LCASTOL

CHAPTER 24
PROFESSIONAL MONEY MANAGEMENT,
ALTERNATIVE INVESTMENTS & INDUSTRY ETHICS
 THE ASSET MANAGEMENT INDUSTRY:
STRUCTURE AND EVOLUTION
Private Management &
Investment Company
Advisory
• Contract directly with a • Co-mingling of investment
management and advisory firm capital of several clients in an
• Private management and investment company
advisory firms develop a • A Investment company offers a
personal relationship with general solution
clients • Invest a pool of funds
• Each client’s assets are held in belonging to many individuals
a separate account in a single portfolio of
• Customized but security securities
portfolio are likely to be guided • Issue new shares representing
by the firm’s overall the proportional ownership of
investment philosophy the fund
 ORGANIZATION AND MANAGEMENT OF
INVESMENT COMPANIES
Investment Companies Net Asset Value Formula
• They are the financial intermediaries that pool the
assets of individual investors and invest the fund in
securities or other assets
• Major Duties
 Investment research
 Management of the portfolio
 Administrative duties
• The management fee is generally stated as a
percentage of the total value of the fund
• Family of funds helps achieve economies of scale

Valuing Investment Company Shares

• The NAV for an investment company is analogous to
the share price of a corporation’s common stock.
• The NAV of the fund shares will increase as the value
of the underlying assets (the fund security portfolio)
increases
 CLOSED-END VERSUS OPEN-END
INVESTMENT COMPANIES
Closed-End Investment Company Open-End Investment Companies
• Functions like any other public firm and its stock • The company continues to sell and repurchase
trades on the regular secondary market shares after their initial public offerings
• The fund generally doesn’t issue or redeem shares • The fund stands ready to issue or redeem shares at
once it is established the net asset value (NAV)
• The price of the fund is different from its NAV • Investors who buy or sell the shares may have to
• It is a puzzle for modern finance why close-end pay sales charges (the load)
funds often sell at a discount from NAV • These funds are normally called mutual funds
• It is often a means of investing in a pool of assets
from a foreign country
• Example: Filipino Fund
 CLOSED-END VERSUS OPEN-END
INVESTMENT COMPANIES
Load versus No-Load Open-End Fund
• The offering price for a share of a load fund equals the NAV of the share plus a sale charge.
• A no-load fund imposes no initial sales charge so it sells shares at the NAV.
• Several variations exist between the full-load fund and the pure no-load fund
 Low-load fund
 12b-1 plan
 Funds have contingent, deferred sales loads
• Locally: UITFs vs. Mutual funds

Fund Management Fees

• Charge annual management fees to compensate professional managers of the fund
• The fee typically is a percentage of the average net assets of the fund varying from about 0.25 to
1.00 percent
• Management fees are a major factor driving the creation of new funds
 CLOSED-END VERSUS OPEN-END
INVESTMENT COMPANIES
Investment Company Portfolio Objectives
• Equity funds: They invest almost exclusively in common stocks
• Bond funds : These funds concentrate on various types of bonds to generate high current income with minimal
risk
• Balanced funds: They diversify outside a single market by combining common stock with fixed income securities
• Money market funds: They invest in diversified portfolios of short-term securities

Global Investment Companies

• Funds that invest in non-U.S. securities are generally called either international funds or global funds
• International funds often hold only non-U.S. stocks from such countries as Germany, Japan, Singapore, and
Korea
• Global funds contain both U.S. and non-U.S. securities
• A increasing large number of non-U.S. investment companies that offer both domestic and global products in
their local markets
 CLOSED-END VERSUS OPEN-END
INVESTMENT COMPANIES
Breakdown by Fund Characteristics
1. By major Means of Distribution
• Sales force
• Direct purchase from the fund
• Direct institutional marketing
2. By Investment Objective
• Equity funds
• Bond funds
• Hybrid funds
• Money market funds
 POP QUIZ

Which of the following is true about open-ended investment companies?

a. The company continues to sell and repurchase shares after their initial public offerings
b. The fund stands ready to issue or redeem shares at the net asset value (NAV)
c. Investors who buy or sell the shares may have to pay sales charges (the load)
d. All of the above

Answer: D
 INVESTING IN ALTERNATIVE ASSET
CLASSES
Basic Concepts
• Alternative Assets
 Hedge funds
 Private equity
 Real estate
 Natural resources and commodities
• Management Structure
 Structured as a limited partnership rather
than as a mutual fund to manage the
commingled assets
• The Fund “alpha” (See Exhibit 24.14)
 Excess returns generated by the fund,
implying the superior performance by the
fund management
 HEDGE FUNDS
The Development
• Hedge fund investing is not new and can be
traced back to 1949, structured as a
partnership structure with an incentive fee
for superior performance
• Hedge funds are actively managed
investment pools whose managers use a wide
range of strategies, often including buying
with borrowed money and trading esoteric
assets, in an effort to beat average investment
returns
• With both long and short and financial
leverage, it is able to produce superior
returns than traditional investment structures,
such as mutual funds
 HEDGE FUNDS
Characteristics
• As a private partnership, hedge funds are generally
less restricted in how and where they can make
investments
• Less correlated with traditional asset class
investments, providing diversification benefits
• Hedge fund investments are far less liquid than
mutual fund (or even closed-end fund) shares
• There are severe limitations on when and how
often investment capital can be contributed to or
removed from a partnership
• Performance allocation and high-watermark
Returns
• Not all hedge funds are the same when it comes to
their risk and return profiles
• The returns to these strategies show a high degree
of variability on a year-to year basis, in both an
absolute and a relative sense
 HEDGE FUND STRATEGIES
Equity-Based Strategies
• Long-short equity: Managers attempt to identify
misvalued stocks and take long positions in the
undervalued ones and short positions in the overvalued
ones
• Equity market neutral: attempt to limit the overall
volatility exposure of the fund by taking offsetting risk
positions on the long and short side, an effort that might
also involve adopting derivative positions.
Opportunistic Strategies
• High yield and distressed: Invest in risky bonds
• Global macro: This broad class of strategies seeks to
profit from changes in global economies
• Managed futures: This strategy entails using long and
short positions in a variety of futures contracts
• Special situations: Events like bankruptcies, spinoffs
HEDGE FUND STRATEGIES
Arbitrage-Based Strategies
• Fixed-income arbitrage: Returns are generated by taking
advantage of bond pricing disparities caused by changing
market events, investor preferences, or fluctuations in the
fixed-income market
• Convertible arbitrage: Seeks to profit from disparities in
the relationship between prices for convertible bonds and
the underlying common stock
• Merger (risk) arbitrage: Returns are dependent upon the
magnitude of the spread on merger transactions, which
are directly related to the likelihood of the deal
Multiple strategies
• Fund of funds: Invest in a number of funds so as to
achieve a well-diversified allocation to the hedge fund
investment space
 RISK ARBITRAGE INVESTING: A CLOSER
LOOK
• Take equity positions in companies that are
the target of a merger or takeover attempt
• Require managers to compare their own
subjective judgment about the success of the
proposed takeover with the success
probability implied by the market price of the
target firm’s stock following the
announcement of the deal
• If the manager thinks the takeover is more
likely to occur than the market does, he or
she will buy target firm shares.
• The manager might short sell the target firm
shares if he or she thinks the proposed deal is
less likely to be completed
 PRIVATE EQUITY
Basic Concepts
Refers to any ownership interest in an asset (or assets) that is not tradable in a public market
• Typically fund either new companies or established firms that are seeking to change their organizational structure or are
experiencing financial distress
• Generally far less liquid than public stock holdings and are therefore considered to be long-term positions within an
investor’s overall portfolio
Characteristics
• Higher return and low liquidity
• Good sources of diversification
Three Subcategories
• Venture Capital
• Seed
• Early stage
• Later stage
• Buyouts
• Special Situations
• Distressed Debt
• Mezzanine Financing
 PRIVATE EQUITY
The Investment Process
• The zero-stage capital: Using their
personal savings and bank loans
• The venture capital: Seek to obtain the
additional seed and early-stage funding
they need to advance their idea to the
next level; in exchange, the venture capital
firm receives an equity stake in the
company
• The venture capital firm will ultimately
want to liquidate their equity holdings in
order to create a return on their
investment
 Buyout
 IPO
 PRIVATE EQUITY
Returns to Private Equity Funds
• Private equity commitments should be viewed as
long-term, highly illiquid investments
• The return pattern known as the “J-curve effect”
 Average annual returns for these investments
tend to be quite high over time
 The initial years of a new private equity
commitment usually produce negative returns
• In addition to its higher overall risk level, there
exists a huge dispersion in fund returns, that is,
good performance vs. bad performance managers
 PRIVATE EQUITY - EXAMPLE
KKR Acquires Stake in First Gen through
Voluntary Tender Offer
June 28, 2020 08:30 PM Eastern Daylight Time
• The Offeror intends to acquire all of these tendered
common shares at a price of ₱22.50 (US$0.45) per common
share on July 1, 2020, the cross date previously set out in
the Offeror’s tender documents, representing a total
investment value of ₱9.6bn (US$192.2mm), representing
approximately 11.9% of First Gen’s outstanding common
shares.

