SML & Passive Funds

This lesson shares a nuanced overview of Security Market Line (SML)) with a solved question on calculating Alpha. Finally, a look at how passive funds performed in the United States between 2009 and 2018. The relationship between expected required market rate of return plotted with Beta (standardized measure of systematic risk) is defined as Capital Asset Pricing Model. The model does not reward diversifiable risk, rather values assets based on their systematic risk. Under equilibrium all securities must lie on the straight line with expected rate of return on the y axis and beta on the x axis. Watch the video to know more.

Video: SML & Passive Funds | The middle Road 

Beta β measures risk of an asset proportion to the risk in the market portfolio. It measures the standardized covariance of the asset with the market portfolio. The expected return of an asset on SML depends on its beta and all assets that lie on SML are fairly valued or have an Alpha equal to zero. Undervalued stocks/assets will lie above the SML while overvalued below the SML. SML helps an asset manager in balancing the portfolio.

Jensen’s Alpha = Return of the Portfolio – Required Rate of Return given by CAPM. It’s a type of risk adjusted return measure. 

Passive funds have outperformed active funds on average, with the exception of private equity, which has outperformed and grown assets steadily over the past nine years from 2009 to 2018.