Introducing CAPM Service

The latest service on the Alpholio™ patent-based analytical platform implements the capital asset pricing model (CAPM). Specifically, the service calculates the security characteristic line (SCL) with related statistics. In addition, the service provides statistics for the difference between periodic returns of the analyzed and reference securities.

In contrast to the traditional CAPM, which uses a theoretical market portfolio as a reference, the service allows the use of any available security. This has a practical implication of comparing concrete investment vehicles as opposed to evaluating a real security against an uninvestable “market” index, such as the S&P 500®. However, in both cases the reference is a single factor, whose periodic returns try to explain the returns of the analyzed security.

To demonstrate the service in action, let’s analyze the Vanguard Health Care Fund (VGHCX, Investor Shares; VGHAX, Admiral Shares). We covered this fund in one of the previous posts. This analysis will begin in January 2013, when the fund was fully taken over by its current manager.

Here are the fund’s exposures through June 2017, derived from the Fund Analysis service:

Reference Weights for Vanguard Health Care Fund Investor Shares (VGHCX)

The fund had equivalent positions in the Guggenheim S&P 500® Equal Weight Health Care ETF (RYH), iShares Global Healthcare ETF (IXJ) and iShares U.S. Pharmaceuticals ETF (IHE). Collectively, these positions formed a reference ETF portfolio with volatility comparable to that of the fund.

Let’s use the Total Return service to determine which of these three ETFs most closely tracked the fund’s returns over the same period:

Total Return of Vanguard Health Care Fund Investor Shares (VGHCX) and Reference ETFs (RYH, IXJ and IHE)

As could be expected, RYH, the ETF with the dominant weight in the reference portfolio, turned out to be the best fit. Therefore, let’s choose this ETF as a CAPM reference for the fund, using excess (i.e. net of risk-free rate) monthly returns of both securities:

CAPM for Vanguard Health Care Fund Investor Shares (VGHCX) and Guggenheim S&P 500® Equal Weight Health Care ETF (RYH)

The beta coefficient of the fund vs. the ETF was somewhat below one, a result of the slightly lower standard deviation (see statistics below the Total Return chart) and the 0.959 correlation coefficient (separately obtained from the Correlation service). With the t-statistic much higher than two, the beta coefficient was statistically significant. The alpha intercept, while positive, was not statistically significant. With the R-squared of almost 92, the regression fit was quite good.

Here is the expanded bottom panel of statistics:

Return Difference Statistics for Vanguard Health Care Fund Investor Shares (VGHCX) and Guggenheim S&P 500® Equal Weight Health Care ETF (RYH)

The mean difference between monthly returns of the fund and the ETF was slightly negative and had a substantial standard deviation. The low t-statistic indicated that the return difference was not statistically significant. By this measure, any value subtracted by active management of the fund could be attributed to bad luck and not a lack skill. If performance of the fund and the ETF were unchanged, it would take almost 212 years for the return difference to become statistically significant (and still be negative).

Since the fund had a considerable portion of its assets in foreign equities, IXJ could also be a relevant CAPM reference:

CAPM for Vanguard Health Care Fund Investor Shares (VGHCX) and iShares Global Healthcare ETF (IXJ)

In this case, the alpha intercept was large and statistically significant, although the R-squared was slightly lower. Similarly, the average return difference was a positive 0.35% and was statistically significant, requiring only 3.1 years to become so (statistics not shown here for brevity). This underscores that the choice of an appropriate reference security is critical because the CAPM regression uses only a single explanatory variable.

To try the new CAPM service, please register on our website.

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Analysis of Baron Asset Fund
analysis, mutual fund

A recent story in Barron’s covers the Baron Asset Fund (BARAX; Retail class shares). This $3 billion, mid-cap fund has a 1.31% expense ratio and 13% turnover. According to the article

Over the past five years, the fund returned 15% a year on average, better than 84% of its Morningstar mid-cap growth peers.

The current manager took over the fund in late January 2008. Therefore, the following analyses will start in February 2008, the first full month under sole management.

The primary prospectus benchmark for the fund is the Russell Midcap Growth Index. One of the long-lived and accessible implementations of this index is the iShares Russell Mid-Cap Growth ETF (IWP). Alpholio™ calculations indicate that through June 2017 the fund returned more than the ETF in only 32% of all rolling 36-month periods, 39% of 24-month periods and 38% of 12-month periods.

Rolling 36-Month Returns of Baron Asset Fund (BARAX) and iShares iShares Russell Mid-Cap Growth ETF (IWP)

The median cumulative (not annualized) underperformance over a rolling 36-month period was 3%.

In contrast to our earlier post about the fund, this analysis will use a simpler variant of the patented Alpholio™ methodology, in which both the membership and weights of ETFs in the reference portfolio are fixed. Here is the resulting chart of the cumulative RealAlpha™ with statistics for Baron Asset:

Cumulative RealAlpha™ for Baron Asset Fund (BARAX)

With a comparable volatility, the fund cumulatively underperformed its reference ETF portfolio by over 52%.

The following chart with related statistics illustrates the constant composition of the reference ETF portfolio (the membership was limited to a maximum of six ETFs):

Reference Weights for Baron Asset Fund (BARAX)

The fund had major equivalent positions in the Consumer Discretionary Select Sector SPDR® Fund (XLY), iShares Morningstar Mid-Cap Growth ETF (JKH), iShares S&P Small-Cap 600 Growth ETF (IJT), First Trust US Equity Opportunities ETF (FPX), Guggenheim Insider Sentiment ETF (NFO), and iShares U.S. Medical Devices ETF (IHI). These positions constituted average exposures the fund generated over the entire analysis period. They should be viewed in the context of the overall investment portfolio of which the fund may be part.

The final chart with traditional statistics compares the total return of Baron Asset to that of the aforementioned IWP and JKH:

Total Return for Baron Asset Fund (BARAX), iShares Russell Mid-Cap Growth ETF (IWP) and iShares Morningstar Mid-Cap Growth ETF (JKH)

The fund performed similarly to JKH (best-fit mid-cap ETF) but underperformed IWP (benchmark mid-cap ETF). Despite a relatively low turnover, in each of the past four years the fund had significant long-term capital gain distributions, which made it much less tax-efficient than these two ETFs. At the end of August, the fund held only 55 equity positions, with top-ten holdings accounting for almost 43% of assets. Divesting just a few of these positions could result in additional large distributions.

In sum, under current management the Baron Asset Fund did not outperform the available investment alternatives on a risk-adjusted basis. Any value added was consumed by a sizeable management fee.

To learn more about the Baron Asset and other mutual funds, please register on our website.

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