sharath-sury
Thank You! Your rating has been saved.
Author:
Just In! Dr. MBS Investigates The BETA -- a response to "Sharath Sury Explains The Alpha"The BETA Significance by Dr. M. Sury
CHICAGO, APRIL 5 /Everything-Finance.net/ — Sharath Sury explains that the returns from a fund are attributable to three sources – the Manager’s skill, the Market and Random fluctuations. The return derived from the Manager’s skill alone (if consistent during the period of observation) is called Alpha (Greek letter a). The return attributable to the Market is denoted as a multiple Beta (Greek letter b) of the Market’s return. Finally the random fluctuation is denoted as Epsilon (Greek letter e). While this is a simple concept, there is quite a bit of complexity swept under the word “Market”.
When the investable universe is U.S. Domestic equities (more specifically, the members of an index such as S&P 500), then the market is that index and so the volatility of the index becomes the Market risk. Beta, in this case, represents the “relative volatility” (called Covariance) in the fund per unit level of Market volatility. The return of the fund attributable becomes Beta* X where X is the return of the S&P 500. When we take this more precise definition, and analyze what is practiced in the industry, we come to realize that the definition of Market can be different in different contexts. Thus, for example, we look at both equities and debt instruments; the Market has to include not only Stocks, but Bonds of all types as well. If we wish to include the entire World Markets, then the return attributable to market is Beta*W where W is the return of a portfolio that consist of all bonds and equities in the entire world.
To simplify the discussion, some analysts have taken the approach that the return W of the entire World market is not significantly different from a “workable subset” such as the MSCI World Index and any small difference can be included in the Epsilon factor. This still does not address the fact that there are other asset classes (e.g. Commodities and real estate) that also can be invested and are actually traded in practice.
Yet another complexity in defining the “market” is the inability (or unwillingness) of the investor to participate in certain segments of the market. For example, an investor may wish to invest only in Socially Responsible Investments (SRI). This would then restrict what the “Market” can include.
Thus, for an investment advisor, the practical approach consists of the following steps: (a) Determine the “universe of investments” applicable to this investor and identify one or more (non overlapping) asset classes that represent this universe (b) Identify the allocation of assets to be invested in each class (c) construct a “custom index” using these allocations and find the “calculated returns” of the custom index to be used as the “Market return” X and (d) use statistical “regression” technique to find the regression coefficient of the Fund’s historical returns relative to the corresponding market returns X.
There are several variations of the above technique in the literature using multi- dimensional Statistics which are beyond the scope of this note.
|
Reviews
There are no reviews to display.
Please add a review of this post:
