Case: ASSESSING PORTFOLIO PERFORMANCE
Mary and Nick have an investment portfolio containing four assets. It was developed to provide them with a balance between current income and capital appreciation. Rather than acquire fund units or diversify within a given class of asset, they developed their portfolio with the idea of diversifying across various types of assets. The portfolio currently contains shares, industrial bonds, managed fund units and options. They acquired each of these during the past three years, and they plan to invest in other assets sometime in the future. Currently, they are interested in measuring the return on their investment and assessing how well they have done relative to the market. They hope that the return earned over the past calendar year is in excess of what they would have earned by investing in a portfolio consisting of the ASX 300 Index. Their research has indicated that the risk-free rate was 7.2% and that the (before-tax) return on the ASX 300 portfolio was 10.1% during the past year. With the aid of a friend, they have been able to estimate the beta of their portfolio, which was 1.20. In their analysis, they have planned to ignore taxes, because they feel their earnings have been adequately sheltered. Because they did not make any portfolio transactions during the past year, all of their investments have been held more than 12 months, and they would have to consider only unrealised capital gains, if any. To make the necessary calculations, they have gathered the following information on each of the four assets in their portfolio. Shares. They own 400 shares of KJ Enterprises. KJ is a diversified manufacturer of metal pipe and is known for its unbroken stream of dividends. Over the past few years, it has entered new markets and, as a result, has offered moderate capital appreciation potential. Its share price has risen from $17.25 at the start of the last calendar year to $18.75 at the end of the year. During the year, quarterly cash dividends of $0.20, $0.20, $0.25 and $0.25 were paid. Industrial bonds. They own eight T Industries bonds. The bonds have a $1000 par value, have a 9.250% coupon, and are due in 2021. They are A-rated by Moody's. The bond was quoted at 97.000 at the beginning of the year and ended the calendar year at 96.375%. Managed fund. They hold 500 units in the Holt Fund, a balanced fund. The dividend distributions on the fund during the year consisted of $0.60 in investment income and $0.50 in capital gains. The fund's NAV at the beginning of the calendar year was $19.45, and it ended the year at $20.02. Options. They own 100 options contracts on the shares of a company they follow. The value of these contracts totalled $26 000 at the beginning of the calendar year. At year-end the total value of the options contracts was $29 000.
QUESTIONS
1. Calculate the holding period return on a before-tax basis for each of these four assets.
2. Recognising that all gains on their investments were unrealised, calculate the before-tax portfolio HPR for their four-asset portfolio during the past calendar year. Evaluate this return relative to its current income and capital gain components.
3. Use the HPR calculated in question 1 to compute Jensen's measure (Jensen's alpha). Use that measure to analyse the performance of the portfolio on a risk-adjusted, market-adjusted basis. Comment on your finding. Is it reasonable to use Jensen's measure to evaluate a four-vehicle portfolio? Why or why not?
4. On the basis of your analysis in questions 1, 2 and 3, what, if any, recommendations might you offer them relative to the revision of their portfolio? Explain your recommendations.