securities firms and investment securities firms secondary … · 2013-06-18 · 1 securities firms...
TRANSCRIPT
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Securities Firms
and Investment
Banks
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Securities Firms and Investment
Banks (IBs)
Investment banks (IBs) help corporations and governments raise capital through debt and equity security issues in the primary market underwriting is assisting in the issue of new securities
IBs also advise on mergers and acquisitions (M&As) and corporate restructuring
Securities firms assist in the trading of securities in secondary markets broker-dealers assist in the trading of existing securities
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Lines of Business
Investment banking first time debt and equity issues occur through initial
public offerings (IPOs)
new issues from a firm whose debt or equity is already traded are called seasoned equity offerings (SEOs)
a private placement is a securities issue that is placed with one or a few large institutional investors
public offerings are offered to the public at large
IBs act only as an agent in best efforts underwriting
IBs act as principals in firm commitments
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Lines of Business
Venture capital (VC) is a professionally managed pool of money used to finance new (i.e., start-up) and often high-risk firms VC usually purchases an equity stake in the start-up
usually become active in management of the start-up
institutional venture capital firms find and fund the most promising new firms
venture capital limited partnerships
financial venture capital firms
corporate venture capital firms
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Lines of Business
Private equity investments Private equity (PE) differs from VC in funds sources and in
types of investments
PE firms raise funds by selling securities rather than commingling private funds
PE firms often acquire established existing firms rather than purchase start-ups
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Lines of Business
Market making involves the creation of secondary markets for an issue of securities agency transactions are two-way transactions on behalf
of customers
with principal transactions market makers seek to profit for their own accounts
Investment banks managed $88 trillion in derivatives securities in 2010
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Lines of Business
Trading involves taking an active net position in an asset Position trading involves relatively long-term positions in
assets
Pure arbitrage involves attempts to profit from price discrepancies
Risk arbitrage involves attempts to profit by forecasting information releases
Program trading is the simultaneous buying and selling of at least 15 different stocks valued at $1 million or more
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Lines of Business
Trading (continued) Stock brokerage involves trading on behalf of customers
Electronic brokerage offers customers direct access, via the internet, to the trading floor
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Lines of Business
Investing involves managing pools of assets such
as closed- and open-end mutual funds
as agents
as principals
Cash management involves deposit-like accounts
such as money market mutual funds (MMMFs) that
offer check writing privileges
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Lines of Business
Merger and acquisition (M&A) assistance
M&A activity brings large fees to bankers
M&A business remains very cyclical and depends on the
economy
M&A activity by year
US Global
2008 $924 billion $2.85 trillion
2009 713 1.70
2010* 452 1.28
* First nine months
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Lines of Business
Other Service Functions
Security custodian services
Clearance and settlement services
Escrow services, research and advice on divestitures, and
asset sales
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Industry Performance
Industry trends depend heavily on the state of the
stock market and the economy
Commission income fell after the 1987 stock market crash
and the 2001-2002 stock market decline
Improvements in the U.S. economy in the mid-2000s led
to increases in commission income but income fell with the
stock market in 2006-2008 because of rising oil prices and
the subprime mortgage collapse
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Industry Performance
Performance (continued)
Revenues and profits fell record amounts in 2008, but
rebounded sharply in 2009
Industry employment fell sharply
Low interest rates and strong stock market helped fuel
profit recovery
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Balance Sheets of Securities
Firms and Investment Banks (IBs)
Selected Major Assets (2010)
Receivables from other broker-dealers 33.79%
Long positions in securities and commodities 26.54%
Reverse repurchase agreements 26.40%
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Balance Sheets of Securities
Firms and Investment Banks (IBs)
Selected Major Liabilities and Equity (2010)
Payables to other broker-dealers 14.25%
Payables to customers 13.35%
Short positions in securities and commodities 10.29%
Repurchase agreements 40.82%
Other non-subordinated liabilities 9.80%
Equity 4.94%
(SEC requires minimum net worth to assets of 2%)
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Regulation of Securities Firms
and Investment Banks (IBs)
The Securities and Exchange Commission
(SEC) is the primary regulator of the securities
industry
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Regulation of Securities Firms
and Investment Banks (IBs)
The Sarbanes-Oxley Act (SOX) of 2002
created an independent auditing oversight board
under the SEC
increased penalties for corporate wrongdoers
forced faster and more extensive financial
disclosure
created avenues of recourse for aggrieved
shareholders
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Regulation of Securities Firms
and Investment Banks (IBs)
The SEC sets rules governing underwriting
and trading activity
SEC Rule 144A defines boundaries between
public offerings and private placements
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Regulation of Securities Firms
and Investment Banks (IBs)
The government can also mandate higher capital
requirements for larger and for interconnected firms
Conclusion: Government oversight of industry practices has
increased as a result of the bill
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Regulation of Securities Firms
and Investment Banks (IBs)
Executive compensation restrictions imposed by the Obama
administration
Strengthen the independence of the compensation
committee from senior management
Shareholders now also have a non-binding vote on
executive compensation packages
Administration has a say on executive pay for firms that
accepted bailout money
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Global Issues
