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# The Determinants Of Mutual Fund Growth In Pakistan

This study is actually about the mutual fund growth and the determinants which are influencing on the growth of these funds. We ask whether the growth of funds is influences by the management fee, family proportion and the expense ratio or not. How much these variables influenced the growth of funds. We further check out the relation of the family assets and the return on the funds with the performance of the funds. Investors are paying the charges to control the funds and for the growth of the funds in the shape of management fee and the administrative charges. We study the behavior and the output of the funds from the duration of 2005-2009. We selected the funds which are listed in KSE. The funds are selected which are in the family proportions because of the nature of regression model which is used for the calculation of the effect of determinants on the growth of the funds. We use two models for the interpretation of the data. These are fixed effect model and cross section model. Through these models we elaborate the effects of different factors on the growth of these funds. We focus on the management fee for checking the efficiency of the funds management. Whether these are contributing in the growth of the funds or not, if not then these fee is only for the benefit of funds management

## INTRODUCTION

In Pakistan the mutual fund industry handles a significant portion of the assets of individual investors. Basically there are many factors which can affects on the growth of the mutual fund. In these determinants of the mutual funds which can affect the growth of the mutual fund we are focusing on the management fee, the main focus is on the charging of the management fee and its impact on the growth. Whether it is beneficial for the growth or not? Along with this we are determining some other major determinants of which can influence on the growth of these funds in Pakistan. Compensation to managers is primarily in the form of a Management fee. With few exceptions, Management fees are charged as a percentage of the assets under management rather than on the basis of performance. It is therefore in the interest of management to grow the total assets in the fund and in the associated fund family. One tool that managers may use to grow funds is the Management fee. The fees, which are limited to1% to 3% per year as Management fee, are used to cover administrative costs.

This paper studies whether or not the charging of a Management fee support the investors by growing the worth of mutual funds family along with that of some other determinants. Next we checked that the charging of Management fee leads to greater cash inflow for the funds which charge them. We focus on various mutual funds existing in the Karachi Stock Exchange and listed there, in order to control for the variety of commission payment schemes associated with management fee charging funds that are now available to shareholders and are in the group of families charging Management fee.

## LITERATURE REVIEW

These are some of the review from the experts and the researchers. Academic opinion on mutual fund fees is generally critical. Bogle, points out that the average cost of owning mutual funds has risen over 100 percent in the last sixty years. Freeman and Brown contend mutual fund advisory fees alone are excessively high. In their view the mutual fund industry is dominated by conflicts of interest where the mutual fund boards fail to negotiate arms-length management contracts with asset managers. In their view asset managers are over compensated for the services that they provide. Similarly Ang, Chen and Lin argue that the primary benefit that managers can provide to the shareholders is the reduction of expenses. The reason is that management has more control over expenses than over any other aspect of the return to the shareholders. Therefore, if managers are not working to reduce expenses they are failing to carry out their primary duty to the shareholders.

Golec found that fund managers are compensated primarily on the basis of a percentage of the assets under management. That compensation scheme provides fund managers with a strong incentive to grow fund assets regardless of the degree to which such growth is consistent with shareholder welfare. Collins, along with Livingston and O’Neal (1998) and O’Neal (1999) argue that some investors pay to receive professional investment advice and assistance in the purchase of mutual funds. Essentially they argue that brokers provide some combination of resolving asymmetric information for investors and providing a needed service in completing and maintaining the required records in order to complete the investing process. We closely examine the issue of whether brokers primarily resolve asymmetric information or primarily provide investors with record completion and maintenance services. One way to grow the assets is to well manage the fund by the fund management of that varies funds. Management fees provide a source of funds for controlling and managing the funds.

Naim Sipra (2008) one of the interesting things to note is the low correlation between the funds and the market portfolio. In US studies the correlation between the market and mutual funds is often 0.9 or above. A high correlation with the market is an indication of a high degree of diversification. The low correlation in the Pakistani case suggests that the mutual funds are not doing a very good job of diversification. The low correlation and also the low betas are probably due to inclusion of fixed income securities such as the Term Finance Certificates (TFCs) in the portfolios of these funds. Since the composition of the funds is not publicly known therefore it is not possible to analyze this issue any further. Ali S M, Malik A S (2006) A Capital markets play a vital role in the economic development of a country. It is now widely accepted that there is a direct correlation between economic growth and the development of the financial sector. Mutual funds are considered to be an important source of injecting liquidity into the capital markets. A well established financial intermediation system facilitates the economic activity by mobilizing domestic as well as foreign savings.

