Question

Instructions:

You have just received an inheritance of $10,000 and you decide that you should invest the money rather than blow it on frivolous items. You have decided that you will invest the money in one of two types of mutual funds. The first type that you are considering follows a large-value approach to investing. This means that the mutual fund invests only in large, established companies that are considered to be a good bargain. The second type following a large-growth approach to investing. This means that the mutual fund invests in large companies that are experiencing solid revenue growth. To make an informed decision, you decide to reach the rate of return for the past 3 years for each type of mutual fund. The mutual fund must have a Morningstar rating of four or five stars.

The Morningstar mutual-fund rating system ranks mutual funds, using one to five stars. The stars divide the mutual-fund performances into quintiles: that is, a mutual fund with a one-star rating is in the bottom 20% of mutual funds in its category, a mutual fund with two-stars is in between the 21st and 40th percentile, and so on. These data can be found at www.morningstar.com or screen.yahoo.com/funds.html

Obtain a random sample of at least 15 mutual funds from each investment category. Determine the 3 years rate of return for each fund.

Obtain a 95% confidence interval for the difference between the mean rates of return. Interpret the interval.

You are going to write a report detailing which investment category seems superior.

The report contains 4-5 paragraphs in .doc or .docx format with supporting data supporting your conclusion.

Attach the Excel sheet used for the primary data source.

Answer 1

Solution:

Firm	3 Years % Rate of Return
American Century All Cap	8.71
Alger Responsible Investing	5.94
William Blair Growth 1	6.39
Buffalo Growth	7.58
Eaton Vance Growth	9.39
Franklin Dyna Tech Adv	10.84
Nationwide Growth C	7.62
Goldman Sachs Dynamic US Equity C	6.1
Transamerica Capital Growth	9.42
Catalyst Insider Buying A	1.43
Transamerica Multi Cap Growth B	-4.5
JP Morgan Large Cap Growth RG	10.07
Kinetics Internet Adv A	1.58
Neuberger Berman Guardian C	5.67
Profunds NASDAQ 100 Inv	13.8

Mean Percentage = Average of 3 years % Rate of Return

= 100.04 / 15

= 6.669333

Standard Deviation = 4.4778 [STDEV(B2:B16)] excel formula

Confidence Interval = (1.96 * 4.4778) / 3.8729

= 2.266128

Value based approach to Investment

Firm	3 Years % Rate of Return
AB Value B	4.51
American Century Equity Income Inv	10.98
Invesco Comstock RS	6.97
Baywood Socially Responsible Investment	2.83
Zacks Dividend Investor	7.81
Vanguard Klindsor Investment	7.52
JP Morgan Growth and Income	7.85
American Century Value	8.48
Toway	8.99
Sims Total Return	0.09
Invesco Low Volatility Equity Yield C	3.55
Pioneer Equity Income R	10.09
Principal Large Cap Value C	4.44
Fairholme	-0.71
RNC Genter Dividend Income	6.56

Mean Percentage = Average of 3 years % Rate of Return

= 89.96 / 15

= 5.997333

Standard Deviation = 3.459353 [STDEV(Bx:By)] excel formula (replace x and y by the cell no.)

Confidence Interval = (1.96 * 3.459353) / 3.8729

= 2.266128

MUTUAL FUND

‘Mutual fund-this is a professionally managed company that pools a group of people and invests their money in stocks, bonds or other securities especially those that might be difficult to recreate on their own’. Before investing into a mutual fund, one must consider the type of the mutual fund, the style used and the key points of the mutual fund; this is so because here are over ‘3500 mutual fund and each fund has a unique feature thus caters for a certain risk profile. Decision should be made after critical analysis ,that is, one has to understand the investment goals and be comfortable with the risk levels involved so as to reduce investment risks while ensuring you meet the investment objective.’ The approaches of investing into a mutual fund are stated as top-down approach, bottom-up approach, combination of top-down and bottom-up and finally the technical analysis approach.

‘The common types of mutual funds are: Money market fund(offers safer investments but with lower return rate and invests in short-term fixed income securities such as treasury bills), fixed income fund (this aims at having money into the fund on a regular basis through interest earned by buying investments e.g. high yield corporate bonds that pay a fixed rate of return and involves higher risks than those of money market fund),equity fund money (invests in stocks and aims at growing faster than the stated funds thus have higher losing risks), balanced funds (invest in a mixture of equites and fixed income security as it tries to strike a balance between achieving high return and the risk of losing money), index funds on the other hand aim on tracking performance of specific index. The specific fund focuses on specialized mandates e.g. real estate and finally the funds of funds are involved in other funds.’

Though growth and value funds seek to provide best possible returns, the distinguishing factors are the approach taken, markets they are best suited and stock picking policy. A large growth fund invests in companies with market value greater than 10 billion that the fund managers deem to be growth oriented (faster than average growth rate as measured by cash flow, earnings or revenue). These funds have higher return levels but the risks involved are also great, they require slightly higher tolerance for risks and longer time span. A large value fund invests in companies with market value greater than 10 billion that fund managers believe are undervalued by the market after looking at the margin safety involved with that company. These funds tend to be safer and produce more current income than growth funds. The table below shows the major difference between a large growth fund and a large value fund.

	A large growth fund	A large value fund
Characteristic	Focuses on companies with above average growth in sales and earnings. Stocks tend to have above marked price-to-earnings and price-to-sales ratio due to rapidly growing sales and earnings.	Focuses on companies with lower than average growth in sales and earnings. Stocks tend to have lower marked price-to-earnings and price-to-sales ratio but the stocks have higher dividend yields.
Risk	High risk level involved as the price-to-earning or price-to-book ratio may decline due to unforeseen events	Lowe risk levels involved as the market may have correctly priced the underlying, in which case they may never realize their intrinsic value.

My endeavour to look for the best mutual fund to invest my inheritance of 10000 was narrowed down to either choosing a large value or a large growth mutual fund after a bank advisor had given me details about the other types of mutual fund. From the data attached in the excel file and calculations made it is seen that the large value mutual fund is better than the large growth mutual fund as it has a lower margin error resulting in a lower confidence interval as it shows lesser risks are involved, as illustrated below.

Confidence interval (C.I.) = mean ± margin of error

Margin of error = (Z* × S) / √n

Where Z* is the Z factor which is obtained at different confidence level, in our case the confidence level is 95% and Z* = 1.96, n is number of samples and s is the standard deviation as shown in the excel file.

For a large growth fund

Margin of error = (1.96 × 4.4778) / √15 = 2.66

C.I. = 6.669 ± 2.66 = 4.009 or 9.329

For a large value fund

Margin of error = (1.96 × 3.459353) / √15 = 1.75

C.I. = 6.669 ± 2.66 = 4.247 or 7.747

I had to do further study before deciding on the investing on a blended funds .The key point of interest that I considered were; the exit load, the fund performance, the expense ratio, the fund sponsor integrity, fund management team experience, tax implications, investment style and objective among others. Despite the large value fund being better than large growth fund, ‘the blended fund is best as they not only exhibit characteristics of the large value(high value conscious) fund but also those of the large growth (growing companies) fund resulting in lower risk level while having high return rates. The blended fund has potential capital appreciation, current income, low price-to-earnings ratio and stock that can often reinvest revenue back into business operation. The blended fund maintains an equity exposure as it incorporates deep value names displaying credible paths towards improvement, as well as high expectation growth companies with long-term potential remains underestimated by the market.