Introduction Data Javier Estrada Price indices v . Total return - PDF document

Application 1: Background – Mean Returns Javier Estrada ADFIN – Winter/2014 1. Introduction • The relevance of dividends 2. Mean Returns • Calculations • The relationship between AM, GM, and SD • The relationship between AM, GM, and forecasting • The relationship between GM, DWM, and market timing Introduction  Data Javier Estrada  Price indices v . Total return indices IESE Business • Public sources publish price indices School • Careful if you assess performance by using data from Barcelona Spain Yahoo Finance, Google Finance, newspapers, …  Public sources typically omit dividends Go  Why are dividends important?  S&P‐500 (1900‐2013) • AM(TR): 11.5% • AM(PI): 7.0% • Difference: 4.5% a year  Taking out 39% of the return in the average period takes out ‘a bit’ more than 39% of long‐term terminal wealth ADFIN Winter/2014 1

Introduction – S&P 500 Javier Estrada IESE TR Business School Barcelona Spain PI ADFIN Winter/2014 Introduction – S&P 500 Javier Estrada IESE $33,254 Remember the importance of … Business School ⦁ dividends Barcelona ⦁ reinvesting dividends Spain $307 ADFIN Winter/2014 2

AM, GM, and SD – Excel Commands  Returns Javier Estrada  TR indices  R t = I t / I t ‐ 1 –1 yields the total return IESE Business  Some useful Excel commands School Barcelona  Count → ‘ =COUNT( Range ) ’ Spain  AM → ‘ =AVERAGE( Range ) ’  SD → ‘ =STDEV( Range ) ’ or ‘ STDEVP( Range ) ’  Arrays  GM → With the PRODUCT array → With the GEOMEAN array GoXls ADFIN Winter/2014 AM, GM, and SD  Recall two important facts Javier Estrada  AM ≥ GM (Virtually always → AM > GM) IESE Business  AM–GM = f + (Volatility) School Barcelona  The whole point of Q3 was to explore the Spain relationship between AM, GM, and SD further  Two important issues for portfolio optimization • GM as a function of AM and SD • Variance drag (GMM) GoXls ADFIN Winter/2014 3

AM, GM, and Forecasting  Forecasting Javier Estrada  Blume’s formula IESE Business • Combines the AM and the GM in a return forecast School Barcelona Spain ‐ T = Number of observations in the sample ‐ N = Number of periods ahead for which the forecast is made ADFIN Winter/2014 GM, DWM, and Market Timing  Recall … Javier Estrada  the critical distinction between … IESE Business • investment return (GM) School • investor return (DWM) Barcelona Spain  it is possible that DWM>GM or DWM<GM  whether DWM>GM or DWM<GM depends on investors’ ability to time the market ADFIN Winter/2014 GoXls 4

GM, DWM, and Market Timing Javier Estrada IESE Business During his 13 years managing School the Fidelity Magellan fund, Barcelona Spain Peter Lynch provided investors with a 29% 29% annualized return. During the same period, half half of the investors in Magellan lost lost money. ADFIN Winter/2014 GM, DWM, and Market Timing Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014 5

GM, DWM, and Market Timing Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014 GM, DWM, and Market Timing Javier Estrada IESE Business School Barcelona Spain ADFIN Winter/2014 6