John’s current portfolio of $500,000 is invested as follows:
Current value Expected annual return Annual standard deviation
Bonds $100,000 3.6% 1.2%
HSBC shares $250,000 8% 12%
SaSa shares $150,000 10% 18%
John soon expects to receive a gratuity of $200,000 and plans to invest the entire amount in an index fund that best complements the current portfolio. John is considering the following four index funds. His selection criteria are to maintain or increase the expected return of the current portfolio and maintain or reduce the volatility of his current portfolio.
Assignment File 11 Expected annual return Annual standard deviation Correlation of returns with current portfolio
Fund A 9% 11% 0.8
Fund B 10% 12% 0.9
Fund C 8% 10% 0.6
FundD 7% 9% 0.5
The annual standard deviation of John’s current portfolio is 10.5%.
a) Required: Determine the expected return of John’s current portfolio.?
b) Without doing any calculations, discuss and explain which fund John should include in his current portfolio.?