Finance 301 1st Edition Lecture 16 Outline of Last Lecture I Background on mutual funds II Mutual funds categories III Management of mutual funds Outline of Current Lecture IV Money Market Funds V Other Types of Funds VI Performance of Mutual Funds VII Valuation of Bond Mutual Funds Current Lecture I Money Market Funds a What is a money market fund i Fund that invests in money market securities b Why would we invest in these funds instead of stock and bond mutual funds i Diversify and provide less risk can liquidate very quickly in and out c What are their assets i Their assets are treasury bills commercial paper certificates for deposit d What is their risk i No term risk no liquidity risk has default risk but it is very small these investments 99 are good VERY safe investments get in and get out ii Interest rate risk fear of quickly rising interest rates II Other Types of Funds a Private Equity Funds i Private equity funds pool money provided by individual and institutional investors and buy majority or entire stakes in businesses ii What do they try and accomplish 1 Trying to make higher returns need to have about 100 000 to get in They pool money and buy companies b Exchange Traded Funds i Designed to mimic particular stock indexes ii What are the major difference between ETFs and mutual funds iii These are closed end funds not opened end funds They do not issue new shares all of the time Sell the ETF to investors like an IPO and then they sell between themselves ETFs may only be 25 stocks instead of 75 or 100 Based on a sector People like these because they are expecting higher returns and there is more risk here you are trading between investors Expected to move up and down like the securities that are in the et iv Examples include PowerShares QQQ or Cube QQQQ which represents the Nasdaq 100 index of technology firms v Another popular ETF is the Standard Poor s Depository Receipt SPDR or Spider representing the S P 500 index c Hedge Funds i Another investment fund but usually closed end funds and much more expensive than open end mutual funds ii They differ in several ways 1 Require a much larger initial investment such as 1 million 2 Many hedge funds are not open in the sense that they may not always accept additional investments or accommodate redemption requests unless advance notice is provided 3 Hedge funds have been subject to minimal regulation 4 Hedge funds invest in a wide variety of investments to achieve high returns 5 Big time money 6 Very risky tell them straight up like private equity expecting to make 15 or 20 7 Play derivates anything d Use of Financial Leverage i What do I mean by financial leverage 1 Borrowing money They borrow money to invest because you are expecting to make more money than the interest rate 2 ROI return on investment and ROE return on equity here we are looking at ROE e Hedge Fund Fees i Charge management fees ii Charge incentive fees iii Take wealthy people money and invest it they charge 1 to 2 a year not as expensive as mutual funds but it is still a cost they also make money from incentive fees where they charge generally around 20 of profits f Performance of Hedge Funds during the Credit Crisis i Some hedge funds failed during the credit crisis in 2008 Why They were invested in mortgage backed securities and failed lost it when real estate went bad g Short Selling by Hedge Funds i During the credit crisis in 2008 hedge funds were accused of making market conditions worse Why would they make conditions worse They sold short Hoping price of the stock drops h Madoff Fund Scandal i What did Bernard Madoff do Ponzi Scheme he convinced people to invest in him but all you are doing is passing money around from people who invested Promised them a 10 return Telling them to buy stocks and buy auctions ii How was he able to do continue as a hedge fund for so long He was able to do this because he was a well liked person and a good salesman one of the largest trader on NASDAQ All of the people wanted to get out when the market collapses He defaulted on his investors cause he was just spending money himself he couldn t afford to pay his investors back iii The potential losses to investors were estimated to be as high as 50 billion making this possibly the biggest financial scandal in U S history i Regulatory Reform of Hedge Funds i The Financial Reform Act of 2010 contained provisions to stabilize the financial system ii Mandates that hedge funds managing more than 100 million register with the SEC as investment advisors iii Must also disclose financial data that can be used by the Financial Stability Oversight Council created by the Financial Reform Act in order to assess systemic risk in the financial system iv Prevents commercial banks from investing more than 3 of their capital in hedge funds private equity funds or real estate funds j Real Estate Investment Trusts i Real estate investment trusts can be classified as stocks on real estate companies ii Equity REITs invest directly in property a lot of them are certain types of real estate such as apartment hotels ect iii Mortgage REITs invest in mortgages and mortgage backed securities these were the ones that really got hurt during the financial crisis iv Hybrid REITs invest in properties and mortgages v Sell for cheap like regular stocks act like large cap stocks What happened during the credit crisis They had trouble during the crisis because all real estate was going down in value but so did the whole stock market vi REITS pay out a high dividend you will definitely get a dividend k III Performance of Mutual Funds a Change in Market Conditions b Change in Sector Conditions c Change in Management Abilities d V f MKT SECTOR MANAB e f Note that the sign on the SECTOR is different than what is in the text g If sector goes up They go up h Management goes up they go up IV Valuation of Bond Mutual Funds a V f Rf RP MANAB b Change in risk free rate occurs or change in risk premium occurs on interest rates they go up or down c Risk premium goes down bond mutual fund go up in value because