Question

22. If I were to provide you with five years of monthly returns for a particular mutual fund (60 return observations), how would you go about identifying the style of that mutual fund?

Answer 1

For analyzing mutual funds, we need to look at long-term performance, which can be considered a period of atleast 5 years. We can determine the fund manager's ability to manage an investment portfolio through a full market cycle including that during recession as well as growth periods covering bull and bear markets usually lasting 5 years. Also we need to determine how the fund performed during the ups and the downs of the market to determine their risk optimization strategy and asset allocation across multiple asset classes available in the market. Further, a return based style analysis for any mutual fund can be executed using quadratic optimization of the asset class factor model. This method was proposed by William Sharpe and we can analyze the relative performance of the funds to determine the style of mutual fund and can also perform an attribution analysis of the excess fund return of the funds over index or other benchmark to determine the quality of selection with the timing factor.