Muhammad Akbar Saeed (2004) during the last two years, mutual fund sector has more than tripled in size to Rs. 112 billion (as of 31-Dec-04). The industry players are predicting that the business is likely to grow by 200 percent over the next five years. The success of the industry will lie in several factors, one of which will be the role of regulators and their efforts to continuously evolve the code of corporate governance for the mutual fund industry. Moeen Cheema and Sikandar A. shah (2006) Mutual funds are becoming vehicles of securities investments most favored by the general public worldwide. Whereas, this trend is more pronounced in the developed securities markets of the United States of America and Europe, mutual funds are increasingly gaining the public attention in the developing economies as well. Pakistan is not an exception to this global trend and even though mutual funds form a comparatively small segment of the securities markets, they have grown phenomenally over the last few years.

According to the Mutual Fund Association of Pakistan (MUFAP), whereas mutual funds may not shield investors from the risks associated with overall market failure, the ability to diversify that they provide may reassure public investors as regards the failure of individual companies and hence make them less wary of insider opportunism in any given corporation. We similarly consult some of the related articles for this purpose, which can be seen from the references. We also consult some of the conflicting matters with the course instructor. In summary, Management fee is basically for the controlling of the mutual funds and for the growing purpose of the funds. But is it working well for the growth of the mutual funds which funds are being charging this fee.

## HYPOTHESES AND METHODOLOGY

This paper studies whether the shareholders income and their wealth increase from the growth of the mutual funds through the charging of Management fees. The main focus on the Management Fee but there are some other determinants like family proportion, expense ratio, return through sharp ratio and assets turnover in that specific duration which we selected for the research purpose. There are a number of ways in which investors could enjoy by the growing of wealth from funds which charge this fee. Since the fee is used for administrative expenses. It could aid investors by making them aware of high quality managed funds that might otherwise be invisible to them. There are several possible examples of funds where this might apply.

First, funds charging this management fee lead the higher total returns. Funds with greater total returns would benefit investors in that, if the superior performance was persistent, investors would have a higher terminal wealth from investing in these funds than they would have from investing in other funds. A fee showing the existence superior total returns would be of great of interest to investors. The null hypothesis:

Ho: There is no difference between the total returns of mutual funds that charge the Management fee and those that do not charge the Management fee will be tested.

Second, the Management fee might be a signal to investors of a greater risk adjusted rate of return. A greater risk adjusted return would imply that investors could earn superior returns with less chance of loss with respect to other portfolios offering the same level of return. The second null hypothesis to be tested is:

Ho: There is no difference in risk adjusted returns between the risk adjusted return of mutual funds that charge the Management fee and those that do not charge the Management fee.

2nd hypothesis will be tested using Sharpe Ratio.

It needs to be noted that these null hypotheses could be rejected either because the funds charging the Management fee over perform or because they under perform. If there is persistent over performance, the over performance is in the interest of the investors. However, persistent under performance would mean that the fee being paid by the investors is being used to let them know that these mutual funds are not performing well that will leave the investors with less terminal wealth. Such a result would be consistent with the view that Management fees are inconsistent with shareholders income growth.

Third, the funds charging the Management fee could be the funds that have lower expense ratios. The numerator of the expense ratio includes all of the operating costs of managing the fund; including the management fee and other administrative costs as well as all the expenses. It may be that after the Management fee is removed from the expense ratio the fund has lower expenses than other funds. Such a result would support the idea that the fee itself is merely a substitute for other costs and that the investor in such a fund is no worse off, and could be better off than the investor in a fund that does not have the fee. The null hypothesis to be tested is:

Ho: There is no difference of the expense ratios of the funds on the growth of the mutual funds.

3rd hypothesis will be tested after subtracting the Management fee from the expense ratio. The null hypothesis could be rejected because the funds charging the fee have lower expense ratios or because the funds charging the fee have greater expense ratios. In the first case the management fee would be in the interests of shareholders and in the second case the fee would not be in the interests of shareholders.

