Asset ManagementAsset Management

Lecture OneLecture One

IntroductionIntroduction

Book:Book: Investments 8th edition by Bodie, Kane and Investments 8th edition by Bodie, Kane and

MarcusMarcusEvaluation: Evaluation:

HomeworkHomeworkThree casesThree casesQuizzesQuizzesFinal exam 50%Final exam 50%

Office hour: Wednesday 14:00 to 15:00 Office hour: Wednesday 14:00 to 15:00

IntroductionIntroduction

Theories Theories PracticesPractices Institutional knowledgeInstitutional knowledgeCasesCases

Outline for todayOutline for today

What is asset management?What is asset management?Asset classesAsset classesAsset management processAsset management process

Asset ManagementAsset Management

Asset management: to meet specified Asset management: to meet specified investment goals for the benefit of the investors. investment goals for the benefit of the investors. financial assets financial assets real assets (real estate, commodities)real assets (real estate, commodities)

Investors Investors institutions (insurance companies, pension funds, institutions (insurance companies, pension funds,

corporations etc.)corporations etc.) private investors private investors

direct via investment contractsdirect via investment contracts collective investment schemes (e.g. mutual funds) .collective investment schemes (e.g. mutual funds) .

Global fund management industry, 2007Global fund management industry, 2007(values in US$ trillion)(values in US$ trillion)

pension funds, 28.2, 23%

insurance funds, 19.9, 16%

mutual funds, 26.2, 21%

sov. Wealth funds, 3.3, 3%

hedge funds, 2.3, 2%

private equity, 2, 2%

private wealth, 40, 33%

pension funds

insurance funds

mutual funds

sov. Wealth funds

hedge funds

private equity

private wealth

Global (conventional) fund management Global (conventional) fund management industry by countryindustry by country

US49%

UK9%

Japan6%

France6%

Germany4%

Netherlands2%

Switzerland1%

Other23%

US

UK

Japan

France

Germany

Netherlands

Switzerland

Other

Global (conventional) fund management Global (conventional) fund management industry by countryindustry by country

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

US UKJa

pan

Franc

e

Germ

any

Nether

lands

Switzer

land

Other

Insurance

Mutual

Pension

15 Largest Asset Management Firms by assets 15 Largest Asset Management Firms by assets under management as of 31 December 2006.under management as of 31 December 2006.

Rank Manager Assets under management

(US$ billion) Country

1. UBS AG 2,452 Switzerland

2. Barclays Global Investors 1,814 UK

3. State Street Global Advisors 1,745 US

4. AXA Group 1,740 France

5. Allianz Group 1,708 Germany

6. Fidelity Investments 1,635 US

7. Capital Group 1,404 US

8. Deutsche Bank 1,274 Germany

9. Vanguard Group 1,167 US

10. BlackRock 1,125 US

11. Credit Suisse 1,093 Switzerland

12. JPMorgan Chase 1,014 US

13. Mellon Financial 995 US

14. Legg Mason 958 US

15. BNP Paribas 817 France

Asset classesAsset classes

The money marketThe money marketT billsT billsCertificates of depositCertificates of depositEurodollarsEurodollarsFederal fundsFederal funds

borrowing by U.S. banks from the Federal Reserve borrowing by U.S. banks from the Federal Reserve through Dec. 2007:through Dec. 2007:

borrowing by U.S. banks from the Federal Reserve borrowing by U.S. banks from the Federal Reserve through Dec. 2008:through Dec. 2008:

Asset ClassesAsset Classes

Money marketMoney marketBond marketBond market

T notes and T bondsT notes and T bonds International bondsInternational bondsMunicipal bondsMunicipal bondsCorporate bondsCorporate bondsMortgage-backed pass-through securitiesMortgage-backed pass-through securities

Mortgage related agencies Mortgage related agencies Federal National Mortgage Association, Fannie MaeFederal National Mortgage Association, Fannie Mae Government National Mortgage Association, Ginnie MaeGovernment National Mortgage Association, Ginnie Mae

S&P 500 Stock Price 1985-2009S&P 500 Stock Price 1985-2009

Global indices 2008Global indices 2008

Best vs. worst performingBest vs. worst performing stock markets 2008 stock markets 2008

Asset management processAsset management process Planning with the clientPlanning with the client

Investor objectives, constraints and preferencesInvestor objectives, constraints and preferences Execution by the asset manager:Execution by the asset manager:

Asset allocation Asset allocation Risk and return, effects of diversification (views on inflation, growth, Risk and return, effects of diversification (views on inflation, growth,

etc.)etc.) Security selectionSecurity selection

Market efficiency: can we beat the market? (private info)Market efficiency: can we beat the market? (private info) ExecutionExecution

How and when do you trade? (trading speed, trading costs)How and when do you trade? (trading speed, trading costs)

Evaluation:Evaluation: What are the risk and the return of the portfolio?What are the risk and the return of the portfolio? Does the manager underperform or outperform?Does the manager underperform or outperform?

Planning Planning

objectivesobjectives ConstraintsConstraints policiespolicies

Return Return requirementsrequirements

liquidityliquidity Asset allocationAsset allocation

Risk toleranceRisk tolerance HorizonHorizon diversificationdiversification

RegulationsRegulations Risk positioningRisk positioning

TaxesTaxes Tax positioningTax positioning

Unique needsUnique needs Income Income generationgeneration

ObjectivesObjectives

Type of investorType of investor Return requirementReturn requirement Risk toleranceRisk tolerance

Individual and personal Individual and personal truststrusts

Life cycleLife cycle Life cycleLife cycle

Mutual fundsMutual funds VariableVariable VariableVariable

Pension fundsPension funds Assumed rate of returnAssumed rate of return Depends on proximity of Depends on proximity of payoutspayouts

Endowment fundsEndowment funds Determined by current Determined by current income needs and needs income needs and needs for asset growthfor asset growth

Generally conservativeGenerally conservative

Life insurance Life insurance companiescompanies

Exceed new money rate Exceed new money rate by sufficient marginby sufficient margin

ConservativeConservative

Non-life insurance Non-life insurance companiescompanies

No minimumNo minimum conservativeconservative

BanksBanks Interest spreadInterest spread variablevariable

ConstraintsConstraints

Type of investorType of investor LiquidityLiquidity HorizonHorizon RegulationsRegulations taxestaxes

Individual and Individual and personal trustspersonal trusts

VariableVariable Life cycleLife cycle NoneNone VariableVariable

Mutual fundsMutual funds HighHigh VariableVariable FewFew NoneNone

Pension fundsPension funds Young: low;Young: low;

Old: highOld: high

LongLong ERISAERISA NoneNone

Endowment Endowment fundsfunds

LowLow LongLong FewFew NoneNone

Life insurance Life insurance companiescompanies

LowLow LongLong FewFew YesYes

Non-life Non-life insurance insurance companiescompanies

HighHigh ShortShort FewFew YesYes

BanksBanks HighHigh ShortShort ChangingChanging YesYes

Asset allocationAsset allocation

Specify asset classes to be included in the Specify asset classes to be included in the portfolioportfolio

Specify capital market expectationsSpecify capital market expectationsDerive the efficient market frontierDerive the efficient market frontierFind the optimal asset mixFind the optimal asset mix

Retirement planning modelsRetirement planning models

Retirements consumption depends on life Retirements consumption depends on life expectancy. expectancy.

Life cycle of risk toleranceLife cycle of risk toleranceBallpark Estimate Model Ballpark Estimate Model

http://www.choosetosave.org/ballpark/http://www.choosetosave.org/ballpark/

Ballpark Estimate ModelBallpark Estimate Model Assuming a constant real interest rate of Assuming a constant real interest rate of 3%.3%. For example, let’s say Jane is a For example, let’s say Jane is a 35-year-old35-year-old woman with two children, woman with two children,

earning earning $30,000$30,000 per year. per year. Jane has determined that she will need Jane has determined that she will need 70%70% of her current annual of her current annual

income, i.e. income, i.e. $21,000$21,000, to maintain her standard of living in retirement. , to maintain her standard of living in retirement. Jane would then subtract the income she expects to receive from Social Jane would then subtract the income she expects to receive from Social

Security ($Security ($12,00012,000 in her case) from $21,000, equaling $9,000. This is how in her case) from $21,000, equaling $9,000. This is how much Jane needs to make up for each retirement year.much Jane needs to make up for each retirement year.

Jane expects to retire at age Jane expects to retire at age 6565 and if she is willing to assume that her life and if she is willing to assume that her life expectancy will be equal to the average female at that age (expectancy will be equal to the average female at that age (8686), she ), she would multiply $9,000 by would multiply $9,000 by 16.416.4 for a result of $147,600 for a result of $147,600

Jane has already saved $2,000 in her 401(k) plan. She plans to retire in Jane has already saved $2,000 in her 401(k) plan. She plans to retire in 30 years so she multiplies $2,000 x30 years so she multiplies $2,000 x 2.4 2.4 equaling $4,800. She subtracts equaling $4,800. She subtracts that from her total, making her projected total savings needed at that from her total, making her projected total savings needed at retirement $142,800. retirement $142,800.

Jane then multiplies $142,800 x Jane then multiplies $142,800 x .020.020 = $2,856. This is the amount Jane = $2,856. This is the amount Jane will need to save in the current year for her retirement (it is assumed the will need to save in the current year for her retirement (it is assumed the annual contribution will increase with inflation in future years).annual contribution will increase with inflation in future years).