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Introduction

This report is aim to analyse the benefits of risk-adjusted performance measurements to Zeus
Asset Management. Zeus Asset Management is a fund management firm founded in 1968 in
Atlanta by Tir Jerry Schneider. It serves both institutional and individual investors and with
more than $1.7 million assets under management. The director of research, John Abbot, is
considering adopting risk-adjusted approach in performance assessment.
Zeuss competitiveness analysis
Zeuss main competitors are the mutual funds in particular market. Compared with those
competitors, Zeus has strong competitive advantages.
Firstly, different from many managed funds of actively trading, Zeuss investment
philosophy is based on the belief that superior investment results should be achieved over
many years by a conservative, risk-adverse, quality-oriented approach to investment
management. This can be seen by its strategic asset allocation which focuses on medium to
long term capital growth.
Secondly, Zeus is well known for its commitment to relationship-oriented services. The team
devotes a lot in managing the client relationship. Thirdly, unlike most of its competitors, Zeus
has a more skilled and experienced portfolio management group. More than 75% of its
investment professionals were CFAs and received MBA from top business schools. The
average age of the fund managers is 44 compared that with Fidelity of 26.
Moreover, Zeus has a large client base including mutual funds, trust funds, foundations and
endowment, insurance companies, corporations and individual investors. Zeus pays special
attention to their tax issues through carefully selecting the investment products best suit the
clients tax status.
In addition, Zeus has its unique approach in portfolio management. For example, in terms of
the mutual fund, instead of each portfolio manager specializing in the municipal-bond market,
one portfolio manager has the sole responsibility for that market. In that way, the municipal
bonds can be managed more efficiently and meanwhile, Zeus can have cost advantage by
trading at a large volume. Moreover, investment professionals make due diligence trips to
company plants and headquarters in order to find out the real good stocks.


Main products of Zeus
Mutual fund
Zeuss mutual funds are designed to meet the need of individuals who do not meet the
requirements of individually managed portfolio or who have special requirements on
investments. Mutual funds can bring the benefits of economies of scale, low transaction cost
and some tax benefit.
Equity fund
The equity mutual fund was a medium to large capital-growth fund that mimicked the
institutional growth-stock portfolio, which reflects the firms investment philosophy.
However, the fund didn't perform well because of a weak cash policy until the new director
developed a new investment process. The return during 06/01/1995 to 12/31/1997 is higher
than the Lipper Growth Index but still lower than the S&P Index.
Bond fund
A little different from other funds, the bond fund is an actively managed fund which aim to
maximize total return in a way that is consistent with the preservation of capital. The
portfolio managers actively manage the market timing, duration and yield curve of the bonds
and also use powerful computer models to identify arbitrage opportunities and synthetic
bonds to create higher yield.
Balanced fund
The balanced fund sought long-term growth of capital and income through a diversified
portfolio allocated among high-quality equities and fixed-income securities. The balanced
fund benefited from the changes in investment process for the equity and bond portfolios.
International equity fund
The international equity fund is an important component in Zeuss investment portfolio. It
invests in stocks outside the U.S, which has different risks and low correlation of the current
portfolio. Therefore, it increased the diversification and total return of the portfolio.

Current performance measurements and their shortcomings
Currently, Zeus uses the absolute and relative measures in perform measurements. Absolute
measures usually includes the holding period return (HPR) and the present value of future
return. Absolute measurements are easy to calculate and reflect the earning ability of a
portfolio. However, they do not capture the risks associated with the investment portfolios.
Investors may be misled if only looking at those measurements since one high-return
portfolio may have high risks and do not match with their risk tolerance.
The simplest and most popular way to adjust returns for risk is to compare the portfolios
return with the returns on a comparison universe, which is often called relative measurements.
It is calculated by comparing the HPR to that of a benchmark, which can be either an index or
a similar company figure. It is simple to use but choosing the appropriate benchmark is also
crucial as different benchmark will lead to totally different results and hence affect the
investment decisions.
Risk-adjusted return measurements
Risk-adjusted return measurements are usually considered superior than absolute
measurements since they take the risks into consideration. Specific methods of adjusting the
returns for risks include the Sharpe Ratio, Treynor Ratio, Jensens Alpha, beta, and
information ratio.
Sharpe Ratio measures the portfolio risk premium for each unit of total risk. It is calculated
using the formula:

. It is simple to calculate and can be used to compare portfolios with


different risks. However, the Sharpe Ratio is based on normal distribution and it is believed
that the non-systematic risks can be eliminated by diversification.
That comes the Treynor Ratio which calculated using the formula:

