Identifying Closet Index Funds Workout
- 03:30
How an investment may be able to identify closet index funds - funds advertized as actively managed, but holding securities closely in line with the benchmark.
Transcript
In this workout, we're asked to identify which of the following funds a b or c is most likely a closet Index Fund.
We're given some information about the average return of the fund and of The Benchmark. We're also given some information about standard deviation of the fund and The Benchmark and we can see that.
Funds as return is pretty similar to The Benchmark fun see very similar to The Benchmark as well and fun be a little bit further away. And in terms of standard deviation see pretty close to the Benchmark standard deviation.
Be closest next and then a bit further away. So looking at those data points. It's not so obvious as to which is a closet Index Fund. Also when we look at the beta, they're all pretty close to the beats up of the benchmarks. I'm gonna be to off one.
And the information ratio well because fund a and fun to see both underperformed against that Benchmark. The information ratio is not going to give us much information.
What is going to be useful for us though is the tracking error the r squared and the active share? Tracking error captures the volatility of the difference in return between the Benchmark and the fund itself and you can see here for fun. See that's a very low number so that tracking error suggests that the performance of the portfolio is very close to the performance of The Benchmark.
If we look at the r squared r squared explains how much of the performance of the portfolio or the fund can be explained by the performance of The Benchmark and here we can see that for fun see against really high Almost 100% or one indicating that the performance of portfolio see or fun see is very close to that of the benchmark.
The Oscar is also pretty high for fund a as well up at that 0.85 or 85% So 85% of the performance of fund a can be explained by the performance of The Benchmark.
If we then come down to active share active share which tells us how much of the funds Holdings are different from those of the benchmark.
There's more evidence here to suggest. That fun. See is a Tracker fund with its tracking Arab being exceptionally low r squared being very close to one or 100% active share of only 2.1% telling us that only 2.1% of the positions are different from The Benchmark. That would really strongly suggest. That fun. See is a Tracker fund.
If we come back over to fund a though fund a had that r squared that's also pretty high 85% of the performance of the portfolio can be explained by the performance of The Benchmark. If we look at active share active share for fund a is only 25.6% indicating that only around a quarter of the positions in the portfolio a different from those of The Benchmark or another words fund a is 75% the same Holdings as the benchmark.
So in conclusion, this would suggest that funds C is most likely a Tracker fund fund a with its relatively High tracking error relatively low r squared and relatively High active share, although not above the 60% Benchmark that we typically take as an active fund would still probably say that fund B is an active portfolio for fund a with its relatively High r squared and relatively low active share is most likely to be our closet Index Fund.