A performance analysis of Swedbank s Generations Funds

Transcription

1 PORTFOLIO EVALUATION A performance analysis of Swedbank s Generations Funds SohailMohseni msl07004@student.mdh.se LiyinGao lgo07001@student.mdh.se This thesis will discuss the Swedish Pension System and different solutions for private pension investment as well as providing a fund evaluation of the Swedbank Robur s Generation Funds. Tutor: Level: Department: Fil.dr. Johan Lindén Bachelor thesis in Economics, 15 hp Sustainable development of society and technology

2 Abstract Date: Thursday, 27th May 2010 Level: Bachelor thesis in Economics, 15 hp Authors: Sohail Mohseni Liyin Gao Tutor: Fil.dr. Johan Lindén Purpose: This thesis will introduce a brief presentation of the Swedish Pension System and different pension solutions as well as investigating the four generation funds offered by Swedbank AB where the main purpose is to answer the following question: Whether Transfer funds are able to outperform their comparable index and similar comparative funds or not. Method: The evaluation is based on the theoretical tools from different theories of financial economics. Extensions of existing models will be derived. Conclusions and results: None of the Generation Funds managed by Swedbank Robur outperformed their comparable benchmark index. However, remarkable and positive results was discovered when comparison between other competitive and similar funds in same category was completed.

3 Acknowledgements We want to extend our profoundly thanks and warm greetings the following persons for their insights into the project and valuable comments; Mrs. Eva W Andersson Office Manager Swedbank Mr. Henrik Bohman Office Manager Swedbank Dr. Johan Lindén Supervisor Mälardalen University I am eternally grateful to my chief and role model Mrs. Eva W Andersson for her trust and constant encouragements. I feel very fortunate and thankful for being a part of Swedbank and working with my high-qualified colleagues. / Sohail Mohseni Furthermore, we would like to sincerely thank our supervisor Dr. Johan Lindén for letting us work independently and for providing us with the opportunity to pursue this thesis. Finally, we would like to express our warm thanks, greetings and love to our parents who has always been our sources of inspiration and has always providing the support in order to get us on the straight line!

4 Table of contents 1 INTRODUCTION Background The Aim of the Thesis Limitations THE SWEDISH PENSION SYSTEM The General Procedure Private Pension Possibilities Traditional Pension Insurance Mutual Fund Insurance Capital Pension Insurance Individual Pension Savings (IPS) Generation Funds Transfer Transfer Transfer Transfer THEORETICAL FRAMEWORK The Capital Asset Pricing Model (CAPM) Arithmetic Mean vs. Geometric Mean Risk and Return Systematic Risk vs. Unsystematic Risk The Measures of Portfolio Evaluation Sharpe Ratio M Square Jensen s Alpha METHOLOGY DATA SELECTION Choice of comparable index IMPERICAL FINDINGS Performance evaluation using Sharpe Ratio Measure Performance evaluation using Jensen s Alpha CONCLUSION References APPENDIX

5 List of Figures FIGURE 1 THE STRUCTURE OF SWEDISH PENSION SYSTEM FIGURE 2 GENERATION FUND S RISK AND AGE ALLOCATION FIGURE 3 TRANSFER 80 PORTFOLIO FIGURE 4 TRANSFER 80 GEOGRAPHICAL DIVERSIFICATION FIGURE 5 TRANSFER 70 PORTFOLIO FIGURE 6 TRANSFER 70 GEOGRAPHICAL DIVERSIFICATION FIGURE 7 TRANSFER 60 PORTFOLIO FIGURE 8 TRANSFER 60 GEOGRAPHICAL DIVERSIFICATION FIGURE 9 TRANSFER 50 PORTFOLIO FIGURE 10 TRANSFER 50 GEOGRAPHICAL DIVERSIFICATION FIGURE 11 SHARPE RATIO FOR BLANDFOND GENERATION AND BENCHMARK INDEX FIGURE 12 SHARPE RATIO FOR BLANDFOND GENERATION AND BENCHMARK INDEX FIGURE 13 JENSEN S ALPHA AND BETA FOR BLANDFOND GENERATION FIGURE 14 BETA OF GENERATION FUNDS FIGURE 15 JENSEN S ALPHA AND BETA FOR BLANDFOND GENERATION FIGURE 16 BETA OF COMPARABLE FUNDS List of Equations EQUATION 1 CAPM EQUATION 2 BETA OF CAPM EQUATION 3 ARITHMETIC MEAN EQUATION 4 GEOMETRIC MEAN EQUATION 5 SHARP RATIO EQUATION 6 M-SQUARE EQUATION 7 JENSEN S ALPHA EQUATION 8 ARITHMETIC MEAN VERIFYING HISTORICAL PERFORMANCE List of Tables TABLE 1 SHARP RATIO- AND M-SQUARE FINDINGS 6-27 TABLE 2 PERFORMANCE EVALUATION JENSEN S ALPHA 6-30

