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Do private sector fund managers outperform in Indian mutual fund industry? - A study of 10 mutual funds.
“This study is about the performance evaluation of mutual funds in India. The increased instability of financial market has given rise to increased financial risks faced by the investors. Investors need a financial intermediary who provides the required knowledge and professional expertise on successful investing. Mutual Funds are one of the perfect places where an investor can take the advantage of expertise knowledge and get the maximum out of the financial markets.”
“This study uses sample of private managed and public managed Indian mutual funds of varied net asset value to investigate and find out the differences in their performance. Net Asset Value (NAV) of each fund providers is taken from their website and these values are matched with the website of Association of Mutual Funds in India (AMFI) to ensure the integrity. This study considers performance of each fund for the period from 1st September 2006 to 31 July 2009. These values are regressed with the return of BSE and then using various evaluation techniques like NAV, Sharpe method, Treynor method and Jensen Alpha. At the end of this study, my ultimate aim is to find out the whether private sector fund managers outperform in India or not.”
“This study will examine and assess the selected funds and find out the best fund managers among them, rank these funds on the based of various measures and solve the main dissertation question as whether private sector managed funds outperform public sector managed funds or not. This study illustrates the ranking of performance of mutual funds as already categorised as public and private managed funds.”
I. I Introduction
In the competitive and complicated business world investing is ever challenging task for the ordinary people. People used to invest their savings in various types of investments like stocks, bonds, insurance etc. However, many investors feel difficult in selecting and managing these securities, apart from that, entering into these markets is very difficult for investors. Perhaps, mutual funds are the most appropriate investment option for small investors. We know that financial markets become more sophisticated and complex; investors need a financial intermediary who provides the required knowledge and professional expertise on successful investing. Mutual Funds are one of the perfect places where an investor can take the advantage of expertise knowledge and get the maximum out of the financial markets.
“Mutual funds are known as a part of what is known as financial service industry. These include two basic types of financial institutions, depository and non depository and mutual fund industry included in non depository institutions.” (John A. Haslem 2003).Basically Mutual Fund is a “trust that pools the savings of a number of investors who share a common financial goal. This pool of money is invested in accordance with a stated objective. The joint ownership of the fund is thus “mutual”, i.e. the fund belongs to all investors. The money thus collected is then invested in capital market instruments such as shares, debentures and other securities” (Ray Russell 1986). “One of the cardinal rules of investing is not to put all of one's investments “eggs” in one basket.” Investor can lower the risk that they run to achieve a given rate of return or achieve higher returns for a given level of risk by diversifying across and with in broad categories most commonly equities and bond (Yasuyuki 2008). Mutual fund is a type of services organisations that receives money from its shareholders and then. Thus, it is clear that when investors buy shares in a mutual fund, they actually become part owner of a widely diversified portfolio of securities. In an abstract sense, a mutual fund can be thought of as the financial product sold to the public by an investment company. That is, the investment company builds and manages a portfolio of securities and sells ownership interests- shares of stock- in that portfolio through a vehicle known as “mutual fund”. Then the fund managers are managing and controlling this money. Then these pools of money invest in capital market instruments such as shares, bonds and other securities by the fund managers. The income earned through these investments and the capital appreciation realized is shared by its unit holders in proportion to the number of units owned by them. Thus, a Mutual Fund is the most suitable investment option to the ordinary man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.
The Asian financial markets, considered to be emerging markets, are under- going impressive growth and spectacular progress, making them the focus of both professional and academic interests.As an important financial intermediary, mutual fund industry faces a rapid growth all over the world, especially in India. As a growing economy, in India, there are lots of mutual funds providers competing in the financial market. The impressive growth can be attributed to the entry of commercial banks and the private players in the mutual fund industry coupled with the rapid growth of the Indian capital markets during the last couple of years. The main objective of investing in a mutual fund scheme is to diversify risk of portfolios. Though the mutual funds invest in diversified portfolio, the investors can take different levels of risk in order to achieve that scheme's objectives. Therefore, while evaluating and comparing the performance of fund schemes, the returns should be measured with its risks involved in achieving these returns.