Securities firms and investment banks are by far the
most global of any group of financial institutions
U.S. firms are increasingly looking to expand their
business abroad—particularly into China and India
Increase in cross-border strategic alliances Mutual Funds and
Hedge Funds
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Mutual Funds and Hedge Funds
Mutual Funds (MFs) and Hedge Funds (HFs) are financial institutions (FIs) that pool the financial resources of individuals and companies and invest those resources in portfolios of assets
The first MF was established in Boston in 1924
By 1970, 360 MFs held about $50 billion in assets
Money market mutual funds (MMMFs) were introduced in 1970
Tax-exempt MMMFs were introduced in 1979
By 2010, more than 7,567 MFs held just over $11 trillion in assets
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Mutual Funds
Cash flows into MFs are highly correlated with the return on
stock markets
Growth has also resulted from the rise in retirement funds
under management by MFs
MFs managed ~ 25% of retirement fund assets in 2010
MFs are the second most important group of FIs as
measured by asset size; second only to commercial banks
Banks’ share of all MF assets was 8% in 2010
Insurance companies managed 7% of MF industry assets in
2010
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Money Market Mutual
Funds Money Flows
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Mutual Funds
The barriers to entry in the MF industry are low the largest MF sponsors have not increased their market
share recently
the largest 25 MF companies managed 76% of industry assets in 1990
the largest 25 MF companies managed 75% of industry assets in 2010, about the same
the composition of the top 25 firms in the industry has changed
seven of the largest 25 firms in 2010 were not among the top 25 in 1990
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Mutual Funds
The MF industry has two sectors
short-term funds invest in securities with original maturities of less than one year
money market mutual funds
tax-exempt money market mutual funds
long-term funds invest in portfolios of securities with original maturities of more than one year
equity funds consist of common and preferred stock
bond funds consist of fixed-income capital market debt securities
hybrid funds consist of both stock and bond securities
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Mutual Funds
Approximately 25% of long-term funds are index funds
index funds are funds in which managers buy securities in proportions similar to those included in a specified major index
index funds involve little research or management, which results in lower management fees and higher returns than actively managed funds
Exchange traded funds (ETFs) are also designed to replicate market indexes
traded on exchanges at prices determined by the market
management fees are lower than actively traded funds
unlike index funds, ETFs can be traded during the day, sold short, and purchased on margin
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Mutual Funds
Money market mutual funds (MMMFs) provide an alternative investment to interest-bearing deposits at commercial banks
bank deposits are relatively less risky, because they are FDIC insured, and generally offer lower returns than MMMFs
Households own the majority of MFs
owned 59.8% of long-term funds in 2010
owned 40.2% of short-term funds in 2010
43.9% of all U.S. households owned MFs in 2010—which represents ~51.6 million households
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Mutual Funds
MF managers must specify their fund’s investment objectives
in a prospectus (a formal summary of a proposed
investment), which is made available to potential investors
holds lists of the securities invested in by the funds
in 1998 the Securities and Exchange Commission (SEC)
mandated that prospectuses must be written in “plain
English” instead of overly legal language (i.e., legalese)
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Mutual Funds
Mutual funds are required to publish the specific objectives of the fund in the prospectus
No investor should invest in a fund without carefully reading the prospectus
The prospectus will contain historical return information, usually for 1-year, 3-year and 5-year periods and perhaps longer
The prospectus must also show historical fees and the effect of those fees on a given investment over time
Little information on risk is usually provided
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Types of Mutual Funds
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Largest Mutual Funds in Assets
Held (2010)
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Mutual Funds
Investor returns from MF ownership reflect three components
income and dividends on portfolio assets
capital gains on assets bought and sold at higher prices
capital appreciation on assets held in the fund
MF assets are marked to market daily
prices are adjusted daily to reflect changes in the current market prices of the portfolio’s assets
Then net asset value (NAV) of a MF share is equal to the market value of the assets in the MF portfolio less liabilities divided by the number of shares outstanding
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Mutual Funds
An open-end MF is a fund for which the supply of shares is not fixed, but can increase or decrease daily with purchases and redemptions of shares
A closed-end investment company is a specialized investment company that has a fixed supply of outstanding shares, but invests in the securities and assets of other firms
A real estate investment trust is a closed-end investment company that specializes in investing in mortgages, property, or real estate company shares
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Mutual Funds
MFs charge investors fees for the services they provide sales loads
12b-1 fees are fees related to the distribution costs of MF shares
cannot exceed 1% of average annual net assets for load funds
cannot exceed 0.25% of average annual net assets for no-load funds
MFs may offer different share classes with different combinations of loads
A load fund is an MF with an up-front sales or commission charge that the investor must pay
A no-load fund is an MF that does not charge up-front sales or commission charges on the sale of mutual fund shares to investors
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Mutual Funds
In 2010 average fees and expenses paid by mutual fund investors were 0.99% on stock funds and 0.75% on bond funds
These expenses have continued to fall over the last decade
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The Effect of Costs on MF Returns
This year an investor placed $10,000 in a mutual fund with a 6% load
(one time fee) and estimated annual expenses of 1.35%. Fees are
charged against average assets for the year. The fund’s gross return
is 11.5%. What was the investor’s first year return net of loads and
expenses?