If it is found that the management fee is not supporting the growth of the mutual funds of shareholders, the other alternative is that the fee is in the favor of the fund management. It would be in the interest of fund management to charge the management fee if the existence of the fee led to faster asset growth than could otherwise be expected. Management desires faster asset growth because of the manner in which management is compensated.

Fourth, managers might be using management fees to grow funds more rapidly than they would otherwise be growing.

The growth of the fund from time t to t+1 is defined as:

Gi = (Assetst - Assetst -1(1+R))/Assetst -1 (1)……Equation

Where Gi is the growth rate in the assets under management by fund i from time t-1 to time t. Assetst are the net assets under management at time t. Since the assets under management may grow either due to new sales or returns, equation 1 eliminates the growth that is due to returns. For all of the funds in the study, the management fee is based on the net assets under management which may provide a managerial incentive to grow the fund as rapidly as possible.

Ho: The growth rate of mutual funds that charge management fee is higher as compare to the funds which are not charging the fee.

We will test whether the funds that charge the fees actually are growing faster using a regression model that controls for risk adjusted return, asset turnover rate, the relative size of the mutual fund within a family of funds, the expense ratio of the fund other than the management fee and the level of the management fee.

Gi = β 0 + β 1RARi + β 2ATi + β 3ASSETi + β 4FAMPROi + β 5ERi + β 6FEEi + β i …2) Equation

Gi is the growth due to new investment in funds i from previous year t to current year t+1. Growth is defined by equation 1.

This sign (?) Measures the sensitivity of the growth rate of the mutual fund to the specified factor in each case. An expected positive sign means that the growth rate is expected to respond positively to increases in the variable. An expected negative sign means that the growth rate is expected to respond negatively to increases in the variable. The expected sign is specified for each of the control variables.

RARi is the risk adjusted returns on fund i from year t to t+1, estimated by using the Sharpe Ratio. In accordance with past findings, this control variable is hypothesized to have a positive sign and does take a positive sign.

ATi is the asset turnover for fund i which is measured through the formula of Net Income divided by the Total Assets. Turnover is a measure of investing activity. The greater the turnover, the greater the cost of operating the fund. Holding all else equal, the greater the cost of operating the fund the lower the growth in the fund. This variable is hypothesized to have a negative sign and does have a negative sign.

ASSETi is the total assets of fund i at time t. The larger a fund, generally, the older the fund is so that assets serve as a proxy for the age of the fund. The older a fund, the more well known the fund is to the investing public and the easier it will be to sell the fund. Assets are expected to and do have a positive relation with growth.

FAMPROi is the proportion of the mutual fund family assets made up by fund i. The larger the proportion of the family assets in the fund the slower will be the growth, as management efforts will be directed primarily at the newer, smaller funds. This variable is expected to have a negative sign and generally has a negative sign.

ERi is the expense ratio of fund i , less the management fee from all the expenses. The expense ratio includes all of the costs that the management company charges to the fund including the management fee, trading costs, and any other expenses. Since the purpose of the test is to isolate the effect of the management fee, that fee is subtracted from the expense ratio. The greater the expense ratio, the lower the growth. Investors should prefer a lower cost fund to a higher cost fund. The variable generally has the expected negative sign.

FEEi is the level of the Management fee. For the vast majority of the funds in the study, this variable will be charged by 1% to 3%. It is expected that the null hypothesis will be rejected and that this variable will have a positive sign which is generally the case.

The regression model (Equation 2) is estimated on an annual basis for the years 2004 through 2009 for all funds that have all required data available. Equity and fixed income funds are examined separately. A positive and significant sign on the FEE variable will lead to a rejection of the null hypothesis and will be consistent with the idea that the Management fee is used by management to increase growth in assets.

There are two economic rationales that apply to the imposition of the Management fee on mutual fund investors. The first is that investors are the primary beneficiaries. The second is that fund management is the primary beneficiary of the fee. The major contribution of this paper is to determine whether the facts are more consistent with the investors or the managers being the beneficiaries for mutual funds.

