Lazard US Mid Cap Equity Portfolio - Case Study Example

Lazard US Mid Cap Equity Portfolio Lecturer: Lazard US Mid Cap Equity Portfolio Introduction The emphasis of portfolio management is shrewd investing. Diversification is a plus in sound investment decision making but obtaining the right mix of investments is rather a daunting task. Funds range on in terms of investment, duration, investment requirement and taxes. The types of funds available are: Growth funds: these funds desire to grow capital over the long haul with rapidly growing earnings and normally high P/E ratios. These funds are more volatile than the bongs and money market funds but with significant return possibilities Growth and income funds: desire to grow capital and generate current income as well. These kind of invest in stocks of companies with solid financial base are return patterns Income equity funds: invest in a mix of bonds and dividend paying stocks as they also target current income and capital growth Balanced funds: have long term objectives and emphasize on capital growth, and current income. Invest in bonds, stocks, and short term securities, and always ensure the right hedging against huge fluctuations in short term investment options. Bond funds: designed to meet the current income requirements of shareholder, and they invest primarily in corporate and government bonds and T-bills Money market funds: invest in securities such as commercial papers, T-bills, certificates of deposit and other stable but monetary related securities. These are currency related investments and no guarantees are made on such funds. Target date funds: These include retirement and pension funds as they are the major types in this category with the date of maturity of the fund known. These kinds of funds are made for strictly long term investments. Lazard US Mid Cap Equity Portfolio Background LZMIX, ticker for the Lazard US mid cap portfolio for institutional shares, is a fund under the hazard investment fund. The fund is a balanced fund for institutional investors that were created in 1997 for this primary reason. The fund as at the 4/30/2012, the net assets of Lazard mid cap Equity portfolio was approximately values at $105.7 million, including $58.2 million worth of shares held institutionally. Recent performance The fund has a yield rate of 0.28% with no loadings applicable to the investment. Expenses incurred in transactions are given at the rate of 0.92%. Morningstar rates the management fee as average level, showing it in line with industry charges. LZMIX turnover is quoted at 83%, while the minimum investment an investment can make is $100000. The fund performance ranges as other in the institutional investment portfolio; weighted against the Russell midcap index is just 0.57 point shy in the period of it has traded. However, in the short run, the observation is not as quite. The funds 5 year valuation gives a negative posting making against its benchmark. The one year measure is also a less value compared to the Russell index. There company funds performance is more of a cycle with high peaks and low troughs, just as the options it invests in. The year to date (2012 to date) gives a strong index value, but not the month- end value, that oscillates back to the negative, showing signs of high volatility in the investment options and maybe weakness in the fund management. Mutual Fund The Lazard US Mid cap equity portfolio is one of the funds in the Hazardnet group that hope to generate strong returns and outshine peers in the market of institutional investment and set the benchmark for the complete market cycle. The fund has a bottom-up loom to stock selection, as is shown by all portfolios held by HazardNet. They conduct the fundamental analysis before investing, with emphasis on sustainability of returns. This is ensured by though analysis of the accounting employed by the companies and the historical statistics of benefits offered, that is, high P/E, dividend yield and stability of stock. Quantitative research is done to ensure that the target company’s underlying internal and industry risks are known and diversification of investment done to this effect. Value at risk is a measurement that estimates the largest expected loss to a given investment decision at some predetermined confidence level. This is intended to caution investors about the potential loss of investments and help them revise their investment options to less risky ones. The approach taken is always pessimistic as all revenues projected in investment apply a worst case scenario approach. This means that the highlight of financial data is the extreme left that threatens gains made by other investment options, and this is traced out using a distribution table. In our case, the historical monthly returns, and range is used to show the extremeness of the data returns under 95% confidence interval. The standard deviation as a measure of dispersion is also applied in measuring the risk involved. The final method applied is the application of beta that measures the maximum expected loss under a given premise; say not more than some given percentage at a given period. For portfolio management, adjustment of period length should be done cautiously as this might lead to inconsistent information being obtained since it might focus on a weak period with high deviations and outlier return prices that reflect a weak portfolio. Limitation of value at risk The greatest weakness of this approach is the use of historical data that is subject to selection by the portfolio manager. The manger may select a period of relative calmness in the fund and reflect success that is not present in the present market. Also, the time period may interlope, a economically stable period and a turbulent economic one, meaning that forecasting done o the historical data will be underestimating the loss. LZMIX measurement Adjustment for risk is important in the valuation of funds and a rate free of risk, the existing market rate of investment and the expected risk need to be obtained in order for forecasting to be possible. The performance of a given stock or portfolio over a given period is measured using excess returns which means the