There are various factors and thinking that went behind the decision to take this area, industry and the topic to research on. As a finance student, I prefer this mutual fund industry as my interest and keen to know more about the mutual fund industry, especially in India. Mutual funds are best known for the medium to long term investment, however with several mutual fund entrants, the question is the choice of best mutual fund from these. Here, in this study, I am focusing on this mutual fund selection problems faced by investors. Though there is lots of investment options within the mutual funds (balanced, growth, dividend...), the choice of fund based on a reputation of a sponsor remains to be probed. This study is about an assessment and evaluation of both Indian and foreign mutual fund's performance. There is a hypothetical assumption that foreign sponsored mutual funds outperform in Indian Mutual fund industry as they have better quality staffs and wide range of resources as compared to Indian funds. My focus is on testing on this particular hypothesis. Though this study is based only on 3 years in a bear market, the study result will illustrate a complete picture about the performance of Indian Mutual fund industry.
This study is to assess and evaluate the performance of mutual funds by studying Indian mutual funds managed by public limited companies and private limited companies for 3 year period starting from September 2006 to July 2009. For the significance of this study, I randomly selected 5 public sector managed and private sector managed income funds with growth option. By taking in to account net asset value (NAV) of each fund and the return of BSE sensex Index for the respective periods, I can find out return and risk of these various funds. After that, need to find out various performance results of each funds by using various performance measures such as Sharpe ratio, Jensen Alpha and Treynor ratio.
Evaluation of portfolio performance is a wide area for study, there is enormous literature on this particular subject. After considering some previous researches on behalf of this performance evaluation of mutual funds, a critical review on these previous researches and a few techniques are using to solve for this particular problem. The main objectives of this study are to identify and compare the performance of Indian public sector managed and private sector managed mutual funds, and to find the extent of diversification.
II. Literature reviews
Literature reviews on evaluation of mutual funds performance is a vast subject. Evaluation of portfolio performance is one of the most discussed areas where financial economists still work on it. A few theories and research studies that have influenced the preparation of this study is as follows.
Like any investment, return performance of an investment is a major decision making element. The amount of dividend paid by the fund, its capital gains, and its growth in capital are the important elements of a return. As mutual fund's buying and selling usually carried out at prices based on the current market value of all the securities held in the fund's portfolio. This value stands for the book values of other assets, such as cash and receivables from the securities transactions, that the fund might hold at that time, though for all practical purposes, these other assets generally account for only a tiny fraction of the fund's total portfolio. “The current market value of a mutual fund is known as Net Asset Value (NAV); it is measured at least once a day and represents the underlying value of shares of portfolio in a particular mutual fund. The term is commonly used in relation to collective investment scheme.” (H Sadhak, 2003) Net Asset Value is a good indicator of the performance evaluation of a mutual fund; better NAV fund stands for good performance and vice versa.
“However, while calculating the average portfolio returns that does not mean that task is done. The return must be adjusted for risk before they can be compared meaningfully. The simplest and most popular way to adjust returns for portfolio risk is to compare rates of return with those other investment fund with similar risk characteristics. “According to the risk-adjusted performance measure approach, the benchmark portfolio of a managed fund is a linear combination of a risk-free asset and a market portfolio of risky assets, such that, the systematic risks of the combination and the managed fund are the same. The investment performance of a fund management may then be judged by the difference between the fund's excess return (the fund's return less the return on the default risk-free asset) and the corresponding excess return on the benchmark portfolio” (Frank Alphonse 2002) Portfolio performance without reckoning the risk exposure do not provide fair and true picture. Various studies in the past have not only examined performance in terms of rate of return but also evaluated portfolio performance in terms of risk-adjusted rate of return (Treynor and Sharpe's indices). (D N Rao 2006) Methods of risk-adjusted performance evaluation using mean-variance criteria came on stage simultaneously with the capital asset pricing model. “Typically, portfolio managers are ranked based on their ability to derive above average returns for a given level of risk and to diversify all unsystematic risk within a portfolio. Above-average risk-adjusted performance could be the result of excellent timing and/or superior security selection. However, measuring performance of individual portfolios can pose a difficult task to analysts because of different investing styles and philosophies. The problem becomes even more complex when the comparison of performance does not account for risk” (Susan and Joanne 2004). The Treynor, Sharpe, and Jensen portfolio measures are derived from the traditional Capital Asset Pricing Model. They can be shown the theoretical basis, positive linear transformations of each other. On a theoretical basis each of these measures should be independent of the corresponding measure of risk. Within a short time, academicians were in a command of a battery of performance measures, and a bounty of scholarly investigation of mutual fund performance was pouring from ivory towers.”
