Capital Markets Fundamentals

Funds & Asset Management (Buy Side)

June 2010

Agenda
Introduction What is an investment fund?

Trends
Value chain Parties involved NAV Summary

AGENDA

Course objectives
To provide individuals with:
an overview of the asset management industry

an introduction to key trends

an introduction to key asset management terminology and processes

to enable attendees to feel confident discussing Asset Management with clients & be able to recognise sales opportunities.

What is Asset Management?

Gives the 100k to e.g.Gartmore to manage

Client has 100K liquid assets to invest

Asset Management is the process of investing pooled capital with the objective of earning a strong rate of return for a given level of risk

Gartmore Invests the money in equities, hedge funds and mutual funds

Note that Annual Management Charge (AMC) is levied on monthly basis

At the end of year one the 100k is now worth 100k + e.g. overall 8% gain

What is the role of an asset manager?

Suppliers

Clients
Private investors (retail investors)
Capital Markets Asset Managers

Corporates

Government

Assets Under Management

Institutional investors

Asset managers act as an intermediary between the issuers of investment assets - governments and corporate institutions - and the market for those assets - individuals and institutional investors

What is a fund?

fund (f nd) n. 1. A source of supply; a stock: a fund of goodwill. a. A sum of money or other resources set aside for a specific purpose: a pension fund.

b. funds Available money; ready cash: short on funds.

A fund is an pooled investment vehicle that is a grouping of individual investment vehicles These products may come from the same or from different asset classes such as equities, bonds, derivatives, cash or even property The component products of a fund will change over time as new products are bought into, or sold out of, the fund Why investment funds? Diversification of the investment portfolio Increase of the buying power by economies of scale Benefit of the professional expertise from the fund management company

What Does Portfolio Management Mean?

The art and science of making decisions about investment mix and policy, matching investments to objectives, asset allocation for individuals and institutions, and balancing risk against. performance. Portfolio management is all about strengths, weaknesses, opportunities and threats in the choice of debt vs. equity, domestic vs. international, growth vs. safety, and many other tradeoffs encountered in the attempt to maximize return at a given appetite for risk. Investopedia explains Portfolio Management In the case of mutual and exchange-traded funds (ETFs), there are two forms of portfolio management: passive and active. Passive management simply tracks a market index, commonly referred to as indexing or index investing. Example strategies: The buy-and-hold strategy, the indexing strategy Active management involves a single manager, co-managers, or a team of managers who attempt to beat the market return by actively managing a fund's portfolio through investment decisions based on research and decisions on individual holdings. Closed-end funds are generally actively managed.

Investors must choose whether to invest in active or passive funds

Passive Management Seeks to replicate the performance of a chosen index e.g. the FTSE 100 index tracking, tracker funds
Fund Index

In theory, managers buy the constituent products (equities, bonds etc) of the chosen index - although in practice they usually sample the index as a substitute Low to very low fees for clients

FTSE 100

Active Management
Fund

Managers stock pick in order to outperform the market asset allocation

Index

They do this according to investment principle or style

Star managers who are able to consistently beat average market returns command status within the industry Fees for clients are higher for active fund management

FTSE 100

A fund pools cash and invests in an asset allocation to grow value

A fund pools the cash of many investors It then invests in a variety of assets in an attempt to grow value Each fund will have a different asset allocation depending on investors risk preferences I.e. How to spread the cash across the different types of assets Risk Profile of different asset classes

Example Building blocks of a fund Derivatives

Equities
Property

D
High High

E
Return
Risk

B
Low Low

Bonds (fixed income)

Cash

Asset allocation also involves selecting industry sector and geography

Asset allocation does not refer only to selecting the mix of asset classes industry sector, geography and other factors are also considered Asset class + Geographic focus +

Industry sector

Asset = allocation

Derivatives 5m Derivatives 5m Healthcare Financial Services Equities 70m Industrials

Telecomms
Consumer Property 5m

Asian tech equity fund

Bonds (fixed income) 15m

Cash 5m

Technology

The manager will select the asset allocation based upon the stated objectives of the fund
A fund will always have stated objectives with regard to the risk the fund takes and the return it aims to generate E.g. growth and income funds Growth fund Risk aim Return aim Higher risk capital growth Higher but more variable
3% 15% 2%

