IFC Analyzing Mutual Fund Performance 4 — Questions and Answers
Question 1: Jensen's alpha of +2.5% means a fund:
- Returned 2.5% more than the risk-free rate
- Returned 2.5% more than what CAPM predicted given its beta (Correct answer)
- Had a standard deviation 2.5% below the benchmark
- Outperformed its peer group by 2.5%
Correct answer: Returned 2.5% more than what CAPM predicted given its beta
Jensen's alpha is the excess return above what the Capital Asset Pricing Model would predict based on the fund's systematic risk (beta).
Question 2: A mutual fund with a Sharpe ratio of 1.2 is generally considered:
- Poor because it is below 1.5
- Good because it exceeds 1.0, indicating strong risk-adjusted returns (Correct answer)
- Poor because higher Sharpe ratios indicate more risk
- Neutral because only absolute returns matter
Correct answer: Good because it exceeds 1.0, indicating strong risk-adjusted returns
A Sharpe ratio above 1.0 is generally considered good, indicating the fund earns more than one unit of return per unit of risk.
Question 3: Why is comparing a Canadian equity fund's performance to a global equity benchmark inappropriate?
- Canadian funds always outperform global funds
- Different benchmarks reflect different market exposures and risk profiles (Correct answer)
- Global benchmarks have higher MERs
- Canadian regulations prohibit cross-benchmark comparisons
Correct answer: Different benchmarks reflect different market exposures and risk profiles
A valid benchmark must match the fund's investment universe; otherwise, performance differences reflect different market exposures, not manager skill.
Question 4: A fund's calendar-year returns were: Year 1: +20%, Year 2: −15%, Year 3: +10%. What is the geometric mean return?
- 5.0%
- 4.1%
- 3.9% (Correct answer)
- 6.7%
Correct answer: 3.9%
Geometric mean = (1.20 × 0.85 × 1.10)^(1/3) − 1 = (1.122)^(1/3) − 1 ≈ 3.9%.
Question 5: Survivorship bias in mutual fund performance databases occurs because:
- Only the largest funds are included in databases
- Funds that closed or merged due to poor performance are excluded from historical data (Correct answer)
- Surviving funds always have higher MERs
- Only funds with 10+ year histories are included
Correct answer: Funds that closed or merged due to poor performance are excluded from historical data
When failed or merged funds are removed from databases, the remaining historical data overstates average industry performance.
Question 6: The 'capture ratio' in mutual fund analysis measures:
- The percentage of benchmark return captured by the fund
- Up-market and down-market performance relative to the benchmark separately (Correct answer)
- The fund's correlation with its benchmark
- The percentage of months the fund beat its benchmark
Correct answer: Up-market and down-market performance relative to the benchmark separately
Capture ratios split performance into upside capture (fund vs. benchmark in rising markets) and downside capture (fund vs. benchmark in falling markets).
Question 7: A fund has an upside capture ratio of 90% and a downside capture ratio of 60%. This indicates the fund:
- Underperforms in all market conditions
- Captures 90% of gains but only 60% of losses — a favorable asymmetric profile (Correct answer)
- Is highly correlated to the benchmark
- Has a negative Jensen's alpha
Correct answer: Captures 90% of gains but only 60% of losses — a favorable asymmetric profile
Capturing more upside (90%) than downside (60%) relative to the benchmark is a desirable asymmetric return profile.
IFC Analyzing Mutual Fund Performance 4
Jensen's alpha of +2.5% means a fund: