Portfolio Management

and Capital Market

Lecture# 11 and 12
 Professional Asset Management

What is Asset Management?

Asset management is the direction of all or part of a client's portfolio by a financial services
institution, usually an investment bank, or an individual. Institutions offer investment services
along with a wide range of traditional and alternative product offerings that might not be
available to the average investor.

Understanding Asset Management

Asset management refers to the management of investments on behalf of others. The process
essentially has a dual mandate - appreciation of a client's assets over time while mitigating risk.
There are investment minimums, which means that this service is generally available to high net-
worth individuals, government entities, corporations and financial intermediaries.

The role of an asset manager consists of determining what investments to make, or avoid, that
will grow a client's portfolio. Rigorous research is conducted utilizing both macro and micro
analytical tools. This includes statistical analysis of the prevailing market trends, interviews with
company officials, and anything else that would aid in achieving the stated goal of client asset
appreciation. Most commonly, the advisor will invest in products such as equity, fixed income,
real estate, commodities, alternative investments and mutual funds.

Accounts held by financial institutions often include check writing privileges, credit cards, debit
cards, margin loans, the automatic sweep of cash balances into a money market fund and
brokerage services.
When individuals deposit money into the account, it is typically placed into a money market fund
that offers a greater return that can be found in regular savings and checking accounts. Account
holders can choose between Federal Deposit Insurance Company-backed (FDIC) funds and non-
FDIC funds. The added benefit to account holders is all of their banking and investing needs can
be serviced by the same institution rather than having separate brokerage account and banking
options.

Key Points:

Asset management refers to the management of investments on behalf of others.

The goal is to grow a client's portfolio over time while mitigating risk.

Asset management is a service offered by financial institutions catering to high net-worth

individuals, government entities, corporations and financial intermediaries.

Example of an Asset Management Institution:

Merrill Lynch offers a Cash Management Account (CMA) to fulfill the needs of clients who
wish to pursue banking and investment options with one vehicle, under one roof. The account
gives investors access to a personal financial advisor. This advisor offers advice and a range of
investment options that include initial public offerings (IPO) in which Merrill Lynch may
participate, as well as foreign currency transactions.

Interest rates for cash deposits are tiered. Deposit accounts can be linked together so that all
eligible funds aggregate to receive the appropriate rate. Securities held in the account fall under
the protective umbrella of the Securities Investor Protection Corporation (SIPC). SIPC does not
shield investor assets from inherent risk but rather protects those assets from financial failure of
the brokerage firm itself.
What are the benefits of professional asset management?

When most people think of working with a stockbroker, they picture a selling interview in which
the broker determines their investment needs and "sells" them a stock, bond or other product.
This is the traditional method which is still used by many of the brokers at the large wire-houses.
Typically, the client never interacts with the broker again until there is more money to invest, or
until the broker thinks it's a good time to reposition the original asset, in which case he or she
will be entitled to another commission. This is why many investors favor a different approach,
known as "asset management." Based on the proven mechanics of modern portfolio theory,
professional asset management is a five-step process to a successful financial future. Here's how
it works:

1. Determine your risk profile and objectives. Through personal consultations with you, we
develop a personal profile of your individual investment needs and objectives, time horizon, and
attitude toward investing.

2. Set your asset allocation policy. We develop a personalized asset allocation policy based on
your needs and objectives, as identified in Step 1. This policy maximizes your investment returns
relative to your risk tolerance through the carefully diversified allocation of your portfolio.

3. Diversify across asset classes and within styles. Your asset allocation policy is implemented
by investing in a well-diversified portfolio. Accounts over $50,000 are managed by preeminent
institutional money management firms, not normally accessible to an individual investor.

4. Rebalance your portfolio. Your investment portfolio is carefully monitored on an ongoing

basis to ensure that it remains consistent with your agreed-upon asset allocation policy. If the
relative value of investments in your portfolio changes enough to become inconsistent with this
policy, it is rebalanced.