## THE DATA

All of the data are taken for the years 2004 through 2009. Since 2004 is the first year and lagged data is needed, the results are presented for all funds for which all data was available for 2005 through 2009. The data are summarized in the table form and data is regarding the equity funds. As far as the collection of the data is concerned so we consult many sources for the collection of the data. Mainly we collect it from KSE. From where the full data was not available and after that we consult the Business recorder, Statistical Bulletin of Pakistan [Federal Bureau of Statistics (2005)] for 2005-2009 and SBP for the collection of the financial reports and the kibor rates. The net asset values are collected from the KSE as well as from Brecorder. The data available in the form of tables and excel sheet which is attach along with this article. Mainly we collect the data of the equity mutual funds. Our focus was on most commonly known mutual funds of the Pakistan market. We selected almost 21 mutual funds from the KSE available sources but because of the running of Regression Model, for which we need only the family funds which are in the form of groups. We neglect the individual funds because of the family proportion concern. So now the data available is of 13 mutual funds which are in the form of family. From that we could generate the family proportion of the mutual funds assets. Because the amount of the data was less for five years so we take the data in the panel form representing through panel EGLS.

## RESULTS

These are some of the results which we conclude from the help of the CROSS SECTION MODEL & FIXED EFFECT MODEL. In econometrics and statistics, a fixed effects model is a statistical model that represents the observed quantities in terms of explanatory variables that are all treated as if those quantities were non-random. This is in contrast to random effects models and mixed models in which either all or some of the explanatory variables are treated as if they arise from the random causes. Often the same structure of model, which is usually a linear regression model, can be treated as any of the three types depending on the analyst's viewpoint, although there may be a natural choice in any given situation.

In panel data analysis, the term fixed effects estimator (also known as the within estimator) is used to refer to an estimator for the coefficients in the regression model. If we assume fixed effects, we impose time independent effects for each entity that are possibly correlated with the regressors.

The major attraction of fixed effects methods in non-experimental research is the ability to control for all stable characteristics of the individuals in the study, thereby eliminating potentially large sources of bias. Within-subject comparisons have also been popular in certain kinds of designed experiments known as changeover or crossover designs (Senn 1993). In these designs, subjects receive different treatments at different times, and a response variable is measured for each treatment. Ideally, the order in which the treatments are received is randomized. The objective of the crossover design is not primarily to reduce bias, but to reduce sampling variability and hence produce more powerful tests of hypotheses. Fixed effects methods cannot estimate coefficients for variables that have no within-subject variation

Time-series cross-section (TSCS) data harness both cross-temporal and cross spatial variation to maximize empirical leverage for theory evaluation. However, this powerful data structure also requires careful consideration of temporal and spatial (cross-unit) heterogeneity, temporal and spatial dynamic processes, and potentially complex stochastic error structures.

In the table 1 which is descriptive table and that is showing the mean, median and standard deviation as well. As it is clear and shows from the descriptive table that the sharp ratio, which is basically the return calculation through the sharp measure, is the negative impact on the growth of the mutual fund. As you will increase the return on the funds or the return increases over the amount of the funds the impact of it is negative on the growth of the mutual fund. Similarly the coefficient of this sharp ratio is also negative impact on the growth of the mutual funds. Now secondly, the asset turnover showing, the mean in the descriptive table representing the negative value which means that if the asset turnover will be negative so it can reduce the growth of the mutual funds. Assets are in the positive form and they show that if the asset of the fund increases so it means that the impact of this on the growth of the fund is positive and it contribute in the growth of the mutual fund. The family proportion of the mutual fund should have the positive impact on the growth of the mutual fund and in the table 1 of the descriptive result, the result of this is positive so it means that the family proportion increasing in this which is the positively impacting on the growth. Expense ratio is resulting negatively on the growth of the funds, and the management fee which is the basic testing of this is also showing the negative impact on the growth of the mutual funds in Pakistan.

