to the S& P 500. Net of fees and expenses, the annual return for the hedge fund index was 10.8 , and the stock index return was 10.3 . Although the after-fee returns were fairly close, the Credit Suisse Tremont Hedge Fund index had a much smaller standard deviation. The index had an annualized standard deviation of returns equal to 7.8 , which was about half the 14.5 standard deviation of the S& P 500. Hedge Fund Growth Hedge funds grew dramatically after 2000. Reports have estimated that in 2000, just over 200 billion was invested in hedge funds, and by the middle of 2005, this amount had grown to over 700 billion. Some estimates suggest that the level of investment in hedge funds in 2005 was actually...

Possible Utility Functions Of Hedge Fund Traders

At all times the rogue trader is in (1) and (2), that is, the total positions are overbet and not diversified and move markets. There is no plan to exit the strategy since it is assumed that trades can be made continuously. Then in a multiperiod or continuous time model it may well be that for the fund managers and traders specific utility functions that it is optimal to take bets that provide enormous gains in some scenarios and huge losses in other scenarios. Kouwenberg and Ziemba (2006) show that in a theoretical continuous time model with incentives, risk taking behavior is greatly moderated if the hedge fund manager's stake in the fund is 30 or more.

Reasons Hedge Funds Use Leverage

Hedge funds use leverage for a variety of reasons. First, a fund borrows money to carry assets greater than the capital on deposit. The manager usually believes that the assets will earn a higher return that the cost of borrowing the money to carry the assets. A hedge fund may carry a position in volatile technology stocks, believing the sector will earn much more than the borrowing rate. A stock picker may handpick the stocks to buy and create a hedge to remove the general market risk. In conjunction with the hedging strategy, borrowing money may be used to increase the return from this stock selection strategy. Similarly, borrowing can be used to magnify the return on any lower-risk strategy. Hedge funds can also use leverage to create short positions. Some hedge funds create positions to benefit from price declines. The short positions allow the fund to profit from the decline of particular stock prices and, when accumulated into a portfolio of short positions, the general decline...

Use taxfree money market and bond funds

Certain kinds of money market and bond funds invest only in bonds issued by governments, and depending on the type of government they invest in, their dividends may not be subject to state and or federal tax. However, after taxes are taken into account, you may find that with tax-free SSl money market or bond funds, you come out ahead of comparable taxable Oj M funds if your tax bracket is high enough. Because of the difference in taxes, the earnings from tax-free investments can end up being greater than what you're left with from comparable taxable investments. If you're in the 28 percent federal bracket or higher, see Chapters 7 and 8 for details on tax-free money market and bond funds.

Invest in taxfriendly stock mutual funds

Unfortunately, stock mutual funds don't have a tax-free version like bond and money market funds do. Unless they're held inside a retirement account, stock fund distributions are always taxable, period. If you're in a high enough tax bracket, these stock distributions can be a significant tax burden. Unfortunately, with stock funds more than any other type of fund, investors often focus exclusively on the pre-tax historical return, ignoring the tax implications of their fund picks. Although there are no tax-free stock funds, you can invest in stock funds that are tax-friendly in other words, funds whose investing style keeps distributions to a minimum. Here's how stock funds can minimize taxable distributions v0 Buy and hold investing. There are two types of stock fund distributions dividends and capital gains. Capital gains distributions are generated when a fund manager sells a stock for a profit that profit must then be given out to the shareholders annually. Some fund managers are...

Hedge Fund Performance

AIM 76.6 Summarize the empirical research on hedge fund performance. Research on hedge fund performance indicates that, on average and after fees, hedge funds have yielded a non-negative alpha. Although the aggregate research points to a positive alpha, we have to say the alpha has been non-negative because some research has found a positive alpha that was not significantly different from zero. Yet, based on past performance, the implication for investors is that a randomly selected hedge fund is expected to have a positive alpha. The following is a list of research that has found alphas to be positive An alpha of 3.7 , which was statistically significant, from January 1999 to March 2004, using a sample of 3,538 hedge funds.1 1 Roger G. Ibbotson and Peng Chen, Sources Of Hedge Fund Returns Alphas, Betas, and Costs, Yale ICF Working Paper No. 05-17, 2005, Yale University New Haven. 2 Robert Kosowski, Narayan Y. Naik and Melvyn Teo, Do Hedge Funds Deliver Alpha A Bayesian and Bootstrap...