Income fund Lower risk steady income Lower but more constant
2% 13% 13%

Asset allocation
(product only)
80%

Equities Bonds Cash Other

Equities Bonds Cash Other

72%

Asset Management is split according to customer base: Institutional (companies etc) and retail (individual consumers)

Retail Asset Management

Clients All individuals who invest (can be segmented into High Net Worth, Mass Affluent and Mass Market) Products Products: Unit Trusts, OEICs, Investment Trusts, Hedge Funds, Fund of Funds Wrappers: ISAs, PEPs, Stakeholder Pensions & SIPPs

Institutional Asset Management

Clients Corporates, Pension Funds, Charities, Insurance funds Products Pension Mandates, (Segregated Accounts Pooled Accounts), and insurance funds (life and general)

Main Management Types (1/4):

Single Manager / Single Share Class

Manager

Fund Manager

Manages

Fund

European Growth

Share class

European Growth EUR

Buy / Sell

Investor

Investors / Distributors

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Main Management Types (2/4):

Single Manager / Multiple Funds and Share Classes

Manager

Fund Manager

Manages

Fund

U.S. Aggressive Growth Fund

U.S. Value Fund

US Aggr. Growth Fund Class A USD

U.S. Value Fund Class A USD

Share class
US Aggr. Growth Fund Class I USD U.S. Value Fund Class I USD

Buy / Sell

Investor

Investors / Distributors

Example: Worldwide Investors Portfolio SICAV 14

Main Management Types (3/4):

Multi-Manager

Manager

Fund Manager 1

Fund Manager 2

Manages Portfolio 1 Portfolio 2

Fund

Fund

Share class

Share Class I USD

Share Class A USD

Buy / Sell Investor Investors / Distributors

Example: PHARMA Health FCP 15

Main Management Types (4/4):

Pooling of Assets

Manager

Fund Manager 1 Manages

Fund Manager 2 Manages

Fund Manager 3

Pool

U.S. Equities 960 Mio 100 % 60 % 40 %

European Equities 840 Mio 76 % 24 %

European Bonds 200 Mio 100 % 50 % 50 % European Balanced Fund Fund Volume = 400 Mio

Fund

Equities World Fund Fund Volume = 1.600 Mio

Share class

Equities World Fund EUR

European Dynamic Fund EUR

Buy / Sell Investor Investors / Distributors

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Investment fund Investment objectives

Fund Money Market Fund e.g. Liquid Reserve Fund Investments Invests in Money Market instruments, e.g.:
1.000.000 Term Deposit 2.500.000 Commercial Paper

Equity Fund e.g. US Value Fund

Invests in Equity (mainly common stocks), e.g.:

10.000 INTEL CORP. Registered Shares 25.000 ACCENTURE LTD. Reg. Shs Cl.A

Bond Fund e.g. US High Yield Fund

Invests in Bonds, e.g.:

800.000 REPUBLIC OF HUNGARY 97 6,75 241117 250.000 FORTIS FINANCE 03 5,75 170305

Invests in other Funds, e.g.: Fund of Funds

1.453 Fidelity European Growth Fund Reg.Shares A 2.500 HSBC GIF-Indian Equity Bearer Shares A (Dis)

Invests in Real Estate Companies or SOPARFIs, e.g.: Real Estate Investment Trust (REIT)
OUTLET MALL SARL CITY AND WEST END PROPERTY HOLDING SARL

Hedge Fund

Uses hedging strategies (e.g. long/short, Arbitrage, Event driven, etc.) or invests in derivatives e.g.:
15 (Contracts) JUN 10YR EURO BUND FUTURE
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ASSET MANAGER

Quiz

1. Name three factors an asset manager might bear in mind when making an asset allocation decision
2. Rank in order of risk starting with the least risky, the following asset classes: Equities, property, cash, derivatives, bonds 3. Name one reason why you should care about asset management.

