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Department of Banking and Finance

BFF5270: Funds Management
Lecture 1
J Wickramanayake and Robert Ads
Consultation hours are to be provided through Moodle
E-mails: j.wickramanayake@monash.edu
Robert.ades@monash.edu

You can e-mail for short e-mail responses

Please note that you will get an e-mail response ONLY IF you use
your Monash e-mail address in line with Monash University email
policy
If VLE (Moodle) email messaging is used by BFF5270
students, email recipient gets the message: DO NOT REPLY
and it is not possible to get a reply from BFF5270 teaching
staff
BFF5270 students are advised to use normal Monash University
emailing to get a response
You can telephone unit leader: 9903 2403 and record a message
slowly and clearly giving your Monash ID, your name, name/code
of unit you are enrolled in and your home/mobile phone number.

Grade Allocation
Weekly tutorial (Moodle) submissions 10% (there is a tutorial
class in the first teaching week)
Mid-term in-class test
10%
Group assignment
30%
Final Examination
50% (must pass)
Group assignment will be discussed and Assignment groups will
be formed in teaching week 1 (first) tutorial
Form groups from among your own tutorial class
Sign group designation form and designate 1 person as a
group leader
Report to your tutor if you have problematic member(s)
Solution problematic member(s) can do the assignment by
themselves: it is a huge task for one student to complete.
Readings for this lecture:

SPH-BKM = BFF5270: Funds Management (customised textbook used

in this unit available at Monash Caulfield bookshop), Chapters 1 and 3;

MTPM = Maginn, J. L., Tuttle, D. L., Pinto, J. E., & McLeavey, D. W.

(2007), Managing investment portfolios: A dynamic process, Chapter 1;

CFA-SPH= CFA Standards of Practice Handbook, pp.1-12; SPH-BKM,3

Chapter 19 (last chapter); MTPM Chapter 10 (pp.678-681).

OUTLINE OF THIS LECTURE

1A: INTRODUCTION TO FUNDS MANAGEMENT
Overview of funds management
Integrated set of steps undertaken in a consistent manner to
create and maintain an appropriate portfolio (combination of
assets) to meet clients stated goals
Portfolio Management Process
Identify investment objectives; capital market expectations and
asset allocation
Major Asset Classes
Equities; fixed income securities; alternative assets; international
investments

Evaluating Funds performance

Evaluating techniques and risk assessment
1B: CFA ETHICS

CFA Standard of Practice Handbook (2014) 11th Edition

What investors expect from a good fund manager and CFA code
4
of ethics

Portfolio Managers

Portfolio managers

Responsible for delivering investment performance

Full authority to make at least some investment
decisions
Accountable for investment results

What investment problems do portfolio

managers solve (see case study on next slide)

To help clients meet their wealth accumulation and

spending needs
To select the weights of asset classes such as
equities, bonds and cash
5

Review of Case (from SPH-BKM)

Jean is retired and has approximately $700,000 in assets
(see next slide for data). She earns a small amount of
income from a part-time job, receives social security
payments and collects income from investments. She
owns her own home and has a modest lifestyle.
Problem:
Jean needs to decide how to best invest her assets
and set a spending policy.
Key Questions:
What do we need to know to best advise her?
What do we need to do to determine the best course
of action?
There are additional questions also in this case
study: students need to attempt this case please.
6

Data

The Asset Management Industry

Two Organization Forms

Contract directly with a management and advisory firm

Relationship with client

Customized
Separate accounts

Commingling of investment capital of several clients in an

investment company

Offers a general investment solution

Invest a pool of funds belonging to many individuals in a single
portfolio of securities
Issue new shares representing the proportional ownership of the
fund
For individual investors with relatively small pools of capital
8

The Asset Management Industry

$
Investor 1
Management and $
advisory firm

$
Investor 2

Security
portfolio(s)
- Account 1
- Account 2

Investor 1
$
Investor 2

Investment
(Fund) company

Fund
Securities
Portfolio

$
9

Organization and Management of

Investment Companies

Valuing Investment Company Shares

The NAV for an investment company is

analogous to the share price of a
corporations common stock.
The NAV of the fund shares will increase as
the value of the underlying assets (the fund
security portfolio) increases
All mutual funds buy and sell orders are
processed at the NAV of the trade date

Total Market Value of Fund Portfolio Fund Expenses

Fund NAV=
Total Fund Shares Outstanding
10

Closed-End Versus Open-End Investment

Companies

Closed-End Investment Company

Functions like any other public firm and its stock trades on
the regular secondary market

The fund generally does not issue or redeem shares once it

is established

The price of the fund is different from its NAV

Shares in American funds are issued at a premium to NAV of up to

10%, while British funds are issued at a premium amounting to at least
5%

After several months the shares may trade at a discount, which persists
and fluctuates accordingly to a mean-reverting pattern

It is a puzzle for modern finance why close-end funds often sell at a

discount from NAV in USA

Closed-End Funds: A Survey (by Dimson and Minio-Kozerski) (Financial

Markets, Institutions & Instruments Volume 8, Issue 2, pages 141, May
11
1999 can be downloaded through Monash University library).

Closed-End Versus Open-End

Investment Companies

Open-End Investment Companies

The company continues to sell and repurchase

shares after their initial public offerings

The fund stands ready to issue or redeem shares at

the net asset value (NAV)

Investors who buy or sell the shares may have to pay

sales charges (the load)

These funds are normally called mutual funds

Funds are generally marketed to the public either

directly by the fund underwriter or indirectly through
brokers acting on behalf of the underwriter

12

Open- and closed-end funds

Similarities:

Diversified portfolios
Professionally managed
Either actively or passively managed
Required to distribute capital gains and dividends to shareholders
Regulated

Differences:

Closed-end funds are traded on a stock exchange

Closed-end funds are bought and sold at market price, and the
transactions can be done throughout the trading day
Closed-end funds use leverage to enhance their returns
13

Investment funds by objectives

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
14

Investment funds by objectives

Global Investment Companies

Funds that invest in countries outside Australia are

generally called either international funds or global
funds
International funds often hold only non-domestic
stocks from such countries as Germany, Japan,
Singapore, and Korea
Global funds contain both Australian and nonAustralian securities
Increasingly large number of investment
companies offer both domestic and global products
in their local markets
15

What do you need to know

about a fund before you invest?
Need to look at a set of essential investment information:
> The funds investment objective
> Investment strategy (how does it plan to achieve the
objective?)
> Asset classes invested in (equities: growth asset class;
bonds: income asset class)?
> Risk profile
> Expected returns
> Historical risk-adjusted returns (performance)
> Benchmarks
> Expense ratio (fee structure)
.. Need to understand its investment process
16

Funds Management

There are gifted investors: Warren Buffet, John Neff, Peter

Lynch, George Soros, etc.
For them, fund management is the art of stock picking.
Portfolio management is secondary (interior
decorator/artist approach)
For others, fund management is carried out through an
integrated and disciplined process of portfolio
management
... illustrated next page

17

Portfolio Management Process

Portfolio Management is an integrated set of activities:

Planning
(1)
Specification and
quantification of
investor
objectives,
constraints and
preferences

Execution
(4a)

(2a)
Portfolio
policies and
strategies

Relevant
economic, social,
political, sector
and security
considerations

Monitoring
investor-related
input factors

(3) Portfolio
construction &
revision
Asset
Allocation,
portfolio
optimization,
security
selection

(2b)
(6)

Feedback

Capital
Market
Expectations

(4b)

(5) Attainment
of investor
objectives
Performance
measurement

Monitoring
economic &
market input
factors
18

Portfolio Management Process (1)

process begins with understanding investors objectives

(1)

An investors objectives, preference and constraints

are identified to develop explicit investment policies
Investment Objectives

Expected Returns
Risk Profile

Investment Constraints

Liquidity Needs
Time Horizon
Unique Needs and Preferences
Tax Concerns
Legal & Regulatory Factors

19

Portfolio Management Process (2)

(2a)

Investment strategies are developed from the

investment policy statement.
Scenarios can be developed.
Simulations can be carried out
Craft a strategic asset allocation (see additional
lecture notes in Moodle)

(2b)

The Investment managers expectations

about the capital market will also affect the
strategic asset allocation process.

Long-run forecasts of risk and return characteristics

for various asset classes
20

Portfolio Management Process (3)

(3)

Portfolio Construction and Revision, Asset

Allocation, Security Selection, Implementation,
and Execution

Strategic approach
Tactical approach
Quantitative approach in security selection
Based on investment objectives and market expectations

21

Major Asset Classes in a Portfolio

Traditional investments

Traditional alternative investments

Cash/Short-term assets (the money market)

Bonds
Equities
Private equity investments
Commodities
Real Estate

Modern alternative investments

Derivatives
Hedge funds
22

Features of Alternative Investments

Have risk-return profiles different to common asset

classes
Relative illiquidity, which requires a corresponding return
premium
Improved diversification relative to stocks and bonds
Complex investment structures, specific expertise, and
lack of reporting transparency
Difficulty appraising performance due to complexity of
establishing benchmarks

23

Asset Allocation of Institutional investors

Equities
40%

Bonds
40%
Real Estate/
Cash
20%

24

Asset Allocation of Individuals

Profile of Wealthy individuals
With Gross Assets Over US$1 million
Cash
6.0
%
Common Stocks
31.2
Bonds
7.8
Life Insurance (cash value)
0.6
Real Estate
23.6
Non-Corporate Business
9.9
Others (deposits, etc.)
20.9
______
100.0 %
======

25

Portfolio Management Process (4)

(4a)

Continuous monitoring of investor-related

input factors
Change of risk/return preferences
Change of liquidity/liabilities positions

(4b)

Continuous monitoring of economic and market factors

Changing economic landscape
Changing socio-political situation

26

Portfolio Management Process (5)

(5)

(6)

Performance Measurement and Monitoring

Benchmarks for relative performance and
investor-related objectives
Performance against benchmarks and targets
Setting loss triggers: loss in any given year (for
particular asset class and portfolio as a whole also)
should not exceed x%
Continuous evaluation for changes in the economic and
socio-political environment may necessitate changes to
investment mandates, asset allocation, security selection
Process flows logically and systematically through an
orderly sequence of decisions
Moves from monitoring back to policy determination in an
on-going manner
27
Applicable for individual and institutional investors

What Do you (if You Are an Investor) Expect

from a Professional Fund Manager?
1. Help determine your investment objectives and develop a portfolio

that is consistent with them.

2. Diversify your portfolio to eliminate unsystematic risk.
3. Maintain your portfolio diversification and your desired risk class or
risk level while allowing flexibility so you could shift between
alternative investment instruments as desired.
4. Attempt to achieve a risk-adjusted performance level that is
superior to that of your relevant benchmark.
5. Administer the account, keep records of costs and transactions,
provide timely information for tax purposes, and reinvest dividends
if desired.
6. Maintain ethical standards of behavior at all times.
28

1B - Chartered Financial Analyst (CFA)

Institute: Ethical and Professional Standards
CFA Standards of Practice Handbook (latest edition)
Please download using the link:
http://www.cfainstitute.org/learning/products/publications/ccb/Pages/ccb.v2014.n4.1.
aspx?PageName=searchresults&ResultsPage=1
You can also download accessing BFF5270 library reading list:
Please check BFF5270 Moodle for the reading list.

Ethics in Investments
Financial markets are vitally important to a well-functioning economy
Trust in information and faith in fairness are essential
Codes of ethics for financial professionals and strict regulations attempt
to create such an environment where financial markets can efficiently
fulfill their economic function
29

CFA Code of Ethics

1.
2.
3.
4.
5.
6.

Act with integrity, competence, diligence, and respect and in

an ethical manner
Place the integrity of the investment profession and the
interests of clients above your own personal interests
Use reasonable care and exercise independent professional
judgment when conducting your duties
Practice and encourage others to practice in a professional
and ethical manner
Promote the integrity and viability of the global capital
markets for the ultimate benefit of society
Maintain and improve their professional competence and
strive to maintain and improve the competence of other
investment professionals
30

CFA Standards of Practice Handbook

Standards are organized into seven general topics:

I. Professionalism
II. Integrity of Capital Markets
III. Duties to Clients
IV. Duties to Employers
V. Investment Analysis, Recommendations, and Actions
VI. Conflicts of Interest
VII. Responsibilities as a CFA Institute Member or CFA Candidate
(See CFA Standards of Practice Handbook)
31

CFA Standards of Practice Handbook

CFA Standards of Practice Handbook, pp.7-9
I. PROFESSIONALISM
A. Knowledge of the Law
B. Independence and Objectivity
C. Misrepresentation
D. Misconduct

II. INTEGRITY OF CAPITAL MARKETS

A. Material Nonpublic Information
B. Market Manipulation
32

CFA Standards of Practice Handbook

III. DUTIES TO CLIENTS
A. Loyalty, Prudence, and Care
B. Fair Dealing
C. Suitability
D. Performance Presentation
E. Preservation of Confidentiality
IV. DUTIES TO EMPLOYERS
A. Loyalty
B. Additional Compensation Arrangements
C. Responsibilities of Supervisors
33

CFA Standards of Practice Handbook

V. INVESTMENT ANALYSIS, RECOMMENDATIONS,
AND ACTIONS
A. Diligence and Reasonable Basis
B. Communication with Clients and Prospective Clients
C. Record Retention

VI. CONFLICTS OF INTEREST

A. Disclosure of Conflicts
B. Priority of Transactions
C. Referral Fees
34

CFA Standards of Practice Handbook

VII. RESPONSIBILITIES AS A CFA INSTITUTE MEMBER OR
CFA CANDIDATE
A. Conduct as Members and Candidates in the CFA
Program
B. Reference to CFA Institute, the CFA Designation, and
the CFA Program
See CFA Standards of Practice Handbook - Solutions to Endof-Reading Problems

35

Problems and questions for students practice:

SPH-BKM, chapter 1, review of case problem and last chapter: problem 4
(please go through it very carefully and attempt the questions asked)
CFA-SPH, p.223 onwards: questions/answers are provided in CFA-SPH,
p.237 onwards (and answers will not be made available through Moodle)
Questions for tutorial submission under tutorial 2 will be made
available through the Moodle in time.

Concluding Comments

Portfolio (or funds) Management is an on-going process in which:

Investment objectives and constraints are identified and specified

Investment strategies are developed

Portfolio composition is decided in detail

Portfolio decisions are initiated by portfolio managers and implemented

by traders

Portfolio performance is measured and evaluated

Investor and market conditions are monitored

Any necessary rebalancing is implemented

Ethical portfolio (funds) management is essential.

36