, where is the beta


of a portfolio under CAPM. Therefore, the Treynor Ratio measures only the systematic risks
of the portfolio so that it is useful only when comparing well diversified portfolios.
Another method to adjust return for risks is Jensens Alpha. It is the difference between the
real return and the expected return predicted by the CAPM. With Jensens Alpha, we can see
that whether the portfolio can generate excess return. Additionally, information ratio divides
the alpha of the portfolio by the non-systematic risk. Similarly, under the CAPM, we can
derive the beta of the portfolio to see whether the portfolio is aggressive or not compared to
the market. The three methods above all based on the CAPM so when we are doing the
modelling work, we must ensure that the inputs of CAPM is accurate and the assumptions are
reasonable.
Choosing the appropriate benchmark
In terms of the bond portfolio, the Lehman Brother Aggregate Bond Index can be used as a
benchmark. The index includes a variety of bonds such as government securities, mortgage
securities, asset-backed securities and corporate securities to simulate the universe of bonds
in the market.
For the equity fund, S&P 500 Index, Lipper Growth Index and BARRA Growth Index can be
chosen as the benchmarks. We choose Lipper Growth Index and BARRA Growth Index
because Zeuss equity fund mainly include medium to long term growth stocks.
For the balanced fund, the Lipper Balanced Index is appropriate and MSCI Index is chosen as
the benchmark for the international fund.
Results of risk-adjusted measurements
Appendix 1 shows the results of the risk-adjusted measurements of Zeus portfolios. First look
at the equity fund. Since the Lipper Growth and BARRA Growth have similar level of
diversification with Zeuss equity fund, we can compare the Treynor ratio. The Treynor ratio
of the whole period is 0.0105, which is almost the same as that of Lipper Growth and
BAARRA Growth. Looking at the subperiod figure, we can see that period 2 performed
much better than period 1 as a result of a series development of investment process. When
compared with S&P Index, we use the Sharpe Ratio since the S&P 500 Index contains not
only the growth stocks. The result is consistent with what we got above. Although there is a
significant improvement in period 2, the Jensens alpha and information ratio indicate that the
fund underperformed the market slightly.
The performance of bond fund is similar with the equity fund. The Sharpe ratio and Treynor
ratio all indicate that period 2 performed much better than period 1. The difference with
equity fund is that the Jensens alpha and information ration of period 2 are positive, which
means the fund outperformed the market in this period. The performance of balanced fund is
almost the same as the bond fund as it is a combination of equity and bond investments.
The performance of international fund is quite different from the others. The beta, Sharpe
ration, Treynor ratio, Jensens alpha and information ratio are all higher than the market
figure, which means, the international fund is aggressive than the market and thus generate
risk premium over the market. The aggressive approach is contradictory to Zeuss risk
appetite to some extent since the international fund is managed by a third party Bohren
International Advisor. In addition, from Appendix 2, we can see that the correlations between
international fund and other funds are relatively low, especially with the bond fund.
Therefore adding a portion of international fund into the clients investment portfolio is
useful in diversification.
To conclude, except the international fund, the other funds of Zeus did not perform well in
the beginning, but after a series of changes and developments, the earning abilities of these
fund are increasing. At the end of 1997, the bond and balanced funds have already
outperformed the market.
Qualitative aspects
Apart from the advantage that it can make the analysis more accurate and robust, adopting
risk-adjusted approach can benefit Zeus in other aspects such as internal control, customer
relationship management and staff education. For example, Zeus can set up a certain risk-
return level as a threshold or benchmark of investments in internal control system to help
control the risk since the firm is risk-adverse. In addition, with the increasing need of
individual clients who are not financial professionals, using risk-adjusted measurements can
help them know better about risk-return relationship and make investment decisions most
suitable for their own risk profile. Moreover, it can help the portfolio managers improve their
investing skills and experience.
Conclusion and recommendation
Based on the analysis result, the developments and changes Zeus has taken in the later period
are useful and should be continued and it is recommended that Zeus should adopted the risk-
adjusted approach. It can help Zeus get a deeper understanding of the nature and behaviour
of investment portfolios, establish its internal control rules regarding the level of risks and
return that portfolio managers should deliver and improve the customer relationship.





Appendix
Appendix 1 Risk-adjusted performance measurements

Appendix 2 Correlations
international equity bond balance
international 1.0000


equity 0.6653

1.0000


bond 0.4102

0.6751

1.0000
balance 0.6482

0.9976

0.7124

1.0000





Appendix 3 Regression summary