Quiz Which of the following statement(s) is/are correct about a mutual fund portfolio? Check all that apply. a) A fund portfolio can consist of stocks, bonds, and money market instruments. b) The investments made in a fund portfolio are based on the objectives of the mutual fund. c) A fund portfolio contains information on the fund's objective, performance history, management, and fees. d) A fund portfolio is managed by an investment company.

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Quiz Which of the following has the lowest level of risk and return? a) Investment in stocks of blue chip companies b) Investment in stocks of small emerging companies c) Investment in commercial paper and banker's acceptances d) Investment in established companies

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Agenda
Introduction What is an investment fund?

Trends
Value chain Parties involved NAV Summary

AGENDA

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Market Trends - 4 major trends that will shape industry growth and profitability
1. MOVE FROM ACCUMULATION TO INCOME AND RISK MANAGEMENT As the biggest demographic wave in our country's history transitions out of the workforce over the next two decades, the retirement opportunity will represent the single largest driver of growth and profitability for the financial services industry.

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Market Trends - 4 major trends that will shape industry growth and profitability
2. MOVE FROM RELATIVE PERFORMANCE TO OUTCOME ORIENTATION Successful firms of the future will break away from the pack and offer fewer products that are also more broadly defined, cutting across current style categories. These winning players will expand the definition of "asset class" by marketing specific outcomes, such as target retirement dates, tax minimization, and income generation

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Market Trends - 4 major trends that will shape industry growth and profitability
3. SEPARATION OF ALPHA AND BETA The move to deemphasize relative performance and focus on outcome is not, of course, being made only by retail investors. Indeed, institutional investors have already begun to employ fundamentally different approaches to asset allocation and performance measurement. In particular, many sponsors of definedbenefit pensions are now actively separating alpha and beta performance, as they attempt to cope with worsening plan deficits amid a persistently low-return environment.

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Market Trends - 4 major trends that will shape industry growth and profitability
What Does Alpha Mean? 1. A measure of performance on a risk-adjusted basis. Alpha takes the volatility (price risk) of a mutual fund and compares its risk-adjusted performance to a benchmark index. The excess return of the fund relative to the return of the benchmark index is a fund's alpha. 2. The abnormal rate of return on a security or portfolio in excess of what would be predicted by an equilibrium model like the capital asset pricing model (CAPM). Investopedia explains Alpha 1. Alpha is one of five technical risk ratios; the others are beta, standard deviation, R-squared, and the Sharpe ratio. These are all statistical measurements used in modern portfolio theory (MPT). All of these indicators are intended to help investors determine the risk-reward profile of a mutual fund. Simply stated, alpha is often considered to represent the value that a portfolio manager adds to or subtracts from a fund's return. A positive alpha of 1.0 means the fund has outperformed its benchmark index by 1%. Correspondingly, a similar negative alpha would indicate an underperformance of 1%. 2. If a CAPM analysis estimates that a portfolio should earn 10% based on the risk of the portfolio but the portfolio actually earns 15%, the portfolio's alpha would be 5%. This 5% is the excess return over what was predicted in the CAPM model.

Market Trends - 4 major trends that will shape industry growth and profitability
What Does Beta Mean? In finance, the beta () of a stock or portfolio is a number describing the relation of its returns with that of the financial market as a whole. Beta is calculated using regression analysis, and you can think of beta as the tendency of a security's returns to respond to swings in the market. A beta of 1 indicates that the security's price will move with the market. A beta of less than 1 means that the security will be less volatile than the market. A beta of greater than 1 indicates that the security's price will be more volatile than the market. For example, if a stock's beta is 1.2, it's theoretically 20% more volatile than the market. Many utilities stocks have a beta of less than 1. Conversely, most high-tech Nasdaq-based stocks have a beta of greater than 1, offering the possibility of a higher rate of return, but also posing more risk.

Market Trends - 4 major trends that will shape industry growth and profitability
4. CONVERGENCE AND EVOLUTION OF ALTERNATIVES As they seek out ways to stabilize their capital base and future cash flow, many alternatives managers are likely to expand into both traditional investment areas and other alternative asset classes. These players will be particularly drawn to the large pools of institutional investor assets that currently reside within the traditional long-only space. And for good reason: institutional investors have been continually increasing their allocations to absolute return products and now account for 40 to 50 percent of all new flows into hedge funds and will likely constitute the majority of flows over the next few years (Exhibit 8).

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How trends are impacting the client.

Trend
Desperately seeking Alpha Availability of cheap Beta via index funds and ETFs Pressure for active managers to deliver Alpha

Impact to Client
Enhanced portfolio construction and trading tools Availability of better data and analytics cross asset class Stronger risk management to oversee new trading strategies and investment vehicles

Demographic impact Focus on wealth preservation and distribution (annuities, draw-down strategies Blurring of traditional broker / dealer and asset manager lines

Less obvious and immediate impact to Client, but will impact trading technology vendor focus Impact to performance measurement toward total return and away from relative performance

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Agenda
Introduction What is an investment fund?

Trends
Value chain Parties involved NAV Summary

AGENDA

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Front-to-Back Trade Flow (1/4)

Value Chain
Investment Strategy Objectives Settings Strategic asset allocation Investment Management
Strategy defined

Research

Key Process Step

Investment Decision Stock selection process

Order Modeling

Pre-Trade Compliance Check

Market and stock analysis

Re-balancing Check against Simulation compliance and Optimization investment Portfolio testing restrictions PM/Front Office support (Pre-Trade Compliance System)

Involved Parties & Systems

Research Teams with Specialists Portfolio Manager (PM)

Investment Committee Product & Research Specialists PMs

PMs (Decision Making Tools)

PMs Front Office support (Order Modeling Tools)

Information complexity

Pain Points

Consensus: Specialist versus PMs

Insufficient decision making tools

Insufficient order modeling tools

Amount and complexity of rules

Risks related to spreadsheets Consistency with post trade compliance

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Front-to-Back Trade Flow (2/4)

Value Chain
Investment Management Availability Check Blocked securities? Non-deliverable instruments? PMs Order Management
Order created Execution received

Key Process Step

Broker /Market election

Identifying the counterparty to release the order to (quotas?) Dealer

Order Release Order release to intermediary, broker or market Dealer

Execution Execution of the order (best price) Dealer

Transmission of Execution Details Provision of execution details to involved parties Dealer/Broker PMs Mid Office

Involved Parties & Systems

Broker Support of Mid Office Phone Order Mgmt. tools using FIX connection, Central tracking Connectivity of broker quotas Order Management Tools

Pain Points

Data Provision and System support

MIFID (quotes, best price)

Connectivity Close to real time provision of data

Compliance with order but optimization by means of Commissions, algorithmic Fees and trading, pooling Charges

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Asset Management Value Chain Challenges and Potential Solutions

Investment Strategy
Research Objective Setting Risk Framework

Investment Management
Portfolio Management Product Strategies Hedging

Order Management and Execution

Order Management Execution Transaction Costs

Investment Accounting and Administration

Custody Fund / Portfolio Administration Client Reporting

Infrastructure & Support

IT Legal HR Finance

Challenges Meet client demands Beat benchmark regarding certifications, products and fund / portfolio structures

Cost reduction

Increased Client demands regarding Reporting Compliance with legal requirements (Abgeltungssteuer, GIPS, DVO, etc.) Cost reduction

Improvement of Fund / Portfolio Management tools as well as Fund / Portfolio Administration Systems Outsource Rationalize Transform Focus IT Investments Deploy large scale apps that do multiple functions break down product silos

Potential Solutions

Enhance products Review capabilities to ensure value based services Asset Allocation and risk tolerances matched to appetite and liabilities Separate portfolio constructors from research Validation / Certification of Asset Management companies (Telos, SAS 70 Reporting, etc.)

Analytics systems and Improve electronic Rationalize Brokers and modeling tools that connectivity to Custodians allow for aggregation of emerging execution Reengineer processes to portfolios or accounts venues and brokers achieve STP Enhance models and Look for internal Real time interfaces to benchmarks crossing custodians in order to perform Attribution models that opportunities daily recons can measure value of Measure and Client Reporting electronically decisions manage transaction delivered to improve speed Integration of strategies costs and execution and analytical flexibility to optimize returns effectiveness New forms of Client Reporting across all assets (i.e. Performance Attribution) Improve quality of Outsource / Insource Fund / reference data Portfolio Administration

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Agenda
Introduction What is an investment fund?

Trends
Value chain Parties involved NAV Summary

AGENDA

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Overview

Promoter

Fund Manager

Broker

Distributor 1 Investors Fund Administration

Distributor 2

Transfer Agent

Custodian

Clearing System

Distributor 3

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Promoter
Promoter

Fund Manager Distributor 1 Investors Distributor 2 Distributor 3

Broker

Transfer Agent

Fund Administration

Custodian

Clearing System

Professional in patrimonial administration (investment management companies, banks, etc.) Initiator of the project, set-up the investment fund incl. selection of board of directors and other implied actors, determination of investment policy/strategy, fee schedule, Creates a legal and administrative structure of the fund and participates on the subscription of the minimum capital of the fund

Fixes the funds sales strategy, sets up the distribution network and conducts the marketing for the fund
Examples: Dexia, FBL, Fidelity, JP Morgan, Sal Oppenheim, ...
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Investor
Promoter

Fund Manager Distributor 1 Investors Distributor 2 Distributor 3

Broker

Transfer Agent

Fund Administration

Custodian

Clearing System

Private (little or large) investors or Institutional investors (banks, insurance companies,...) Invests his/her money based on the prospectus information or based on recommendation from his/her bank, tax advisor, etc. Is allowed to participate on votes within general assemblies of SICAV/SICAF

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Distributor
Promoter

Fund Manager Distributor 1 Investors Distributor 2 Distributor 3

Broker

Transfer Agent

Fund Administration

Custodian

Clearing System

Intermediary between Transfer Agent and Investors

Sells shares of the funds to the investors Signs up the SLA with the TA and distribution agreements with the promoter (incl. pricing conditions, trailer fees, etc.) Ensures the marketing support of the fund Examples: Extrade, Schwab, FBL, Deutsche Bank, ...

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Transfer Agent
Promoter

Fund Manager Distributor 1 Investors Distributor 2 Distributor 3

Broker

Transfer Agent

Fund Administration

Custodian

Clearing System

Collects subscriptions / redemptions from the distributors and calculates commissions Centralizes the distribution side (cash collection) of the fund & reports available cash to fund managers Maintains the Investor register (conservation and update) Conducts the dividend payments of the fund Ensures that the sale, issue, repurchase and cancellation of units in the fund are carried out in accordance with the regulations and the fund documentation (cut-off time) Processes transactions on an Omnibus basis (the transfer agent does not see the individual shareholders accounts) or on a Retail basis (the TA knows who are the individual customers behind each account). Examples: EFA, RBC Dexia Investor Services Bank,...
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Fund Manager
Promoter

Fund Manager Distributor 1 Investors Distributor 2 Distributor 3

Broker

Transfer Agent

Fund Administration

Custodian

Clearing System

Professional in the finance sector and often part of the promoter group Research for necessary information

Asset management: day-to-day management of the funds portfolio

Initializes buying/selling orders according to the investment policy of the fund Examples: FIM, Dexia Asset Management, UBS, Deutsche Bank, ...

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Fund Administration
Promoter

Fund Manager Distributor 1 Investors Distributor 2 Distributor 3

Broker

Transfer Agent

Fund Administration

Custodian

Clearing System

Responsible for the fund administration: Legal publications, reports, minutes, fund prospectus, bi-annual reports, accounts to investors

Contact with the CSSF , auditors, fiscal administration,

Is in general the domiciliation agent of the fund (provides a legal address) Collects information from the Custodian concerning the fund movements In charge of the NAV Calculation Examples: EFA, Fastnet, Credit Agricole, State Street, Deka, ...

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Custodian
Promoter

Fund Manager Distributor 1 Investors Distributor 2 Distributor 3

Broker

Transfer Agent

Fund Administration

Custodian

Clearing System

Is the physical holder/safekeeper of the funds portfolio Ensures that the sale, purchase and cancellation of security trades or other transactions are carried out in accordance with the regulations and the fund documentation (investment policy) Is in general the funds main paying agent Acts in the sole interests of the unit holders. In case of shortcomings investors can turn directly to the depositary for compensation Examples: JP Morgan, Merrill Lynch, Euroclear, Clearstream, ...

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Agenda
Introduction What is an investment fund?

Trends
Value chain Parties involved NAV Summary

AGENDA

43

Definition
NAV = Net Asset Value Total Net Assets per share Calculated on a regular basis (daily, monthly, ) Published via Vendors What Does Net Asset Value ? A mutual fund's price per share or exchange-traded fund's (ETF) per-share value. In both cases, the per-share dollar amount of the fund is calculated by dividing the total value of all the securities in its portfolio, less any liabilities, by the number of fund shares outstanding. Investopedia explains Net Asset Value - NAV In the context of mutual funds, NAV per share is computed once a day based on the closing market prices of the securities in the fund's portfolio. All mutual funds' buy and sell orders are processed at the NAV of the trade date. However, investors must wait until the following day to get the trade price. Mutual funds pay out virtually all of their income and capital gains. As a result, changes in NAV are not the best gauge of mutual fund performance, which is best measured by annual total return. Because ETFs and closed-end funds trade like stocks, their shares trade at market value, which can be a dollar value above (trading at a premium) or below (trading at a discount) NAV.

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Definition in time

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Definitions - NAV Determination (Method 2) Assets

Securities at market value Cash / Bank Realized / unrealized result on security position Realized / unrealized Dividends and interest To be received on Subscriptions Other assets

Short term Liabilities

To be paid on security buy To be paid on redemptions Other liabilities Proratised expenses

= TOTAL NET ASSETS

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Definitions NAV per share

NAV per share

Total Net Assets

Number of shares Day J

Number of shares Day J

Number of shares Day J-1

Subscriptions J-1

Redemptions J-1

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Investment Fund fees & expenses

Running an investment fund involves fees & expenses Some funds impose transaction fees" directly on investors whenever they buy or sell shares. In addition, every fund has regular, recurring, fund-wide "operating expenses." Funds typically pay their operating expenses out of fund assets (investors pay indirectly these costs). The most common fees & expenses are:

Transaction fees
Purchase fees are at charge of shareholders when they buy their shares. Redemption fees are at charge of shareholders when they sell their shares. Exchange fees are at charge of shareholders when they transfer to another share class

Periodic fees
Management- and performance fees are paid out of fund assets to the fund management Administration fees are paid out of funds assets to the fund administration Custody fees are paid out of funds assets to the Custodian (Safekeeper) of the fund

TER = Total Expense Ratio

A commonly used term to make the costs transparent that a fund charges to their investor is the TER (Total Expense Ratio). This is a percentage (often expressed in basis points) is also used to compare funds.

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Agenda
Introduction What is an investment fund?

Trends
Value chain Parties involved NAV Summary

AGENDA

49

Course Summary
An investment fund is a financial investment vehicle that has a number of investors, either private or institutional investors. A fund prospectus defines details the investment objectives and strategies of an investment fund, as well as other more general fund related financial information. Many actors are involved into the investment fund business:

The NAV defines the Net Asset Value of the investment fund

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Quiz

Which of the following statement(s) is/are true about the various types of funds? Check all that apply. a) Stock funds provide investors with long-term capital appreciation. b) Bond funds provide investors with a fluctuating income. c) Money market funds provide investors with high returns. d) Money market funds can be exempt from Federal taxes.

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Quiz
Mr. X wants to invest in a mutual fund that provides regular dividends and high returns. Which mutual fund would you suggest to him? a) Stock funds b) Bond funds c) Money market funds

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Quiz

ABC mutual fund has assets of $ 379,000,000 and liabilities of $ 570,000 at the year-end. There were 4,830,000 shares in the fund at year-end. What is ABC mutual fund's NAV?

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Further reading
The Asset Management Industry in 2010 McKinsey
Technology Trends in Asset Management KX Asset Management Value Levers v1.0 CBT Alpha Beta Investment Management Strategies

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