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7 1 INTRODUCTION In this chapter an introduction of the thesis is presented to the reader where research problem and purpose is discussed. The reader will also obtain a view of the importance of generation funds from the inexperienced investors point of view. 1.1 Background Sweden s social network is considered comfortable and safe by most of its citizens. However, the pension system of Swedes is complicated and requires good knowledge in order to make it optimal at the time of retirement. Since some of the retirement savings are invested in different financial markets and securities, each individual must gain insight into financial markets and thereby receive the optimal returns on their investments during their working lifetime. All investment banks in Sweden takes advantage of this opportunity and provides their customers different types of services and solutions, such as portfolio management and security recommendations etc. If the Swedish individual has the right knowledge, he/she will certainly use the solutions where they have the total control of their own investments. Often when is lack of knowledge or even the lack of time, the investment banks and insurance companies steps in and offers different types of financial services. Swedbank AB and its associates, which is an authorized by the Swedish Financial Supervisory Authority, offer several different services and solutions for its 5.9 million private customers in Sweden. Their customer can often get professional help and recommendations about different kinds of investments thanks to a financial instrument called Det enkla valet (The easy decision). This digital instrument takes different data and facts about the customer in consideration before calculating a customized recommendation and solution for the customer. One question that is Chapter 1-1th Page

8 very essential in this process is how active the customer is in financial markets and security papers. This particularly detail affect the total result tremendously and often when the individuals choose passive, the instrument recommends them a generation fund (based on their risk-preference and age) which is managed by Swedbank Robur AB (Swedbank AB s associated company). The generation funds are called Transfer and they change over the periods of year as the individual grows old. There are today four kinds of generations funds in Swedbank; Transfer 80, Transfer 70, Transfer 60 and Transfer 50. Transfer 80 is a mutual fund and it is the most risky fund which is appropriate for a young investor investing over a long period of time. While Transfer 50 is an interest fund with very low level of risk which is appropriate for older individuals who will retire soon or simply for the individual that do not want to face big risks (and neither high returns). Chapter 1-2th Page

9 1.2 The Aim of the Thesis This thesis will introduce a presentation of the Swedish Pension System and different pension solutions as well as investigating the four generation funds offered by Swedbank AB where the main purpose is to answer the following question: Whether Transfer funds are able to outperform their comparable index and similar, comparative funds or not. 1.3 Limitations We will investigate the fund s performance during last 5 years of investment period ( ). Some generations funds (like transfer 80) are relatively new in the financial markets and crucial history as well as data is missing in order to investigate longer performance period. We use one-year Treasury bill from the Swedish Central Bank as the risk-free asset There will be a major focus on Swedbank s generation funds, more than every second Swedish citizen is a customer of the bank and its associates and mainly due to lack of information and history of the other big bank s generation funds. Chapter 1-3th Page

10 2 THE SWEDISH PENSION SYSTEM 2.1 The General Procedure In Sweden, the pension capital is generated from different kinds of sources. The Swedish individuals receive money from the state in form of public pension and partly from their employers. Today there are also different kinds of financial instruments that can easily measure the total amount of your pension savings just before you retire. Those instruments take different kinds of information and data in consideration (such as age, salary, employee, employment-time etc) and it gives you an approximated statistic. If the individual desires more amount of pension capital than expected and entitled, he/she has the option to invest additional money in the private pension savings. The following figure demonstrates the pension capital inflows from the three different sources: Figure 1 The structure of Swedish Pension System Each year the state authority puts away 18.5 percent of your yearly salary for your pension savings. 16 percent is invested in the national pension funds (orange part) while 2, 5 percent (yellow part) goes to the premium pension authority (PPM). Chapter 2-4th Page

11 The 16 percent-income-based part is invested by the state authority in five AP-funds (The first, seconds, third, fourth and sixth AP-funds). The 2.5 percentage PPM can be influenced by the individuals and saved in private funds. If the individual does not do any active selection of funds, the PPM part will automatically be invested in the seventh AP-fund by the Premium Pension Authority. The state authority pays the current pensioners from the today s AP-funds i.e. the pension system is a pay-as-you-go system. The individual who are being charged today will get their future pension payouts from the future worker s pension fees. Most of the Swedish individuals receive also money from their employees which is referred as occupational pension. The individual may receive occupational pension from different employers if he/she has worked with in different areas. The amount of the occupational pension depends on the agreement between the employers and the union of the employees. It is estimated that most employees will receive approximately 10 percent of their final salary in occupational pension. It is important to observe that individuals who are self-employed and own their own company must save their own occupational pension as well. As mentioned above, there are many acceptable and used instruments that can easily estimate your final pension capital. If they individuals have the option to increase that amount by saving additional money in the private part. Chapter 2-5th Page

12 2.2 Private Pension Possibilities As mentioned earlier, there are many acceptable and used instruments that can easily estimate your final pension capital. The individuals have the option to increase that amount by saving additional money in the private part. There are several ways and solutions that can be used; however it is also important to set up an strategy before deciding which one to go with. The investment strategy for the private pension is related to several aspects. The individuals need to find out how active they are able to track their investments, how good insight they have in financial markets and big risk they are willing to take in order to receive the optimal return on their investments. They must also pay consideration to their incomes as well as tax-liabilities which can be a crucial to make the decision on wheatear investing in tax-deductable or non-tax-deductable options Traditional Pension Insurance This solution can only be managed by insurance companies (Konsumenternasförsäkringsbyrå 2010). Traditional pension insurance permits the company to decide by itself how to invest the money they individuals have saved. This solution can be viewed as a mixed fund of diversified portfolio where the money can be invested in stocks, bonds, real estate and other security papers (Swedbank 2010). Choosing this solution, the companies always guarantees the individual the investments they have done during the year after tax deductions and fees. This means that if the invested capital decreases due to stock market, the companies will make up for the lost piece (Swedbank 2010). The amount of money an individual have saved each year is tax-deductable by 30 percent up to SEK per year. When the individual retires, the payments are income taxed and the money cannot be retrieved before the age of 55. The whole amount cannot be retrieved in a lump sum, the payments must be spread over at least 5 years and can be paid for the rest of the individuals life. Survivors protection Chapter 2-6th Page

13 is also available for the individuals. This implies that in case of death, the insurance will be transferred to individuals within the family. (Swedbank 2010) Mutual Fund Insurance This possibility can also only by insurance companies, even though they use banks as commissioners. With this solution the individual has the total control of the money and decides strategies itself for investments in different funds. Since the individuals are in charge, the return on investments depends on the individuals own knowledge and insight in financial markets. The funds can be changed without any transaction costs. With this solution the individual has no guarantees that the investment they have done will be paid back on retirement time. This solution is also tax-deductable up to SEK/year. (Swedbank 2010) Capital Pension Insurance Capital Pension insurance is a solution where the money can be invested in different types of mutual funds. The individual will not pay any taxes when they retrieve the money during the retirement time, but there is no tax-deductibility during the period of investment. Depending on the insurance company s or banks terms, the capital pension insurance can be paid as a lump sum and the insurance can be repurchased in advance by insurance company. (Swedbank 2010) Individual Pension Savings (IPS) Individual pension savings (IPS) are tax-deductable by 30 percent up to SEK/year and with this solution the individual can freely influence their own investments and choose among different types of Swedish and foreign security papers. In order to offer Individual Pension Savings (IPS) for Swedish individuals, the banks must be authorized by the Swedish Financial Supervisory Authority. The individuals have the option to change pension institute (the authorized bank) during the period of investments with a charge of fee from current institute. The return on Chapter 2-7th Page

14 investments works in the same ways as in Mutual Pension Insurance i.e. it is completely dependent on the individuals financial knowledge and skills. (Swedbank 2010) 2.3 Generation Funds In early June 2004 Swedbank launch their generation funds to the Swedish financial market. The generation funds are called Transfer and they are customized for different age categories. If the individuals wants to save additional money into their pension savings in form of private pension, Transfer funds is a comfortable solution when time and financial skills are issues. The Transfer funds are like a portfolio managed by the bank during the working years until the individual retires. During this long investment period the managers of the fund will make sure that the fund is administrated according to the individual s age and risk preference. The risk of the fund will decrease the older the individuals get i.e. young investors funds will include a lot of risky stock and less interest rates, while the old investors fund will mainly include different types of interest rates and non-risky assets. (Swedbank 2010) Figure 2 Generation Fund s risk and age allocation Chapter 2-8th Page

15 2.3.1 Transfer 80 Transfer 80 is an appropriate choice of fund for individuals born during the 1980 s. This fund maintains both Swedish and foreign stock as well as other security papers. At the start-up, the fund consists of large proportions of risky stocks, but this will as mentioned earlier decrease the closer retirement the individual gets. Over time, the reduction of stocks will decrease from percent to percent of the fund (See the figure below). The returns of the Fund are paid out in December each year. (Swedbank 2010) This figure demonstrates the diversification of Transfer 80 in percentage. Figure 3 Transfer 80 Portfolio This figure demonstrates the geographical diversification of Transfer 80 in percentage Figure 4 Transfer 80 Geographical Diversification In this paper Transfer 80 is also compared with SPP Generation 80 which has the required historical data and performance that is necessary in an acceptable analysis. SPP Generation 80 has operated in the Swedish market since year 2000 and works exactly as Transfer 80 and both this funds has the same investor segment. Chapter 2-9th Page

16 2.3.2 Transfer 70 This fund is created for individuals born in 1970s and it is comparatively more stable in theory than Transfer 80. In Transfer 70, the maximum percentage of stock are 72 percent and more than one third of the fund invested in different types of interest rates, both long runs and short runs. The main market of this fund is Sweden and almost 93 percent of the individual s capital will be invested in Swedish security papers. This figure demonstrates the diversification of Transfer 70 in percentage. Figure 5 Transfer 70 Portfolio This figure demonstrates the geographical diversification of Transfer 70 in percentage Figure 6 Transfer 70 Geographical Diversification SPP Generation 70 and SEB Generation 70 are the appropriate comparable and comparative funds for Transfer 70. Chapter 2-10th Page

17 2.3.3 Transfer 60 Transfer 60 is created for the average Joe i.e. this is in theory the most balanced fund of all generation funds within Swedbank. The amount of stock is about 47 percent and the major part of the portfolio is placed in different interest rates, mostly long run and older than 1 year. The Swedish market is also dominants in the geographically market structure with almost 96 percent and only 2, 25 percent is invested in Asian securities excluding Japan. This figure demonstrates the diversification of Transfer 60 in percentage. Figure 7 Transfer 60 Portfolio This figure demonstrates the geographical diversification of Transfer 60 in percentage Figure 8 Transfer 60 Geographical Diversification For this Fund, SEB Generation 60 and SPP Generation 60 are chosen as appropriate comparable Fund. Among all Generation Funds for people born during the 70 s these two operated in the same way with equal amount of diversification level and similar investment strategy. Chapter 2-11th Page

18 2.3.4 Transfer 50 This generation fund is created and managed for two types of individuals, the old one who are near to retirement time and the frightened risk-averse one. In theory and in real practical life, this fund is the safest one in the range of generation funds and consists more than 70 percent of long-run interest rates. Transfer 50 consists of only 25 percentages of stocks which are in the safe-stock-category within the Swedish market. Swedish market is considered most safe and makes up to more the 97 percentage of the fund. SEB generation 50 and SPP Generation 50 is chosen as comparable benchmark funds. This figure demonstrates the diversification of Transfer 50 in percentage. Figure 9 Transfer 50 Portfolio This figure demonstrates the geographical diversification of Transfer 50 in percentage Figure 10 Transfer 50 Geographical Diversification Chapter 2-12th Page

19 3 THEORETICAL FRAMEWORK In this chapter a brief description of the chosen theories related to performance evaluation of the Generations Funds are written. This section also explains the content of each different model with their respective advantage and disadvantages 3.1 The Capital Asset Pricing Model (CAPM) Harry Markowitz introduced Modern Portfolio Theory (MPT) back in 1952 and the function of this investment theory is to try maximizing the return and minimizing the risk by calculating the selection and right combination of different assets. 12 year later, William Sharpe developed and published the Capital Asset Pricing Model (CAPM) in order to determine the relationship between risk and expected return of a risky security that is to be added to an already well-diversified portfolio. In order to evaluate possible investments, it is necessary to get a benchmark rate of return. The mentioned relationship serves this requirement and it also helps making a theoretical and appropriate guess about the expected return of assets that have not yet been traded in the market place. In CAPM model, the risk is referred as beta and it can together with a risk-free rate predict the expected risk premium for an asset. The CAPM is used for pricing an individual security or a portfolio and since it is a single index model it implies that returns of a certain assets are linearly related to the covariance of its return with the return of the market portfolio. The CAPM will provide a return that will serve the investor to determine whether he/she should invest or abstain due to the return that is required to sufficiently compensate the investor for the risk related to the investment (Bodie et. al. 2009). Here is the mathematically form of the Capital Asset Pricing Model: Equation 1 CAPM Chapter 3-13th Page

20 Where: E(ri) rf B rm E(rm)-rf = The Expectec Return = The risk-free interest rate = Beta ( The sensitivity of the asset returns to market returns) = Return of market portfolio = Market premium or risk premium Mathematically beta of the Capital Asset Pricing model is calculated by following equation; Equation 2 Beta of CAPM Where; = Covariance between security and market return = Variance of the market return In a well diversified portfolio, the beta coefficient of the Capital Asset pricing model is referred as the systematic risk which accounts all the risk. Wheatear a portfolio is correlated to the return of the market as a whole or not, is measured by the beta coefficient. In other words, the beta coefficient acts like a risk measurement which illustrates how sensitive the portfolio movements are to the market movements. (Bodie et. al. 2009) The Capital Asset Pricing Model has several simplifying assumptions and the most essential ones are presented below: o All investors aim to rational and risk averse o All investors plan for one holding period Chapter 3-14th Page

21 o They all assume that all information is available at the same time to for everybody o The markets are perfect competitive o Investors have a limitless capacity to borrow and lend at the risk-free rate. o The financial market is perfect: there are no transaction costs and neither taxes. All assets are traded and are infinitely divisible. Eugene Fama and Kenneth French, who are the developers of the three factor model, have criticized the CAPM for not clarifying the return of the stocks due to the CAPM is greatly affected by its various assumptions. The return of the Funds is estimated to be constant, since the CAPM is a static model. Roll (1977) were skeptical and unconvinced that the CAPM could calculate the true market portfolio in reality due to its relationship implied that the market portfolio was efficient in the mean-variance sense. Although many of CAPMs assumption ignore many practical complexities and in spite of all criticism, the CAPM is still widely used and accepted in practice such as evaluating cost of capital of analyzing the performance of portfolios. The model has been criticized a lot and all this assumption are hard to fulfill in reality, but there is also a lack of better options and as financial theory it may still describe reality in a reasonable way (Amence and Le Sourd 2003). Chapter 3-15th Page

22 3.2 Arithmetic Mean vs. Geometric Mean In order to estimate the main characteristics of a set of numbers, the arithmetic mean or the geometric mean (which are averages) must be calculated. arithmetic mean return can be calculated by the following formula: The Equation 3 Arithmetic Mean Where n is the period of investments Since the arithmetic mean is a neutral estimator of portfolio s expected future return, it is used for the future performance of portfolios. The geometric mean (or compound geometric rate of return) represents the descending neutral estimator of portfolio s expected return in any future period of investments (Bodie et. al. 2009). The Arithmetic mean is interpreted as the expected return for the following period (Amenc and Le Sourd 2003). The geometric mean return can be calculated by following formula; Equation 4 Geometric Mean If the past performance of a fund or portfolio needs to be analyzed, the geometric mean is as acceptable method which can be used. This method gives a constant rate of return that is needed to earn each year to match the actual performance over some past period of investments. (Bodie et. al. 2009) Chapter 3-16th Page

23 3.3 Risk and Return All investors have to accept the fact that returns can be in form of gains but also losses. The volatility of the expected return is associated as the normal risk and this is also the cause why investors expect lower return with lower volatility (Simon 1998). Risk and return has a directly proportional relationship to each other and investors who like to have a high return must face high risks as well. However, most investors are more sensitive to increased risk and then increased return. It is necessary that investors should consider a quantity of risks in order to achieve a certain desired return (Padgette 1995) Systematic Risk vs. Unsystematic Risk If we diversify the portfolio by including the more different types of assets and spreading the money among large numbers, the risk is assumed to decrease. The systematic risk of an asset is the risk that is associated with macroeconomic forces and affects an entire financial market. It is also an estimated risk of collapse of the entire financial market and not just a particular asset. Global actions such as those of war or natural catastrophe would be considered as a part of systematic risk and it cannot be avoided by portfolio diversification (Amenc and Le Sourd 2003). The unsystematic risk is an estimated risk of price change due to certain circumstances of a specific security. For instance, suppose that an investor decides to invest in a company that offers IT-solutions and consultancy. There are many unsystematic risks here. For example, the clients can lose trust in the accountability of the company or another competitor can outperform the IT-services offered of the company. In contrast to systematic risk, the unsystematic risk can be avoided by a well diversified portfolio. For instance, the investor can reduce the risk by spreading the invested amount of capital evenly between the company and its competitors or even among other companies (Steven Roman 2004). Chapter 3-17th Page

24 3.4 The Measures of Portfolio Evaluation It is fairly easy to fall into the trap of using a measure that will lead to astray. The best basis of comparison is the average performance of portfolios/funds in the same category and with the same risk as the one which is about to be compared (Jonathan Pond 2010). This is also the simplest and most popular way of comparison of portfolios and funds i.e. to compare rates of returns with those other investment funds that has similar risk ranking. The disadvantage of this way of comparing performance is that some fund managers may concentrate on some certain security groups so that the characteristics of different funds will not be relevantly comparable. (Bodie et. al. 2009) Sharpe Ratio Sharpe s ratio is used to determine the excess return or risk premium of a portfolio compared with the risk-free rate and thereafter compared with the total risk of the portfolio. The measure is figured by use of standard deviation and it was introduced by William Sharpe back in The measure is a reward-to-variability ratio i.e. It figures out the amount of money that is expected to be earned in contrast to the risk that the investors are able and willing to take. Since the Sharpe s ratio is a risk adjusted measure, it enables the relative performance of a portfolio that not very diversified to be evaluated because the unsystematic risk taken by the manager is already included in this measure (Amenc and Le Sourd 2003). The following figure illustrates the model of Sharpe s Ratio. Equation 5 Sharp Ratio Where; = Average Return of the Fund = Average risk-free rate of return = The standard deviation of the portfolio = The average surplus of the fund Chapter 3-18th Page

25 3.4.2 M Square Another risk adjusted measure of portfolio performance is the M square which stands for Modigliani Squared. This measure converts the Sharpe s ratio into percentage and thereby makes the understanding of Sharpe s ratio much easier. The major advantage of the M-square is that it can use the market opportunity cost of risk and adjust all the portfolios to the level of risk in the unmanaged market benchmark. In other words, it adjusts the total risk of a fund or portfolio equal to the total risk of the market and measuring the returns of the risk matched portfolio. A mixture of T-bills and selected portfolios usually adjusts the risk of portfolio to the risk of the market. Since the M-square is expressed in percentage, investor can without any difficulties understand and compare different portfolios with each other. The M-square can be calculated by the following figure; Equation 6 M-square Where; = The standard deviation of rm and rf = The standard deviation of rp and p = The average return of portfolio = Short term average rf Jensen s Alpha Jensen s measure is the portfolio s alpha value which is also defined as the differential between the return on the portfolio in excess of the risk-free rate and the return explained by the market model. This measure is based on the CAPM and Chapter 3-19th Page

26 it divides the concept of portfolio performance into two parts. One part is the prediction of future security prices and the second part is ability to minimize the unique risk through efficient diversification. The first one puts emphasis on the portfolio managers ability to predict future security prices and the excess return of the portfolio on a given level of the risk. The Jensen s alpha can be used to rank portfolios within same category and this measurement is the most widely used performance measure today when evaluating mutual fund performance. (Amenc and Le Sourd 2003) Equation 7 Jensen s Alpha Where = The average expected total fund return = Estimated Beta of the fund based on the comp. index = The average risk-free rate of return = The average daily returns of the comp. market index The disadvantage of this model is that the result depends on the choice of reference index. When a manager practice a market timing strategy, the Jensen s alpha becomes often negative and does not reflect the real performance of the manager. (Amenc and Le Sourd 2003) Chapter 3-20th Page

