Open-end investment companies must state the portfolio’s investment objective
33 categories of objectives
Differ from open-end funds in that:
Cannot sell shares after initial offering
Can borrow money, trade options and pursue different investment objectives
Most shares are not redeemable at NAVPS
Trade on stock exchanges—can trade at a premium or discount (more common) relative to NAVPS
Are Mutual Funds Markowitz Efficient Investments?
The mutual funds are all inefficient investments
Funds tend to group into clusters corresponding to their investment goals
Mutual funds are required to publish written goal statements
In a few cases fund’s stated objective and performance differed
This income and growth fund performed in the same league as the growth funds .
Scrutinizing Mutual Funds Goal Statements Portfolio’s SDs and Betas were better indicators of portfolio’s actual performance than their goal statements. 13.5% None 9.5% 13.8% 1 None 1 20 0.9 to 1.1 12.2% 10.0% 10.0% 11.2% 7 7 24 15 0.7 to 0.9 9.1% 9.7% 10.1% 6.9% 16 4 5 3 0.5 to 0.7 Income, Growth & Stability Income & Growth Growth & income Growth Income, Growth & Stability Income & Growth Growth & income Growth Beta Category’s average rate of return # of funds claiming each goal 13.5% 0.002304 0.992 22 0.9 to 1.1 High 10.6% 0.001543 0.786 53 0.7 to 0.9 Medium 9.1% 0.000877 0.619 28 0.5 to 0.7 Low Average Rate of Return Average Variance Average Beta # of funds Range of Betas Risk Class
The Avon Fund earned an average return of 8% annually with a standard deviation of 16.6%, while the Blair Fund earned 13.00% annually with a standard deviation of 22.4%. During the same time period the average risk-free rate was 4%.
Which fund was the better performer?
Since SHARPE Blair > SHARPE Avon , Blair was the better performer on a risk-adjusted basis.
SHARPE Example Avon RFR 13% 8% 22.4% 16.6% Standard Deviation of Returns Expected Return, E(r) Blair Slope is 0.4018 for REVAR Blair Slope is 0.241 for REVAR Avon
The Avon Fund earned an average return of 8% annually (Characteristic Line AVON : Alpha: -0.00125; Beta: 0.8125), while the Blair Fund earned 13.00% annually (Characteristic Line BLAIR : Alpha: 0.014; Beta: 1.156). During the same time period the average risk-free rate was 4%.
Which fund was the better performer?
Since TREYNOR Blair > TREYNOR Avon , Blair was the better performer on a risk-adjusted basis.
Mutual funds with the highest average rate of return might not have the highest rank because
A highly aggressive fund may earn higher returns than a less aggressive fund but the higher returns may not be sufficient to compensate for the extra risk taken
Analyzing Performance Statistics While the Yak Fund earned twice as much as the Zebra Fund it is four times as risky. 0% 4% RFR 5% 15% Zebra Fund 20% 30% Yak Fund Standard Deviation Expected Return Possible Investments
By multiplying Zebra’s low SD by 4, we could create a new portfolio on Zebra’s Asset Allocation Line with the same high SD as Yak Fund
By borrowing 4 times as much as the initial equity, one could achieve the following E(r Zebra ):
Analyzing Performance Statistics The leveraged Zebra portfolio dominates the Yak Fund; thus Zebra is a better fund even though Yak has a higher average return. Yak RFR 48% 30% 20% 5% Standard Deviation Expected Return, E(r) Zebra Zebra’s SHARPE = 2.2 Yak’s SHARPE = 1.3 15% Yak’s AAL Zebra’s AAL
General Discussion of Performance Measurement Tools
When investors analyze merits of alternative investments, usually concerned with
Portfolio manager’s ability to select good investments and to not select poor investments
Sharpe, Treynor & Jensen’s Alpha are good tools to evaluate this issue
Portfolio manager’s ability to buy low/sell high and manager’s ability to react to changes in market’s direction
Sharpe, Treynor & Jensen’s Alpha are not good tools for evaluating market timing unless theoretical framework is extended