Question

You recently graduated from university, and your job search led you to Coles Group Limited. Since you thought the company’s business was very promising, you accepted their job offer. As you are finishing your employment paperwork, Michel, who works in the Finance Department, stops by to inform you about the company’s new superannuation plan. Australian companies offer membership of a superannuation fund to their employees, where their Superannuation Guarantee contributions are saved. Superannuation funds have concessional tax arrangements, which saves tax if you save for your retirement through your fund. So, if you can make contributions to the fund from your pre-tax income (known as salary sacrifice), contributions are deducted from your current salary, and no current income tax is paid on the money, and the super fund pays only 15% tax on the contributions. For example, assume your salary will be $130 000 per year. If you contribute $7200 pre-tax to the superannuation fund, you will pay taxes on only $122 800 in income. Taxes will be payable on the initial deposits at 15% and on any capital gains or fund income while you are invested in the fund, and you will not pay taxes when you withdraw the money at retirement, provided you retire at or after turning 60. At Coles, you can contribute up to 6% of your salary to the plan, which will be saved in the fund with your 9% Superannuation Guarantee contributions. The Coles superannuation fund has several options for investments, most of which are managed funds. As you know, a managed fund is usually made up of a portfolio of assets. When you purchase shares in a managed fund, you are actually purchasing partial ownership of the fund’s assets, similar to purchasing shares in a company. The return of the fund is the weighted average of the return of the assets owned by the fund, minus any expenses. The largest expense is typically the management fee paid to the fund manager, which makes all of the investment decisions for the fund. Coles Group Limited uses Down Under Financial Services to manage its superannuation plan. Michel then explains that the retirement investment options offered for employees are as follows: Down Under All Ordinaries Index Fund. This fund tracks the All Ordinaries Index. Shares in the fund are weighted exactly the same as they are in the All Ordinaries Index. This means that the fund’s return is approximately the return of the All Ordinaries Index, minus expenses. With an index fund, the manager is not required to research shares and make investment decisions, so fund expenses are usually low. The Down Under All Ordinaries Index Fund charges expenses of 0.20% of assets per year. Down Under Property Trust Fund. This fund invests primarily in property trust shares. As such, the returns of the fund are slightly less volatile than the All Ordinaries Index. The fund can also invest 10% of its assets in companies based outside Australia and New Zealand. This fund charges 1.70% of assets in expenses per year. Down Under Bond Fund. This fund invests in long-term corporate bonds issued by companies domiciled in Australia and New Zealand. The fund is restricted to investments in bonds with an investment grade credit rating. This fund charges 1.40% in expenses. Down Under Money Market Fund. This fund invests in high-quality debt instruments, which include bank bills and government bonds. As such, the return on money market funds is only slightly higher than the return on government bonds. Because of the credit quality and nature of the investments, there is only a very slight risk of negative return. The fund charges 0.60% in expenses. Using the information provided, answer the following questions: II. The returns of the Down Under Property Trust Fund are less volatile than those of the All Ordinaries Index fund, but more volatile than the rest of the managed funds offered in the superannuation fund. Why would you ever want to invest in the Property Trust Fund? When you examine the expenses of the funds, you will notice that this fund also has the highest expenses. Will this affect your decision to invest in this fund?

1. A measure of risk-adjusted performance that is often used in practice is the Sharpe ratio. The Sharpe ratio is calculated as the risk premium of an asset divided by its standard deviation. The standard deviations and returns for the funds over the past 10 years are listed below. Assuming a risk-free rate of 4%, calculate the Sharpe ratio for each of these. In broad terms, what do you suppose the Sharpe ratio is intended to measure?

DOWN UNDER FUND	TEN-YEAR ANNUAL	STANDARD DEVIATION
All Ordinaries Index Fund	9.15%	19.35
Property Trust Fund	14.05	26.82
Bond Fund	9.53	23.82
Money Market Fund	8.73	11.45

Answer 1

Sharpe Ratio developed by William F Sharpe, Nobel Laureate, to understand returns of an investment over the risks (standard deviation). The formula for the same is

So the Sharpe Ratio for these funds is calculated as follows

	A	B	C	D=B-C	E=D/A
FUND	Standard Deviation	Ten Year Return (p.a)	Risk Free Rate	Risk Premium	Sharpe Ratio
All Ordinaries Index Fund	19.35	9.15%	4%	5.15%	0.2661
Property Trust Fund	26.82	14.05%	4%	10.05%	0.3747
Bond Fund	23.82	9.53%	4%	5.53%	0.0419
Money Market Fund	11.45	8.73%	4%	4.73%	0.4131

Higher sharpe ratio, indicates higher risk premium over less risk. So, Money Market Fund seems better on account of Sharpe Ratio. But there are also many other methods to determine a better fund.

Good Luck