27 4 METHOLOGY The methodology that is used will be presented in the chapter of the thesis. As reader, you will find reasoning behind the selection of models that are used for measuring the performance of Swedbank s generation funds. In this thesis, the average yearly return of the funds is analyzed. To determine the yearly returns from the different Generation Funds, we used different websites such as Morningstar and the official site of each fund, ex. Swedbank Robur which is the manager of Swedbank s Generation Funds. Arithmetic mean is used to calculate the average of the return over a period of five years, Normally the geometric mean is used to calculate the average return because it gives the constant rate of return. However, due to the financial crises in 2008 we were compelled to use the Arithmetic Mean in view of the fact that the Geometric mean does not pay consideration to negative data in The theories estates that the Geometric mean gives a more precisely estimation while the Arithmetic mean is more approximated but not fatal at all. The arithmetic mean verifies the historical performance over a past investment period with the following equation. Equation 8 Arithmetic Mean verifying historical performance In order to do a relative performance comparison between portfolios and between a portfolio and a benchmark, the method of Sharp s Ratio was used. Treynor is also a popular risk measure, however it ignores the firm specific risk and it is therefore not preferable in our case. (Amenc and Le Sourd 2003) Chapter 4-21th Page

28 Sharpe s Ratio evaluates the efficiency of funds and portfolios, but the disadvantage of this model is that it does not allow direct comparison of funds to the market. Therefore, we also used the M-square model which is also preferred over Sharp s ratio. The M-square model permits direct comparisons to the market and considers the total risk of the Fund equal to the total risk of the market. The standard deviation is used as relevant risk exactly as Sharp ratio does and these two models give also the same performance standing. The M-square is still preferred simple because it ranks the funds as well as judging the amount of relative performance of the funds in an uncomplicated way (Bacon 2000). Since this thesis mainly focus on the performance of Swedbank s Generation funds, Jensen s alpha is used in order to compute a reasonable analysis. Chapter 4-22th Page

29 5 DATA SELECTION This chapter explains the data selection procedure and the motivation of selected benchmarks to be associated as the market portfolio. This thesis has collected data for the four Generation Funds managed by Swedbank Robur where the Swedish Market is the dominating market. Some part of the Funds also invests in foreign markets but the regulations, exchange rates and foreign riskfree rates are not measured due the complications and the dominants of Swedish security papers. The Fund details were retrieved from Swedbank Robur and Morningstar which is a well-known and acceptable source for information about different security papers. In order to find the appropriate benchmarks, the style box of Morningstar was used which simplified the identification of comparable indexes and other funds in the same category. The website of the fund managers Swedbank Robur was used to collect different types of data about the Funds. The empirical research will focus on the period to , i.e. 5 years investment period using monthly and yearly data that was retrieved from the database of Swedbank Robur. With the intention of measuring the risk-adjusted performance, it was necessary to use Treasury Bills (Statskuldväxlar) as the risk-free rate. In the investigation, the one year average treasury bills was retrieved from the database of the Swedish Central Bank. In this research, Excel is mainly used for calculations and data handling. Chapter 5-23th Page

30 5.1 Choice of comparable index An appropriate index must be chosen in order to evaluate the beta of the Generation Funds. The beta helps us understand the amount of variation of the fund in relation to the market index. Since the Swedish market dominates the investments an appropriate Swedish market portfolio is a reliable and comparable as the index. As comparable Index we choose Cat 25%Citi WGBI Euros75%FTSE Wd and Cat 50%Citi WGBI Euros50%FTSE Wd which are also used by Morningstar to compare the Generation Funds. To make the evaluation relevant and realistic, the data of other comparable funds in same category was also collected and compared. The dividends of each Fund are reinvested back into each fund, exactly as the chosen benchmark, and all data for the Generation Funds are adjusted according to this dividends principle. Furthermore, information about different competitive and similar funds in the Swedish market is also collected in order to make the evaluation more extended and useful. Nowadays, there are many banks performing in the Swedish market and providing same types of pension solutions and the biggest competitors to Swedbank are Svenska Handelsbanken (SHB), Nordea, SEB and Länsförsäkringarna. But some of these banks s generation funds are relatively new in the market and has lack of performance experience compared to Swedbank s generation funds and are therefore excluded in this paper. For example, SHB s generation 80 did not have five years of historical performance data which is crucial since this analysis has an investment period of five years. Chapter 5-24th Page