Treynor (1965) made the first effort to propose a measure of portfolio performance which considers the risk concerned in a portfolio. According Treynor, “managed portfolios carry market risk, i.e.; the aggregate value of the portfolio is dependent on the market trends. During bull phase, the value may go up and during bear phase, the portfolio value may go down. He introduced the concept of 'beta'' parameter. Beta value represents the degree of variation in the portfolio value compared to the market portfolio”(Madhumita et al, 1991). Treynor's measure uses the portfolio beta to measure the portfolio risk, is fully based on Security Market Line (SML). Higher value of Treynor's index indicates better performance of portfolio and vice versa. “The Treynor's measure of portfolio performance is relative measure that ranks the funds in terms of risk (market risk) and return. The index is also termed as reward to volatility ratio” (D N Rao 2006). Treynor therefore focused only on non-diversifiable risk, assuming that the portfolio has been built in a manner that diversifies away all individual risks. The appropriate measure of portfolio performance is risk premium per unit of ‘market risk' generated by the portfolio. “Risk premium is defined as excess portfolio return over risk-free return. This measure gives the risk premium per unit of beta non-diversifiable risk, which is measured by the portfolio beta”(Pin-Huang Chou 1997). Treynor introduced the concept of 'beta'' parameter. The degree of variation in the portfolio value compared to the market portfolio is represented by Beta. Higher value of Treynor's index indicates superior performance of portfolio and vice versa. Whenever fund return is exceeding the risk free rate and fund beta is above zero, then, a larger T value means a better portfolio for all investors regardless of their individual risk preferences.
Treynor's index = (Rp - Rf) ÷ βp
Rp = Portfolio return over a period
Rf = Risk-free return over a period
βp = Market-risk, beta coefficient
“However, in two other situations where it may have a negative T value as when fund return is below the risk free rate or when fund beta is below zero. If “Treynor value is negative because of fund's return is below risk free rate means that the portfolio performance as very poor. However, if the negativity of T comes from a negative beta, fund's performance is superb. Finally when return of the fund is below the risk free rate and beta of the fund is below zero, then T will be positive, but in order to qualify the fund's performance as good or bad we should see whether return of the fund is above or below the security market line pertaining to the analysis period” (Reilly, 1992).”
Sharpe measure is developed by William F Sharpe in 1965. Sharpe introduced another measure of portfolio performance evaluation. “He replaced 'market risk' (beta parameter) in Treynor's equation .with the 'total risk' parameter, i. €. 'standard deviation and measured performance in terms of risk premium generated per unit of 'total risk'. The Sharpe measure combines a fund's mean return, standard deviation, and the average risk-free return and calculates a ranking number that represents excess return per unit of total risk exposure. Higher value of Sharpe's index indicates better performance of portfolio and vice versa” (C Michele 2001). To calculate the Sharpe measure, use the following equation:
Sharpe's index = (Rp - Rf) ÷ σp
Rp = Portfolio return over a period
Rf = Risk-free return over a period
σp = Total risk, standard deviation of portfolio return
This measure used to assess the risk premium per unit of total risk that is risk premium per unit of portfolio standard deviation of return. Risk premium is the difference between the return of the portfolio and the risk free rate prevailing in the market. Sharpe method illustrates the portfolio performance by comparing portfolios to the capital market line (CML) rather than the security market line (SML). Sharpe measure of fund performance, therefore, evaluates funds performance based on both rate of return and diversification (Sharpe 1967). For a completely diversified portfolio, Treynor and Sharpe indices would give identical rankings. This measure would judge the consistency of mutual fund performance by ranking on it. If any fund's has Sharpe ratio widely varying year to year, it means that fund has not consistently perform well in the market. “Treynor ratio is extremely well know but perhaps less frequently used because it ignores specific risk. If a portfolio is fully diversified with no specific risk the Treynor and Sharpe ratios will give the same ranking. Some academics favour the Treynor ratio because they believe any value gained from being not fully diversified is transitory. Unfortunately the performance analyst does not have the luxury of ignoring specific risk when assessing historic return.” (Carl Bacon)
“The problem in the midst of both Sharpe and Treynor techniques for evaluating "risk-adjusted" returns is that they compare risk with short-term volatility. Therefore, these techniques may perhaps not be applicable in evaluating the relative merits of long-term investments”(Son and Cheng 1981).
