question archive An investor is evaluating the performance of two actively managed mutual funds, A and B
An investor is evaluating the performance of two actively managed mutual funds, A and B
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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% |
a) 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.
b) 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.
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Answer:
a)
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 that means he wants add one mutual fund in addition to market index fund, in this case he should choose Fund B because
Single-index model estimates is 2% + 0.8 (RM-rf)
in this equation 2% is risk free return or most likely acheived return and coefficent is 0.8, this indicated less risky than market. Adding this he can deversify his portfolio and can make optimize return with less risk.
b)
The investor is choosing fund A or fund B to become part of his actively managed stock portfolio, in this case he wants to invest only in mutual funds either in Fund A or Fund B. He sould choose fund A to get maximum return by taking little risk.
