Harold and Kumar are employees with White Castle Advisors. White Castle offers independent investment advice to institutional clients throughout the U.S and Canada. Harold’s and Kumar’s primary responsibility is evaluating the performance of portfolio managers that White Castle’s clients are considering. When necessary, they create customized benchmarks and use the Sharpe, Treynor, ex-post alpha, and M2 measures. These measures adjust a manager’s return for the risk undertaken, where risk is defined as total using the standard deviation or as systematic using beta. Harold and Kumar are preparing an analysis of the performance of the Alpha and Omega Mutual funds. Alpha and Omega are being considered by the endowment of Citi University as an addition to its portfolio. Chuck Prince is the portfolio manager for the Citi endowment. Citi’s current endowment is well diversified, consisting of U.S. and international stocks and bonds, hedge funds, real estate investment trusts, and a small cash position necessary to meet next Quarter’s expenses. In addition to the Alpha and Omega Mutual funds under consideration, Prince is also considering adding individual bonds to Citi’s portfolio because individual bonds have become increasingly more liquid. Harold believes that municipal bonds would be a good consideration because their after-tax return is often higher than that available from corporate bonds. Prince informs them that Citi is also considering adding BBB rated bonds as a small portion of their portfolio, but Kumar believes that this is probably not a good idea because, although he has not reviewed Citi’s investment policy statement, endowments typically have a low ability and willingness to take risk because the endowment must meet the spending needs created by university operating budgets, student scholarships, and faculty salaries. The most recent risk and return measures for both Alpha and Omega are shown below. The minimum acceptable return (MAR) for Citi is the 5.0% spending rate on the endowment, which the endowment has determined using a geometric spending rule. The T-bill return over the same fiscal year was 4.5%. The return on the Wilshire-5000 was used as the market index. The Wilshire 5000 index had a return of 10% with a standard deviation of 21% and a beta of 1.0. Analyzing the results of their performance evaluation, Harold notices that the results demonstrate that the Alpha portfolio is less diversified than the Omega portfolio. Kumar adds that the Omega portfolio would be a better addition to the Citi portfolio than the Alpha fund. Alpha Omega Return 16.5% 15.9% Std. Deviation 38.1% 35.6% Beta 0.8 1.25 Downside Deviation 14.9% 14.0% Which of the two funds is showing a better performance using Treynor ratio?
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