Michael C Jensen developed a portfolio performance measure that seems quite different from the measure of Sharpe and Treynor. Jensen's measure, also called Jensen alpha, is based on the Capital Asset Pricing Model (CAPM) developed in 1968.Jenseen recognise the importance of evaluating a fund managers performance base on a fund's systematic risk and employs the CAPM. “He studied the performance of 54 open ended US mutual funds for the period 1945-64 and found that the returns of mutual funds before the load fees and after management and other expenses were on average 1% per annum below the benchmark return. It calculates the portfolio's excess return. Excess return is the amount by which the portfolio's actual return deviates from its required return, which is determined by using its beta and CAPM.” (Madhumita 2008) The value of excess return may be positive, zero, or negative. Jensen measure indicates the difference between the portfolio's actual return and its required return. Positive values are always preferred for good performance. They indicate that the portfolio earned a return in excess of its risk adjusted, market adjusted required return. Negative values indicate that the portfolio failed to earn its required return. In general, the higher Jensen's measure, the better the portfolio has performed. Only those portfolios with positive Jensen alpha have outperformed the market on a risk adjusted basis. According to this method, the risk premium of the portfolio us equals to the market risk premium times beta of the fund and a random error term. Obviously, according to this model, no one can expect that an intercept for the regression equation, if all the securities are in equilibrium. However, if some superior fund managers can constantly earn positive risk premiums on their portfolios, the always have a positive value. On that occasion, an intercept value which measures positive differences from the model should be included in the equation as follows:
Rjt - Rf = αj + βj (Rm - Rf) + ujt
Jensen uses αj as his fund's performance measure where a superior fund manager would comprise a significant positive αj value because of the regular positive residuals. Inferior managers, in contrast, would comprise a significant negative αj. Average fund managers having no forecasting ability but, still, cannot be considered inferior would earn as much as one could expect on the basis of the CAPM. Similar to Treynor measure, Jensen performance index does not evaluate the ability of fund managers to diversify, since the risk premiums are calculated in terms of fund beta or systematic risk.“Jensen's measure is similar to Treynor's measure; both focus only on non diversifiable risk by using beta. Jensen's measure is preferred because it automatically adjusts for market return through its use of the CAPM. This eliminates the need to compute a measure for the market; no further comparison is necessary. As with the other two measures, the higher the JM value, the better the portfolio is performing.” (Gitman and Joehnk)
The Appraisal ratio is another method for evaluating the funds performance by dividing the alpha of the portfolio by the non-systematic risk of the portfolio. It measures abnormal return per unit risk that in principle could be diversified away by holding a market index portfolio. This ratio is the natural benefit to cost ratio for a portfolio, represents the ratio between the expected abnormal return against the non-systematic risk voluntarily incurred. Funds with higher value according to this method are better performer as they have ability to make good profit and return in its given risk level.
Residual variance is another method, used to evaluate performance of mutual fund. Residual Variance is also called unexplained variance. In general, it is known as the variance of any residual. In particular, it is the variance 2 (y - Y) of the difference between any variate y and its regression function Y. Residual variance is calculated by deducting the result of square value of both fund's beta and market's standard deviation by square value of fund's standard deviation from 1. It tends to reduce as the number of shares held by the mutual fund increases. Therefore, the higher the Residual variance, the less diversified the mutual fund is and vice versa. This Residual variance is used to compare the levels of unsystematic risk in the portfolios of all mutual funds.