## TABLE NO. 1

## Descriptive Analysis

GR SR AT ASSET FP ER FEE

## MEAN

3.989

-1.096

-0.008

2633207

0.365

1.262

54455166

## MEDIAN

0.005

-0.540

0.010

1435134

0.410

1.260

38342000

## MAX.

63.590

2.290

0.450

14193216

1.000

10.900

2.49708

## MIN.

-27.660

-5.010

-1.070

0.00000

0.000

0.000

0.00000

## STD. DEV

12.763

1.470

0.272

3060791

0.255

1.644

53774795

## SKEW.

2.134

-0.946

-1.834

1.951847

0.187

4.008

1.599424

## PROB.

0.000

0.004

0.000

0.0000

0.729

0.000

0.0000

## SUM

259.290

-71.278

-0.525

1.71608

23.400

82.060

3.54709

## OBS.

65

65

65

65

65

65

65

## TABLE NO. 2

## Correlation Matrix

DETERMINANTS

GR

SR

AT

ASSETS

FP

ER

FEE

## GR

1.000

-0.269

-0.578

-0.163

0.062

0.100

-0.146

## SR

-0.269

1.000

0.360

0.124

0.174

-0.186

0.132

## AT

-0.578

0.306

1.000

0.139

0.071

-0.403

0.125

## ASSETS

-0.163

0.123

0.193

1.000

0.503

0.084

0.972

## FP

0.061

0.174

0.071

0.503

1.000

0.270

0.538

## ER

0.100

-0.187

-0.403

0.084

0.270

1.000

0.058

## FEE

-0.146

0.133

0.125

0.972

0.538

0.058

1.000

Now further according to the table 3 which is Fixed Effect Model, we design a panel least squares method in this model for the calculation of the data, in that the sharp ratio is resulting in the negative form and show the result that as the return on the mutual funds increases the growth effected negatively. The coefficient of the sharp ratio is negative and the result is showing significance, which is acceptable. After that assets turnover of it is in negative figure which shows a negative impact on the growth and the prob. Is significance we are keeping the level of the significance here is 0.10. The coefficient of the family proportion is positive that’s good for the growth of the mutual fund but it is not significance because the prob. is higher than the level of significance. The expense ratio is showing the negative result, which means that the increase of the expense ratio is a negative impact on the growth of the mutual funds. Its coefficient value is negative and the value is significant according to the fixed effect model. Now comes the management fee, according to this model the management fee is resulting in the positive value for the fund, that means that the funds that using the Management fee are contributing in the better growth of the fund because the coefficient value is positive but according to this model the fee is not significant here, the result is that the funds charging the fee can make the funds growing as compare to the funds that are not charging the management fee. The factor we assume here that the management fee effect positively for the growth of the funds but because of the political instability and the country economic situation it is not resulting good in the growth of the mutual funds in Pakistan. Lastly according to this model, value of Lassets is positive and the significant level is good which shows the Lassets significant. We take the assets here despite of the assets because of the mismatch and not the proper results from the assets. So it is impacting positively on the growth of the mutual fund. If it increases the mutual fund growth will increase.

## TABLE NO. 3

## Fixed Effect Model

Dependent Variable: GR

Method: Panel Least Squares

Sample: 2005-2009

Total panel (unbalanced) observations: 64

Cross-sections included: 13

DETERMINANTS

COEFFICIENT

STD. ERROR

T-STATISTICS

PROB.

## SR

-3.772

1.532

-2.462

0.018

## AT

-24.784

7.253

-3.417

0.001

## LASSET

0.447

0.155

2.878

0.006

## FP

4.932

9.653

0.512

0.612

## ER

-2.250

1.054

-2.135

0.038

## FEE

1.637

1.427

1.144

0.258

CONSTANT -1.456 4.251 -0.343 0.734

## EFFECTS SPECIFICATIONS

## CROSS-SECTION FIXED (DUMMY VARIABLES)

## PERIOD FIXED (DUMMY VARIABLES)

## ADJUSTIFIED R-SQUARED

0.438

## MEAN.DEP BAR

4.051

## S.E OF REGRESSION

9.639

## S.D. DEP BAR

12.859

## SUM SQUARED RESID

3810.045

## SCHWARZ CRITERION

8.418

## LONG LIKELIHOOD

-221.580

## F-STAT.

3.227

## DURBIN–WATSON STAT

1.896

## PROB F-STAT

0.000

In table 4 and 5, we use the CROSS SECTION MODEL (cross section random effects & cross section weights), according to both of these methods the calculations are same, the coefficient values and the significant are same. The assets turnover is showing the negative value which shows according to it that the more assets turnover can impact the growth of the mutual funds and the value is significant in both methods as well as in the fixed effect model. The value of the sharp ratio means the return of the mutual fund is showing coefficient negative in the random effect method that means that the increase of the return value can effect the growth negatively and growth is less when this return value is high while the value is significant which means it is good for the growth of the mutual fund and same value is showing in the fixed effect method. But in the cross section weights method the value of the return is positive and it is not significant there. So it shows here a that the higher return impact the mutual fund growth positively means higher the return higher the growth of the mutual fund nut it is nit the case here. Family proportion of the mutual funds according to the both methods says that the results are showing positive relationship in the growth of the funds and the higher the family proportion. The values are significant according to the probability measures. Expense ratio according to both of these models reflects the results that expense ratio is impacting the growth of the funds negatively. Means as the ratio of the expense increase the growth is going to be less for the mutual funds. The coefficient value of the expense ratio is in negative value and the value in both the methods shows that this is significant. As far as the Management fee is concerned here so according to the both methods the management fee is impacting on the growth inversely. The coefficient value in both the cases is negative means if the management fee is charged by the mutual fund management so the growth is less than if they don’t charge the management fee. And the value is significant in both the methods. So it is clear from now that according to the Cross Section Model the impact of the management fee is negative on the growth of the mutual funds. The management who is charging the management fee their growth of the mutual funds is less and downward.

## TABLE NO. 4

## Cross Section Weights

Dependent Variable: GR

Method: Panel EGLS (Cross Section Weights)

Sample: 2005-2009

Total panel (unbalanced) observations: 54

Cross-sections included: 13

Linear Estimation after One-Step Weighting Matrix

## VARIABLE

## COEFFICIENT

## STD.ERROR

## T-STAT

## PROB

## SR

0.439

0.825

0.532

0.596

## AT

-32.916

3.815

-8.628

0.000

## FP

4.404

3.353

2.506

0.016

## ER

-2.032

0.719

-2.825

0.006

## FEE

-5.297

1.997

-2.665

0.010

## LASSET

0.447

0.155

2.877

0.006

## WEIGHTED STATISTICS

## R-SQUARED

0.788

## MEAN DEPENDENT VAR

7.211

## ADJ. R-SQRD

0.766

## S.D. DEPENDENT VAR

20.513

## S.E. OF REG

9.905

## SUM SQUARED RESID

4709.255

## DURBIN-WATSON STAT

1.785

## UN-WEIGHTED STATISTICS

## R-SQUARED

0.396

## MEAN DEPENDENT VAR

4.801

## SUM SQUARED RESID

6164.67

## DURBIN-WATSON STAT

1.521

## TABLE NO. 5

## Cross Section Random Effect Model

Dependent Variable: GR

Method: Panel EGLS (Cross-Section random Weights)

Sample: 2005-2009

Total panel (unbalanced) observations: 64

Cross-sections included: 13

Swamy and Arora estimator of component variances

## VARIABLE

## COEFFICIENT

## STD.ERROR

## T-STAT

## PROB

## CONSTANT

1.663

2.777

0.599

0.551

## SR

-1.435

0.972

-1.876

0.952

## AT

-29.005

5.104

-5.682

0.000

## FP

13.775

6.468

2.129

0.037

## ER

-2.021

0.866

-2.134

0.023

## FEE

-3.497

2.877

-1.217

0.228

## EFFECTS SPECIFICATIONS S.D RHO

## CROSS SECTION RANDON

3.045

0.096

## IDIOSYNCRATIC

9.345

0.904

## WEIGHTED STATISTICS

## R-SQUARED

0.432

## MEAN DEPENDENT VAR

3.287

## ADJ. R-SQRD

0.384

## S.D. DEPENDENT VAR

12.429

## S.E. OF REG

9.758

## SUM SQUARED RESID

5522.350

## F-STATISTICS

8.844

## DURBIN-WATSON STAT

1.533

## PROB (F-STAT)

0.000

## UN-WEIGHTED STATISTICS

## R-SQUARED

0.416

## MEAN DEPENDENT VAR

4.051

## SUM SQUARED RESID

6076.710

## DURBIN-WATSON STAT

1.432

So these are the results from the use of the two different models for the testing of the variables and the impact of the determinants on the growth of the mutual funds. As far as the results are concern so it is clear that in most on the factors like the assets turn over, expense ratio, family proportion and assets the results are same in both the methods. But the concern is from the sharp ratio means the returns on the funds is some little bit difference. According to both the methods the results are same for the return but in the cross section model in which two methods were drawn and only the sharp ratio returns are varying there. In management fee the results are totally different for both of the cases. For the confirmation of the results, all the outcomes and the results are in accordance with the study of Mr. Richard J. Dowen, Thomas Mann (2007).