31 6 IMPERICAL FINDINGS 6.1 Performance evaluation using Sharpe Ratio Measure The performance of 12 different generation funds which are divided into two categories are evaluated by Sharpe Ratio measure where Cat 25%Citi WGBI Euros75%FTSE Wd index and Cat 50%Citi WGBI Euros50%FTSE Wd index was chosen as benchmarks. The performance of the funds was discovered to be un-sensitive in relation to the chosen benchmarks and they all underperformed their comparable in terms of risk adjusted return, which can be easily ascertained in table1. Both Sharpe ratio and M-square calculated the excess return per unit of the risks where the portfolio rankings based on the Sharpe ratio and the M-square are always the same. The M-square does not have more or different information than the Sharpe ratio; it is just converted into percentage as explained earlier in this thesis. Regarding the nine funds under Blandfond Generation category, all Sharpe ratio figures were positive. SPP Generation Fund 80 had the best result in its category, while Swedbank s generation Fund Transfer 60 had the best risk-adjusted performance of Swedbank s range of generation funds. However, according to our analysis, all nine funds was underperformed in comparison with its comparable index. The three interest funds under the category Blandfond Generation , show positive result according to Sharpe ratio since they mainly maintains of non-risky Chapter 6-25th Page

32 security papers. It is notable that the positive result does still not affect the total investment capital in big proportions since the rate of returns are (and also expected to be) small. We usually consider the fact that higher risk (beta) generates higher return, but the below figures gives us a different picture. Table 1 indicates that those funds that have higher beta are producing low returns compared to those funds which have less values of beta. For instance, SPP Generation 70 and SEB Generation 50 have highest beta in their respective category (1, and 1, ) but they are still generating the less returns in comparison to the other funds that have less. Swedbank s Transfer 60 had, as mentioned, the highest return with the lowest risk (beta) 0, Regarding to the four generation funds from Swedbank, they all are still good investments because they all have acceptable returns with lower risk than their comparable funds due principle of systematic risk. The overall conclusion about the performance of the selected generation funds using Sharpe ratio is that all of them underperformed their Comparable index. Chapter 6-26th Page

33 Comparable funds Performance Evaluation of Funds using Sharpe ratio & M-square Table 1 Sharp Ratio- and M-square findings Blandfond Generation average yearly return Stander deviation Beta SHARPE RATIO M - Square SPP Generation 50-tal 0,0578 0, , , SPP Generation 60-tal 0,0620 0, ,200,602 0, SPP Generation 70-tal 0,0716 0, ,241,698 0, SPP Generation 80-tal 0,0846 0, ,152,629 0, Swedbank Robur Transfer 60 0,0614 0, , , Swedbank Robur Transfer 70 0,0786 0, ,039,474 0, Swedbank Robur Transfer 80 0,0819 0, ,137,555 0, SEB Generation 60-tal 0,0799 0, ,234,107 0, SEB Generation 70-tal 0,0800 0, ,229,644 0, Cat 25%Citi WGBI Euros75%FTSE Wd (benchmark) 0,0672 0, , statsskuldväxel (risk-free asset) 0,0255 0,01361 Comparable funds Blandfond Generation Swedbank Robur Transfer 50 0, , , , SEB Generation 50-tal 0, , ,325,742 0, SPP Generation 40-tal 0, , , , Cat 50%Citi WGBI Euros50%FTSE Wd (benchmark) 0, , , Sharpe Ratio SWE50 SEB50 SPP40 comparable funds benchmark index Figure 11 Sharpe Ratio for Blandfond Generation and Benchmark Index Chapter 6-27th Page

34 Sharpe Ratio SPP50 SPP70 SWE60 SWE80 SEB70 comparable funds benchmark index Figure 12 Sharpe Ratio for Blandfond Generation and Benchmark index Chapter 6-28th Page

35 6.2 Performance evaluation using Jensen s Alpha We estimated the Jensen s alpha based on the CAPM security market line given in equation 1. The linear regression model was used to obtain the Jensen s alpha which is the deviation of the benchmark model. In Table2 all the alpha results for the generation funds over five years investment period with their comparable indexes are presented. Observe again that a positive alpha value indicates outperformance while a negative value indicates underperformance. Firstly, an examination of the generation funds returns in excess of the risk-free rate on a yearly basis was completed. Thereafter it could be observed that the nine funds was classified by Morningstar in the same category since the investment restriction of the funds where similar. SPP Generation 50 and 60 underperformed during the 5-year investment period while the rest of the generation funds managed to show an outperformance. The three interest rate funds showed a positive alpha. Since Jensen s alpha is used to find out the abnormal return of a fund, investors always seek to find a positive alpha in order to get an abnormal return. From the range of selected funds, SPP Generation 80-tal has the highest return under the category Blandfond Generation In comparison with Swedbank s Generation funds, Transfer 70 had the highest figure and it could give the investors mot abnormal return among similar fund in the same category. Among the nonrisky interest rate funds, SPP Generation 40 had the best return in the category while Transfer 50 and SEB Generation 50 showed similar result. Chapter 6-29th Page

36 The fund analysis shows that the SPP Generation 70 and SEB Generation 50 have both much higher risks (beta) in comparison with similar generation funds offered by Swedbank. It is also notable that SPP Generation 70 and SEB Generation 50 have small values for alpha which means that the investor who chooses these two funds will get little rewards from the risk they suffer. According to the analysis, Transfer 70 and Transfer 50 were considered better than all similar generation funds within the same category. The risk (beta) of them is reasonable compared with the abnormal return they get. Performance Evaluation of Funds using Jensen s Alpha Table 2 Performance Evaluation Jensen s Alpha Beta CAPM ALPHA Comparable funds Blandfond Generation SPP Generation 50-tal 0, , ,00587 SPP Generation 60-tal 1, , ,01356 SPP Generation 70-tal 1, , , SPP Generation 80-tal 1, , , Swedbank Robur Transfer 60 0, , , Swedbank Robur Transfer 70 1, , , Swedbank Robur Transfer 80 1, , , SEB Generation 60-tal 1, , ,003 SEB Generation 70-tal 1, , , Comparable funds Blandfond Generation Swedbank Robur Transfer 50 0, , , SEB Generation 50-tal 1, , , SPP Generation 40-tal 0, , ,00641 Chapter 6-30th Page

