The State of South Carolina's Pension Fund

4. Compare the mean return and standard deviation relation across the Dow 30 stocks versus the mean return and standard deviation relation across the various asset classes from Exhibit 2.

Before we make a comparison, we must be mindful that the statistics for the Dow 30 (Table 2) was calculated on a monthly basis from 1991 to 1998 while statistics for the asset classes (Table 1) were computed on an annual basis from 1926 to 1997: nonetheless, valid observations can be made. As discussed earlier, the four main asset classes epitomize the risk and return concept, whereby asset classes with higher risk, or standard deviations, would also yield higher returns. However, for the Dow 30 stocks, this is not necessarily the case: stocks with higher risk may, in fact, feature lower returns than those stocks with lower risk. For example, Woolworth Corp stocks have a monthly standard deviation of 9.926% but a mean monthly return of only 0.446%, while Coca Cola stocks have a lower standard deviation of 5.847% yet a much higher monthly return of 2.450%. The seeming "violation" of the risk and return tradeoff highlights the existence of a firm-specific risk (also called diversifiable or non-systematic risk), or the risk that arises from specific actions of the firm that may influence the demand and supply, and consequently the price and volatility, of the firm's shares. On the other hand, the asset class designated "common stocks" in Table 1 is representative of the stock market index comprising all the stocks traded within it, where each firm's specific risk has been marginalized and the stock correlations between each firm take precedent. The risk associated with the index as a whole is termed the market risk, or the non-diversifiable or systematic risk, and is generally determined by economic conditions and other systemic events.

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