KKR hikes ownership in First Gen with P8.68-B

Investment
October 6, 2021 | 1:04pm
• KKR said Philippines Clean Energy Holding Inc., a subsidiary,
intends to buy all 262.9 million common shares that were
tendered by shareholders of First Gen at a price of P33 each.
• Once the transaction is completed, KKR will increase its
ownership to approximately 19.9%.
 ETHICS AND REGULATION IN THE PROFESSIONAL
ASSET MANAGEMENT INDUSTRY
Regulation in the Asset Management Industry
• Principal securities laws that govern investment companies
 The Securities Act of 1933
 The Securities Exchange Act of 1934
 The Investment Company Act of 1940
 The Investment Advisers Act of 1940
 The Employee Retirement Income Security Act of 1974
 The Pension Protection Act of 2006
 The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
Regulatory Agencies
 The U.S. Securities and Exchange Commission (SEC) is the main federal agency responsible for regulating
professional asset management activities in the United States
 U.S. Department of Labor: For protection of pension plans, including 401(k) plans
 The Financial Industry Regulatory Authority (FINRA): the largest independent regulator for all securities firms
 U.S. Commodity and Futures Trading Commission: monitors futures and commodities trading activities
 U.S. Internal Revenue Service: setting and enforcing of tax policies
 POP QUIZ
Statement 1: Private equity are less liquid than listed equity investments.
Statement 2: Exit strategies of venture capitalists include both buyouts and initial public offerings.

a. Both statements are true

b. Both statements are false
c. Only statement 1 is true
d. Only statement 2 is true

Answer: A
 ETHICS AND REGULATION IN THE PROFESSIONAL
ASSET MANAGEMENT INDUSTRY

Standards for Ethical Behavior

• The CFA Institute Code of Ethics
• The CFA Institute Standards of Professional Conduct
• The CFA Institute’ Centre for Financial Market Integrity
• Asset Manager Code of Professional Conduct
• Fund Managers Association of the Philippines (FMAP) Code of
Conduct – Adopted CFA Code of Ethics
 ETHICAL STANDARDS
C FA C o d e o f E t h i c s a n d S t a n d a r d s o f P r o f e s s i o n a l C o n d u c t

DUTIES TO CLIENTS CONFLICTS OF INTEREST

• Loyalty, prudence & care • Disclosure of conflicts
• Fair dealing • Priority of transactions
• Suitability • Referral fees
INTEGRITY OF CAPITAL MARKETS
• Material non-public information
• Market manipulation

INVESTMENT ANALYSIS,
RECOMMENDATIONS &
PROFESSIONALISM ACTIONS
DUTIES TO
• Knowledge of the Law • Diligence & reasonable basis
EMPLOYERS • Independence & objectivity • Communication with clients
• Loyalty • Misrepresentation • Record retention
• Additional compensation • Misconduct
agreements
• Responsibility of supervisors
 WHAT DO YOU WANT FROM A
PROFESSIONAL ASSET MANGER?
• Help determine your investment objectives and
develop a portfolio that is consistent with them
• Diversify your portfolio to eliminate unsystematic
risk
• Maintain your portfolio diversification and your
desired risk class while allowing flexibility so you
could shift between alternative investment
instruments as desired
• Attempt to achieve a risk-adjusted performance
level that is superior to that of your relevant
benchmark
• Administer the account, keep records of costs and
transactions, provide timely information for tax
purposes, and reinvest dividends if desired
• Maintain ethical standards of behavior at all times