Question

The manager of GT-KiwiSaver Fund expects the fund to earn a rate of return of 12% this year. The beta (β) of the fund’s portfolio is 0.8. The rate of return available on Treasury Bills (risk-free assets) is 5% p.a. and you expect the rate of return on an NZSX50 Index Fund (the market portfolio) to be 15% p.a.

a. Demonstrate whether you should invest in GT-KiwiSaver Fund or not.

b. Show how you can create a portfolio, with the instruments mentioned in the question, with the same risk as GT-KiwiSaver Fund, but with a higher expected rate of return.

c. Explain why in reality, a mutual fund (such as a KiwiSaver fund) must be able to provide an expected rate of return that is higher than that predicted by the security market line in order for investors to consider the fund an attractive investment opportunity.

Answer 1

a)	Capital Asset Pricing Model
	Ke (Rate of Return)	=	Ri + (Rm - Ri)*Beta
		=	0.05+(0.15-0.05)*0.8
		=	0.13
	Since GT-Kiwisaver fund expects lower return for expected the risk-level, its not advisable to invest in it
b)	By investing 80% of the funds in NZSX50 and 20% of the funds in Risk-free asset, one can earn more returns than the mutual fund with same level of risk
	Expected return	=	(0.15*0.8)+(0.05*0.2)
		=	0.13
c)	Higher the risk, higher should be the returns. Thus, the mutual funds needs to be provide higher returns than the index beacause otherwise
	the investors will directly invest in index funds

answered by: anonymous