Relationship Between Hedge Fund Activities and the Economy

AIM 76.7 Explore the relationship between hedge fund activities and the economy. Regulators are concerned about individual investors because of the hedge fund's relatively high mortality rate. About 10 of hedge funds are liquidated each year because of significant losses, gross misreporting, or simply from investors withdrawing their funds. However, regulators need not be concerned about individual investors, because only sophisticated investors can invest in hedge funds. It is true that sophisticated investors have lost money and will lose money in the future when investing in hedge funds, but there is no reason to believe regulatory supervision will provide any benefit. There is no evidence that the losses sophisticated investors have incurred have produced any social costs. Regulators are concerned about financial institutions because of the counterparty arrangements that hedge funds have with other financial institutions and the leverage that hedge funds use. The concern is that...

Future of Hedge Funds

AIM 76.8 List the various factors that are believed to play a significant role on the future of hedge funds. The amount of capital invested in hedge funds has increased dramatically. As mentioned earlier, the funds invested increased at least threefold from 2000 to 2005. This should lower the future returns that hedge funds can earn, on average, for two reasons. First, it is logical to assume that managers to this point have been using the most profitable strategies. As new money moves into the hedge fund market, managers must select among less profitable strategies. Second, there is only a finite dollar amount of alpha in the market. If there are more funds, the average alpha per fund must decline. Institutional investors that have fiduciary relationships with clients have become major investors in hedge funds. An increasing proportion of investments are from pensions and endowments, either directly or via fund-of-funds. The problem is that unregulated hedge funds can dramatically...

Difference in costs between ETFs and actively managed mutual funds

Difference in costs shown in Table 3.2 can be sensibly higher if ETFs are compared to actively managed mutual funds, which constitute the bulk of the mutual-fund industry. Technically, these additional fees, which can be quite significant, are levied to compensate managers for actively managing the portfolio, such as providing their skills in interpreting market information. According to the fund-tracking firm Lipper Inc., expense ratios for all equity mutual-funds average 1.5 . As mentioned in Chapter 1, the performance of actively managed mutual funds is, at best, equal to that of the market as a whole. Since management 9 A study that has investigated the impact of 12(b)-1 on mutual fund expense ratios was conducted by S. P. Umamaheswar Rao in Economic impact of distribution fees on mutual funds, American Business Review, 19 (1), January 2001, pp. 1-5. Box 3.2 Rule 12(b)-1 or the hidden costs within the mutual-fund industry With mutual-fund fees continuing to draw scrutiny from...

Are Hedge Funds Gaining Market Share From Private Equity

The infiltration of hedge funds into private equity investing is a phenomenon that has been in existence on an infrequent basis for some time. However, this trend has become more systemic throughout the hedge fund industry in recent years. In part, this is because of the sheer growth in the number of hedge funds in existence and the growing amount of assets that they control. It is also because of the increased utilization of hedge strategies that are comprised of quasi-private securities, such as the following secondary purchases of distressed debt, which includes bank debt, revolving credit agreements, and receivables primary lending on a secured basis, which includes all forms of extending credit secured by collateral and activist investing in public companies, which requires the accumulation of public securities either in such size or with such intent that the positions are rendered illiquid from a regulatory perspective. The structural pathway for certain private equity or real...

Impact Of Leverage On Risk Of Hedge Fund Portfolios

Leverage may increase the risk of a portfolio compared to a long-only un-leveraged portfolio of assets. A leveraged long position can lose more than 100 percent of a hedge fund's capital, while an unleveraged long position can lose only 100 percent. Similarly, any short position can appear to be more risky than a long position even if neither position is larger than the capital base of the hedge fund because short positions can lose more than 100 percent of capital. There is no absolute limit on the losses because an asset can double (losing 100 percent of capital), triple (losing 200 percent of capital), or more. Hedge funds are structured so that individual investors cannot lose more than 100 percent of their capital, so potential losses on the portfolio that exceed 100 percent don't necessarily affect hedge fund investors. However, the use of leverage may increase the probability of a loss of a certain magnitude. Investors are concerned about the impact leverage has on the...

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