37 Jensen's Alpha SWE50 SEB50 SPP40 comparable funds Figure 13 Jensen s Alpha and Beta for Blandfond Generation Beta SWE50 SEB50 SPP40 comparable funds Figure 14 Beta of Generation Funds 50 Chapter 6-31th Page

38 Jensen's Alpha comparable SPP50 SPP60 SPP70 SPP80 SWE60 SWE70 SWE80 SEB60 SEB Figure 15 Jensen s Alpha and Beta for Blandfond Generation Beta comparable funds SPP50 SPP60 SPP70 SPP80 SWE60SWE70 SWE80 SEB60 SEB70 Figure 16 Beta of Comparable Funds Chapter 6-32th Page

39 7 CONCLUSION In this thesis, we have analyzed the performance of the four Generation Funds offered by Swedbank to its private Customers where the investment period was between 2005 and We used various models, such as Sharpe ratio, M-square and Jensen s alpha. The general findings in this thesis have figured out that all four generation funds managed by Swedbank Robur did not outperform their comparable Index. However, in comparison with similar comparative generations fund in the Swedish financial market, Transfer 60 and Transfer 50 showed much more positive results compared to other generation funds in same category. Of all four Transfer funds, Transfer 80 had the highest beta value (risk) and according financial theories a high beta value should get the highest risk adjusted return. Unfortunately, our result determined that in practice (the 5 year investment period ) they did not get the highest risk adjusted return even though they have the highest figure for the standard deviation and average yearly return. Transfer 80 and Transfer 70 has quite similar statistics from the calculations of Sharpe Ratio but Transfer 70 has much lower risk which makes it more stable compared to Transfers 80 in real life exactly as in financial theories. Transfer 60 has, firstly, the similar trend as its comparable benchmark index but it has lower sharp ratio compared to SPP Generation 60 and higher Sharpe ratio then SEB Generation 60. SPP Generation has also much higher risk than Transfer 60 and although the SEB Generation 60 has lower Sharp Ratio, they still have nearly the double beta value compared to Transfer 60. This observation makes the Transfer 60 the best choice of generation fund in the Swedish market for individuals born in the 1960 s. Chapter 7-33th Page

40 The average yearly return of Transfer 50 is quite small but according to calculation from Sharpe ratio, this generation fund still gets an acceptable performance value relevant to the small data values. Compared with SEB Generation 50, the adjusted rate of return is similar but the risk of SEB Generation 50 is almost four times bigger than Transfer 50. According to Jensen s alpha, which is used to measure the abnormal return, Transfer 80, 70 and 60 gives notable better abnormal return than other generation funds in the market. As a final point, The Generation Funds managed by Swedbank Robur is a good choice of investment for private pension, especially for individuals who do not have enough time or financial skills. The Swedish Pension System is considered complicated since it allocates pension capital from different sources, but it is important to a good understand in order to make the optimal pension investments and have a comfortable pension at the time of retirement. Some Individuals, who have excellent financial skills, have the chance to generate greater returns by diversifying their pension portfolio carefully as well as actively managing it. A good investor invests the money when the rates are low and sells the security paper when the rates are high. However, it is also very important to pay consideration to the returns and the accountability of the security papers at the same time. These actions can be problematical for an un-skilled individual, but a recommended would be investments in actively manage Generation funds (such as Transfer and SPP etc) where the unskilled individual controls the amount of investments over time. Often, the Swedish individuals invest 500 SEK per month constantly until they retire. By keeping track of the rates of the funds they could adjust the amounts of investments according to the prices i.e. temporarily decrease their investment in Bad Times and increase it in Good Times. Chapter 7-34th Page

41 8 References Konsumenternasförsäkringsbyrå (2010) 9&menu=ART_FAK&avd=ART_FAK Swedbank Ab (2010) Swedbank Robur AB (2010) Noel Amenc & Veronique Le Sourd (2003) Portfolio Theory and performance analysis, The Wiley Finance Series Steven Roman (2000) Introduction to the mathematics of Finance (Springer Undergraduate Mathematics Series Bacon, C (2000), How sharp is the Sharpe ratio?: Risk-adjusted Performance Measures, StatPro Bodie, Z., Kane, A., Marcus, A. (2009) Investments, McGraw-Hill Higher Education Fabozzi, F. Modigliani, F., Ferri, M. (1994) Foundations of Financial Markets and Institutions, Prentice-Hall Inc. Fama, E. Kenneth, F. (2004) The Capital Asset Pricing Model: Theory and Evidence, Journal of Economic Perspectives 18, Chapter 8-35th Page