difference between the market rate of return and the risk free rate of return. We are using the aggregate monthly performance of the standard & Poor 500 index for the period under study as the market rate, and convert the index into rate by the difference in the index values for corresponding trading periods and then dividing by the previous period. This is the logarithmic price return that can still be obtained by taking the natural logarithm of the stock relative. These measurement functions follow the form of the capital asset pricing model that evaluates the risk in terms of risk free portfolios. The formula for CAPM shall be referred to quite frequently in performance analysis. Noting the formula for reference  Where = risk free rate β =beta of the security = expected market return = equity market premium beta of the security=99% alpha=0.27% The two common measures that I have used that employ this principle are the Sharpe and Treynor index. Sharpe index Also known as the reward to variability ratio, the Sharpe index measures the total variability of the returns as the measure of risk in a given portfolio. The formula is Sharpe index= = Average excess rate/ Standard deviation Where -average return on fund -average risk free rate -standard deviation of fund’s return From the results in the excel file Sharpe index=0.7563/6.07=0.12=12% The value of the index is hinged on the mean return value of the fund relative to the mean risk free rate and the standard deviation. The Standard deviation has an inverse relationship with the index it is divided to the difference in the value of the stocks. This means that the index measures the investment on the basis of what can be invested risk free, and any value above this risk free value and with small deviation is considered that the fund is well performed. Value of the funds is 0.12. Standard deviation is applicable when the distribution of the excess returns is symmetric. This is even used in Arbitrage pricing where the investments are ranked according to their standard deviations. However, the trading aspect brings in asymmetry as the forces that come into play are many and had to predict rendering the use of the standard deviations not ideal. Treynor index This formula measures the investment portfolio in terms of the beta value, which measures the unit risk compared to the aggregate as in Sharpe index. The beta value is obtained from CAPM that traces the relationship between the fund rate and the market rate factoring in the value of the risk free interest. Treynor index=  Where -average return on fund -average risk free rate -beta for fund’s return From the excel file=average return on fund-average risk free rate=0.7563 beta for fund’s return=99% Treynor index=0.7563/99=0.007 which is almost equal to 0.01 It is observed for both of the methods of valuation, that the value obtained when you compute the index is negative is if the fund’s average return is less than the average risk free return. 0.01 is the computed value for the Treynor index. The beta value is computed and gives a value of 0.99. The observed β>0 signifying average performance of the fund and this is not satisfactory as the investors’ funds are underutilized by the manager. Information ratio This is a measure of efficiency for the method applied in the valuation. It measures the fund value against the benchmark chosen. The ratio explicitly measures the degree by which the portfolio has beaten the set benchmark and the consistency at which it has beaten the benchmark. The information ratio is used in the measure of the portfolio manager’s capacity to generate excess returns in reference to the ratio set as the benchmark. It also indentifies inconsistencies in the investor decisions. An information ratio defines the opportunities that an active manager can undertake and are available to him. The returns in the fund are as a result of systematic and unsystematic returns, where the unsystematic returns are uncorrelated with the systematic ones. The benchmark chosen is the one that best measures the volatility of the unsystematic returns, as risk is the only measure on a manager’s pro-activeness in decision making. The volatility of the residuals is also called the tracking error. The mutual of America small cap value instl(MAVSX) index is used the benchmark with the 2 year monthly yield rate since its introduction in the US at is hence computed as IR=  The value from the data gives an IR value of 0.1. The portfolio outperforms the benchmark by 10% and does so I the period under consideration as the average of excess returns with regard to the benchmark produce a positive value, 0.54%. Jensen index This index uses the capital asset pricing model to determine whether the fund has outperformed the market index. Jensen index utilizes the security line as its benchmark. This method is used in adjusting the beat risk such that the riskier securities have higher returns. The model in CAPM is expected to have an intercept value of 0, meaning the error terms in the regression are made to cover the residual value and the security line intercept the excess returns line at zero. However, the Jensen model provides for high risk investments and the alpha value is taken as the vertical intercept. For our fund, the intercept is at -0.27%. This means that our fund value has a value almost zero, reflecting on the mangers good timing and investing abilities. This can be traced by a security market line against the regressed line means that when the market goes north, the fund will go up with even a greater proportion. Even though the manager is showing strong skills in hedging and timing, the level of performance is mediocre, as will be highlighted by other measures. References LZMIX monthly financial data. Retrieved on 21 May 2012 from http://finance.yahoo.com Mayo, H.B., (2010). Investments: An Introduction. Cengage Learning. Madura, J., (2012). Financial Markets and Institutions: 10th Edition. Cengage Learning. Elton Edwin et al. (2009). Modern Portfolio Theory and Investment Analysis. John Wiley & Sons. Morningstar. Lazard US Mid Cap Equity Instl LZMIX. Retrieved on 21 May 2012 from http://quote.morningstar.com/fund/f.aspx?t=LZMIX. Read More