5. Report the results. We will communicate with you on a regular basis and provide a
comprehensive reporting package showing account level performance reports and statements
providing details of your account -- including total asset value and a record of all transactions
that occurred during the reporting period.
What Is a Mutual Fund?

A mutual fund is a type of financial vehicle made up of a pool of money collected from many
investors to invest in securities like stocks, bonds, money market instruments, and other assets.
Mutual funds are operated by professional money managers, who allocate the fund's assets and
attempt to produce capital gains or income for the fund's investors. A mutual fund's portfolio is
structured and maintained to match the investment objectives stated in its prospectus.

Mutual funds give small or individual investors access to professionally managed portfolios of
equities, bonds, and other securities. Each shareholder, therefore, participates proportionally in
the gains or losses of the fund. Mutual funds invest in a vast number of securities, and
performance is usually tracked as the change in the total market cap of the fund—derived by the
aggregating performance of the underlying investments.

Key points:

A mutual fund is a type of investment vehicle consisting of a portfolio of stocks, bonds, or other
securities.

Mutual funds give small or individual investors access to diversified, professionally managed
portfolios at a low price.

Mutual funds are divided into several kinds of categories, representing the kinds of securities
they invest in, their investment objectives, and the type of returns they seek.

Mutual funds charge annual fees (called expense ratios) and, in some cases, commissions, which
can affect their overall returns.

The overwhelming majority of money in employer-sponsored retirement plans goes into mutual
funds.
What Is a Hedge Funds?

Hedge funds have the same basic pooled fund structure as mutual funds. However, hedge funds
are only offered privately. Typically, they are known for taking higher risk positions with the
goal of higher returns for the investor. As such, they may use options, leverage, short-selling, and
other alternative strategies. Overall, hedge funds are usually managed much more aggressively
than their mutual fund counterparts. Many seek to take globally cyclical positions or to achieve
returns in markets that are falling.

While built around the same concepts for investing as the mutual fund, hedge funds are
structured and regulated much differently. Since hedge funds offer their investments privately,
this requires them to include only accredited investors and allows them to build their fund
structure. Regulation D of the 1933 Act mandates investments from accredited investors in
private, hedge funds.

Accredited investors are deemed to have advanced knowledge of financial market investing,
typically with higher risk tolerance than standard investors. These investors are willing to bypass
the standard protections offered to mutual fund investors for the opportunity to potentially earn
higher returns. As private funds, hedge funds also differ in that they usually deploy a tiered
partnership structure which includes a general partner and limited partners.

The private nature of hedge funds allows them a great deal of flexibility in their investing
provisions and investor terms. As such, hedge funds often charge much higher fees than mutual
funds. They can also offer less liquidity with varying lock-up periods and redemption
allowances.

Some funds may even close redemptions during volatile market periods to protect investors from
a potential selloff in the fund’s portfolio. Overall, it is vital that hedge fund investors fully
understand a fund’s strategy risks and governing terms. These terms are not made public like a
mutual fund prospectus. Instead, hedge funds rely on private placement memorandums, a limited
partnership or operating agreement, and subscription documents to govern their operations.
 Mutual Funds vs. Hedge Funds: What’s the Difference?

Mutual Funds vs. Hedge Funds: An Overview

Both mutual funds and hedge funds are managed portfolios built from pooled funds with the goal
of achieving returns through diversification. This pooling of funds means that a manager—or
group of managers—uses investment capital from multiple investors to invest in securities that
fit a specific strategy.

Mutual funds are offered by institutional fund managers with a variety of options for retail and
institutional investors. Hedge funds target high-net-worth investors. These funds require that
investors meet specific accredited characteristics.

Key Points:

Mutual funds are regulated investment products offered to the public and available for daily
trading.

Hedge funds are private investments that are only available to accredited investors.

Hedge funds are known for using higher risk investing strategies with the goal of achieving
higher returns for their investors.