TAILIEUCHUNG - Understanding Mutual Fund Strategies and Fundamental Risk

It’s also important for managers of start-up funds to understand the numerous expenses associated with operating a hedge fund. As an example, many funds – like the $20 million fund described above – cannot afford a non-bundled third-party vendor’s order management system (OMS), risk management product, aggregation service, trade allocation module and attribution tools. Once a fund understands its expenses, it can determine exactly the asset level and performance combination necessary to cover those expenses and have an adequate profit. For a prospective start-up fund, this analysis will determine whether the business plan is realistic or needs refinement before it. | 6 Understanding Mutual Fund Strategies and Fundamental Risk To make mutual funds work for you you ve got to understand their strategies and risks. Knowing a strategy enables you to properly evaluate performance adopt reasonable expectations and build a portfolio of funds that work together. We just discussed how looking at past returns can help you to set expectations. That s really the what side of the puzzle and this is the why. This isn t part of the formula we ll use in picking funds but it s a key piece of qualitative research that you need to know. I ll take you through the risks and the strategies so that you can invest wisely. You ll feel a lot more confident about your ability to invest when you can separate the deep-value strategies from the relative-value funds. 45 46 FUND SPY This and the following chapters will help you get a handle on the qualitative part of fund picking. When you buy a fund you should understand what it does and be able to articulate why you bought it and why you d sell it. One financial planner told me that when a new client brings him a portfolio he doesn t know what he owns or why he owns it. The following chapters will help you to be sure you re not in that boat. Fundamental Risks All strategies have risks. After all you don t get returns for taking on zero risk. The key is to understand them and be sure they are worth taking. Here are some key risks Concentration risk. Funds with a high percentage of assets in their top holdings aren t necessarily riskier than other funds but they can be. Some take on a lot of individual stock risk. For example if a fund has a stock position over 10 percent or a few over 5 percent it s more vulnerable to problems at an individual company than other funds would be. See Oakmark Select s OAKLX problems from a huge bet on Washington Mutual for example. The fund had a 16 percent weighting in the stock when it was trading for around 50 and it didn t get out until around 3 or 4 a share just before .

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