Market Timing and Stock selection ability of Funds
Market timing involves shifting funds between a market index portfolio and risk free asset, such as T-bill or money market fund, depending on whether the market as a whole is expected to outperform the safe asset. In practice, obviously, most fund managers do not shift fully between risk free assets and the market. Treynor and Mazuy (1966) developed an exclusive model to measure investment managers' market timing abilities.
RP- RF = a + b (rm- rf) + c (rm-rf) ²+ep
Here, RP is the portfolio return and a, b, and c are estimated by the regression analysis. If C turn out to be positive, having evidence of market ability, because this last term will make the characteristic line steeper as (rm-rf) is large. Treynor applied this for a number of mutual funds; however they found little evidence of timing ability”. (B Phaniswara Raju 2009)
Henriksson and Merton proposed a similar but simple methodology in 1981, to test the market timing and stock selection ability of fund managers. According to Henriksson and Merton, “beta of the portfolio takes only two values; a large value if the market is expected to do well and a small value otherwise. Under HM Model, the regression linear index model is
Rp - RF = a + b (rm- rf) + c (rm-rf) D+ep
Where D is a dummy variable t hat equals 1 if rm > rf and zero otherwise. Hence, the beta of the portfolio is b in a bear market and b + c in a bull market” (Henriksson, R.D., (1984).
“Treynor and Mazuy argued that the fund managers who times the market, is continuously changing their beta on the based on the magnitude of the (rm- rf) term. Where as, Henricksson- Merton model used a qualitative approach to market timing. HM Model assumed that market timers are required to predict whether rm > rf (up market) or rm < rf (down market)” (Susan and Joanne 2004). Therefore, a successful market timing fund manager is required to select a high up-market beta or a low down market beta. Here, Intercept term “a” indicate the stock selection ability of a fund.
Henricksson Merton model is simplified in to a regression model. It can be regressed ( rp - rf) with ( rm - rf) and a conditional value (Dummy) as is equals to 1 when ( rm - rf) =>0 and equals to 0 when ( rm - rf)<0. (Yasemin and Lawrence 1996)A good fund manager would be expected to have a positive stock selection coefficient (a), market risk (b) fairly close to 1 showing that it is well diversified and close to market portfolio and coefficient C is positive and significant (P value less than 5%), he is able to select and buy all the correct stocks well in advance to the market going on. The result of this simple regression can explain whether the fund manager have good market timing and stock selection ability or not. As per the above regression, stock selection ability of a fund is the intercept of that analysis. A good stock selection fund manager should have a positive intercept (a) with P value less than 5%. Similarly, the amount of market risk that fund manager have represented by the slope of the regression that is beta of that regression.
Hence, a good fund manager would be expected to have a positive stock selection coefficient (a) and market risk (b) fairly close to 1 and coefficient C should be positive, more importantly these values should be statistically relevant (p value is less than 5%) .
However, consistency of performance of mutual funds would be judge by a study rank on Sharpe ratio rating from year to year. Widely varying ranking on Sharpe ratio of mutual funds means that it does not support consistent performance in the market.
Empirical researches on performance evaluation of mutual funds are vast and wide area. As a quite unique financial product, mutual funds are the number one research area for the financial economists. Though Mutual fund was started in 1924 in Boston, its publicity and popularity to investors are spread in 1960s. The performance evaluation of mutual funds attracts the attention of academics and practitioners for decades. Introduction of Capital Asset Pricing Model (CAPM) accelerated the research for the mutual funds. Previous researches about both global and Indian mutual funds are separately explained in this chapter.
There are numerous researches and studies tested the aspects of the performance evaluation of mutual funds. Many studies examining aspects of performance evaluation of mutual fund, mostly in relation to broader market indices, have been published foundation with Sharpe (1966), Treynor and Mazuy (1966), and Jensen (1968). Latest researches, including those by Wermers (2000) and Arrington (2000), centre of attention on managerial characteristics and their relationship to fund performance.