Amount initially invested
Amount after gross return
Average asset value for year
Fees
Ending amount after fees
Net rate of return (first year)
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Mutual Funds
MFs are heavily regulated because they manage and invest small investor savings
The SEC is the primary regulator
The Securities Act of 1933
The Securities Exchange Act of 1934
The Investment Advisers Act and Investment Company Act of 1940
The Insider Trading and Securities Fraud Enforcement Act of 1988
The Market Reform Act of 1990
The National Securities Market Improvement Act (NSMIA) of 1996
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Mutual Funds
Even with heavy regulation, investor abuses still occur market timing is short-term trading that profits from out-
of-date values on the securities in the fund’s portfolio
late trading involves buys and sells long after prices have been set at 4:00 pm E.T.
directed brokerage occurs when brokers improperly influence investors on their fund recommendations
improperly assessed fees occur when brokers trick customers into thinking they are buying no-load funds or fail to provide discounts properly
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Global Issues
During the 1990s mutual funds were the fasting growing financial institution in the United States
Growth slowed or declined in most major countries of the world in 2001, reversing a decade long trend, but picked up again as the economic growth improved in the mid-2000s, only to decline again during the crisis
In the late 2000s growth in non-U.S. investments outpaced growth in U.S. funds
Total assets of non-U.S. mutual funds were $162.6 billion in 1992 and, as of 2010, there were $14.13 trillion invested in mutual funds outside the U.S.
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Hedge Funds
Hedge funds (HFs) are investment pools that solicit funds from wealthy individuals and other investors (e.g., commercial banks) and invest these funds on their behalf similar to MFs, but smaller funds are not required to register with
the SEC
subject to less regulatory oversight than mutual funds and generally can (and do) take significantly more risk than MFs
do not have to publicly disclose their activities to third parties and thus offer a high degree of privacy
HFs avoid regulation by limiting the number of investors to less than 100 and by requiring investors to be“accredited” accredited investors have net worth over $1 million or annual
income over $200,000 if single (or $300,000 if married)
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Hedge Funds
HFs use more aggressive trading strategies than MFs such as short selling, leverage, program trading, arbitrage, and the use of derivatives
Because not all HFs are registered, industry and firm data cannot be accurately tracked
~ 10,000 HFs in the U.S. in 2010
~ $1.77 trillion in assets in 2010
~ new asset flows track market performance
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Hedge Funds
There are three basic types of HFs
the most risky - HFs use market directional trading
strategies, seek high returns using leverage, and invest
based on anticipating events
moderate risk - HFs have a market neutral (or value)
orientation that favors longer-term investment strategies
risk avoidance - HFs take a market neutral approach and
strive for consistent returns with low risk
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Hedge Funds
Management fees on HFs are computed as a percent of assets under management and run between 1.5% and 2%
Performance fees give fund managers a share of any positive returns earned the average is 20%, but performance fees vary substantially
depending on the HF
a hurdle rate is a benchmark that must be realized before a performance fee can be assessed
a high-water mark is when a manager does not receive a performance fee unless the value of the fund exceeds the highest NAV it has previously achieved
Offshore HFs are attractive to investors because they provide anonymity and are not subject to U.S. taxes
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Hedge Funds
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Hedge Funds
HFs under $100 million in assets are exempt from registration requirements set forth by the Investment Company Act of 1940 HFs have less than 100 investors each, accredited investors,
and are sold only as private placements
HFs are prohibited from abusive (i.e., illegal) trading practices
The Dodd-Frank bill requires that hedge funds with more than $100 million register with the SEC under the Investment Advisors Act
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Hedge Funds
Fund advisors must now report financial information on the funds they manage to the FSOC to help limit systemic risk in the economy
The Federal Reserve can also exercise oversight of funds deemed large enough or interconnected enough to present a systemic risk
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Hedge Funds Performance
The financial crisis reduced the amount of assets in hedge funds because of losses, although a few funds did well during the crisis
The typical hedge fund had negative returns of 15.7% in 2008, with about 75% of funds losing money that year
Even so, many funds outperformed the indexes in the same time period. Although returns were far better in 2009 (in the 20% range), the funds underperformed the S&P 500 over that time period
Fund redemptions followed a similar pattern during the crisis as mutual funds flows
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High Profile Hedge Funds
Problems
The collapse of the two Bear Stearns hedge funds led to
investor losses of $1.6 billion and led to the bankruptcy of the
company
Bernard Madoff Investment Securities run by former
NASDAQ chairman Bernie Madoff ran a $65 billion Ponzi
scheme
In October 2009 a large hedge fund, Galleon Group LLC,
was closed due to an insider trading scandal