Question
An investor is evaluating the performance of two actively managed mutual funds, A and B. The annual risk-free rate of return over the period was
An investor is evaluating the performance of two actively managed mutual funds, A and B. The annual risk-free rate of return over the period was 4%, and the average annual return of the market portfolio was 12%. The standard deviation of the market portfolio returns was 20%. The table below reports the statistics and the regression estimation results of the single-index model for annual excess returns of the two funds.
Fund A | Fund B | |
Average annual excess return | 10.6% | 8.4% |
Standard deviation of annual excess returns | 31% | 20% |
Single-index model estimates | 1% + 1.2 (RM-rf) | 2% + 0.8 (RM-rf) |
Standard deviation of the model residuals | 22% | 9% |
Required a) Calculate the Sharpe ratio and the Treynor measure for each fund. (2 marks)
b) Calculate the M-square measure and the T-square measure for each fund. (4 marks)
c) The investor is going to invest all of his money in one of these two funds. Which fund should he choose? Explain your answer briefly. (2 marks)
d) The investor currently invests all of his money in the market-index fund and would like to change his asset allocation by including some investment in either fund A or fund B. Which fund should he choose? Explain your answer briefly. (2 marks)
e) The investor is choosing fund A or fund B to become part of his actively managed stock portfolio. Which fund should he choose? Explain your answer briefly. (2 marks)
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