pension fund manager is considering investing in two funds to be included in the pension plan’s current portfolio, which is a well-diversified portfolio as proxied by the Russell 3000 index. The first fund under consideration is a growth stock fund, the second a value stock fund. The expected return, standard deviation, standard deviation of residuals, and beta of the funds are as follows: Expected return Standard Deviation Beta Standard deviation of residuals Growth fund (G) 10% 20% 1.1 12% Value fund (V) 12% 12% 1.6 20% The correlation between the two fund returns is .80. The market risk premium is expected to be 6% and the risk-free rate is 1%. Determine and explain which fund should be included in the pension fund’s current portfolio. Justify your answers with a risk-adjusted performance measure and show all your work.
A pension fund manager is considering investing in two funds to be included in the pension plan’s current portfolio, which is a well-diversified portfolio as proxied by the Russell 3000 index. The first fund under consideration is a growth stock fund, the second a value stock fund. The expected return, standard deviation, standard deviation of residuals, and beta of the funds are as follows:
|
Expected return |
Standard Deviation |
Beta |
Standard deviation of residuals |
|
|
Growth fund (G) |
10% |
20% |
1.1 |
12% |
|
Value fund (V) |
12% |
12% |
1.6 |
20% |
The correlation between the two fund returns is .80. The market risk premium is expected to be 6% and the risk-free rate is 1%.
Determine and explain which fund should be included in the pension fund’s current portfolio. Justify your answers with a risk-adjusted performance measure and show all your work.
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