Asset Management Notes

ASSET MANAGEMENT

Lecture 1 – INTRODUCTION AND OVERVIEW OF THE FUND MANAGEMENT INDUSTRY

The 4 main ASSET CLASSES:

1. CASH – notes, coins, banks deposits, short-term government bonds under 1-year because they are the most liquid)

Advantages: liquid, safe (less uncertainty)

Disadvantages: low return, may not be as safe as we think (because of the banking crisis for e.g.)

2. EQUITY/SHARES can be classified into 3 types:

• Domestic (UK) = underlying shares risk (uncertainty of return)

• Developed nation (France, Germany) = underlying shares risk + exchange rate risk

• Emerging market (India, Ecuador) = underlying shares risk + exchange rate risk + political risk

Advantages: offers higher return than bond and cash

Disadvantages: has greater risk than bond and cash

3. FIXED INCOME/BONDS/DEBT can be classified into 3 types:

• Domestic (UK) = interest rate risk + credit risk + rating risk (depending whether the bond will be hold till maturity or not)

• Developed nation (France, Germany)

• Emerging market (India, China)

Advantages: offers higher return than cash

Disadvantages: has greater risk than cash

4. ALTERNATIVES – derivatives, private equity, real-estate, commodities and art

• Advantages: low correlation with other asset classes, well diversified, reduced volatility of overall portfolio

• Disadvantages: illiquidity (higher transaction/trading costs but with ETFs it is less difficult to trade)

ASSET ALLOCATION – the choice of allocating money across different asset classes

SECURITY SELECTION – the choices within asset classes

SERVICES provided by INVESTMENT COMPANIES:

1. Record keeping of what is going on in terms of assets in their fund and administration

2. Access to diversification and divisibility

3. Professional management (professional managers who know what to do with their investors’ money)

4. Lower transaction costs because of bulk trading

NAV (Net Asset Value) – the value of underlying assets that each share has claim to.

NAV = [ASSETS - LIABILITIES] x Number of SHARES

Example:

Suppose there is a fund.

It has got 3 BT shares, each worth $5. Also, it has got 2 BA shares, each worth $10.

Then the value of this fund is $35, in total.

Now, suppose this fund issues 35 fund shares, in total. Then each of this fund shares should worth $1. This $1 is the claim of each fund share on the assets of the fund. That is the NAV!

The 6 types of INVESTMENT COMPANIES:

1. MUTUAL FUNDS (or OPEN-END FUNDS) – the number of shares in the fund responds to fund inflows and outflows. So, the price is equal to NAV (investors trade shares with the fund management company)

2. CLOSED-END FUNDS – fixed number of shares traded at market determined prices which are typically below NAV (investors trade shares on a stock exchange through a broker)

3. EXCHANGE-TRADED FUNDS – index tracking open-end funds traded on exchanges like closed-end funds (it typically tracks stocks, bonds and commodity indices). As the number of shares in the ETF is not fixed, the shares are typically traded at NAV

4. HEDGE FUNDS – open only to high-net-worth and institutional investors. Its investors are subject to “lock-up” periods during which investors cannot take out their investments, so that hedge funds can invest in less liquid assets. Hedge funds are usually less regulated than mutual funds, hence they pursue complex investment strategies such as short-selling and derivatives

5. SOVEREIGN WEALTH FUNDS – country-level investment vehicles owned by the government. They invest state savings, often driven from commodity exports or export surpluses. Large pools of money managed by the government seeking favorable returns for its citizens

6. PRIVATE EQUITY FUNDS – any type of equity investment in which the stock is not freely tradable on a public stock market. They either buy private equity in companies OR raise sufficient funds to buy all the equity in a publicly traded companies and make it private. The majority of investors are institutional

Lecture 2 – THE MARKET EFFICIENCY

Due to the competitiveness of financial market, securities’ prices fully and instantaneously reflect all available relevant information.

Should prices reflect all information? Not necessarily, for 2 reasons:

1. Yes, only if the cost of getting the information is 0.

2. BUT, if the cost of getting the information is positive, it will only pay its costs if it has a value. “PRICES REFLECT INFORMATION UNTIL THE marginal COST NO LONGER EXCEEDS THE marginal BENEFIT.”

The 3 FORMS of EMH (different degrees to which information is incorporated into prices):

1. WEAK – prices reflect all information contained in historic data. If historical data conveyed signals about future performance, investors would have already learnt how to exploit signals already

2. SEMI-STRONG – prices reflect all publicly available information regarding the firm concerned, including the data from firm’s prospectus, production lines, quality of management, etc. which may affect the value of the firm

3. STRONG – prices reflect all available information (both the public and private information that are available only to company insiders) regarding the firm concerned. This requires insiders engage in trading, which is illegal

TECHNICAL ANALYSIS – using historic prices and trading volume information to predict future prices. This analysis is inconsistent with WEAK form of efficiency since that historic information is already incorporated in prices

FUNDAMENTAL ANALYSIS – using economic and accounting information to predict the stocks’ prices. This analysis is inconsistent with SEMI-STRONG form of efficiency since that information is already incorporated in prices

If EMH holds, active management (picking stocks) is largely a waste of time for small investors, hence the best thing for small investors is to buy and hold well-diversified portfolios without trying to find over/under-valued stocks – this is known as the PASSIVE STRATEGY. One common strategy of passive management is to create an index fund which tries to mimic the performance of target...

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