“The unique and establish study on evaluation of the mutual fund performance was done by the Sharpe (1966). He developed a composite performance measure that taken in to account both risk and return of the fund. Using his measures for evaluation, he studied the performance of 34 open-ended mutual funds during the period 1944-63. He reached the conclusion that the typical performance of mutual fund was visibly lower to an investment in the DJIA” (Amitabh Gupta 2002). He was also mentioned in his study about the good performance, as it was associated with low expense ratio and only low relationship was discovered between fund size and performance.
Further study conducted by Treynor & Mazuy (1966), “they found no statistical evidence that fund manager of any 57 funds were not able to guess the market movements in advance. They recommend that an investor in mutual funds was absolutely based on fluctuations in the general market. This study revealed that the progression and improvement in rate of return was because of fund manager's ability to identify under priced shares in the market.”(Jain, P.K. 1982),
Jensen M C (1968) carried a study about the ability of fund manager's selecting undervalued securities. He reached the conclusion that the fund managers could not forecast security prices well enough to recover research expenses and fees the study of 115 mutual funds,.
Fama (1970) come out with a performance index for evaluating a mutual fund for managing portfolios. He mentioned “generally that the performance of managed portfolios could be classified into different parts. He disagreed that the observed return of a fund could be due to ability of fund managers to pick up the best securities at a given level of risk (their selectivity ability). Some share of this return could also arise due to the prediction of general market price movements (their timing ability)” (Timmermann 2004). He also mentioned that return on a portfolio could be subdivided into two components as the return for security selection and the return for bearing risk. A range of better section of both selectivity and risk were also discussed. “Fama developed a model which consisted concepts from modern theories of portfolio selection and capital market equilibrium with those of traditional concepts of what constitute good portfolio management”.(International Research Journal of Finance and Economics 2009)
In 1982 the performance and returns unpredictability of municipal bond funds tested by ‘Stock'. He concluded that bond maturity and risk premium determined by volatility in the market. Cornell, et al. (1991) made an attempt on the low-grade or junk bond funds financial performances.
Droms, et al. (1994) finally reached that benchmarks are performing better than US based international mutual funds. However, two years later, Droms, et al. evidenced that “the expense ratio of US domestic equity funds is seemed to be significantly related to fund performance, that means higher the expense ratio, the higher the return and vice versa” (Journal of banking & finance). But there is no explanation to prove that the results in Droms, et al. (1996) are due to survivorship bias.
Domian, et al. (1997) evaluate the performance of money market funds, however, Singh, et al (1997) analyse the performance of tax-free municipal bond funds. Detzel, et al. (1998) developed a return-generating model that directly relates returns to the characteristics of mutual funds to explain the persistence of returns over time. Dowen, et al. (2004) studied the returns of equity and fixed income funds including descriptive variables of portfolio turnover, expense ratio, tax cost ratio, and potential capital gains experience. They found that fund managers with lower costs produce higher returns, and also those fund managers with larger past returns have increased potential capital gains and more pressure than others.
H. Wolasmal (2001) tested 80 European mutual funds and used JP Morgan Global bond index as risk free rate. He tested these 80 funds with the performance measures like as Sharpe, Treynor and Jensen and ranked them to find top 20 performers from each measure. He found that there is no identity and none of the funds have a fully diversified portfolio as they have still some degree of unsystematic risk. From the top 20 performers, he noticed that each funds need to improve this area as they can get rid of this risk by the complete diversification.
Studies about Indian mutual fund
There are number of studies and researches are carried out to evaluate the performance of mutual funds in India. As Indian mutual fund industry is growing rapidly, it is very inevitable to investors regarding the fund manager's profit making ability. Some of the researches are discussed as follows.
A number of studies carried out in India, in order to find out the productivity of mutual funds. Indian mutual fund has a comparatively higher growth rate than other countries and it enables fund manager to make profit. Some of studies are carried out as below.
In 1982( Jain )studied about UTI, it was carried out for the periods of 1964-65 to 1979-80, it include profitability aspects of unit scheme 1964, Unit Scheme 1971 and Unit Scheme 1976 and findings was poor performances of UTI. Jain finds out that over the years there is no growth in profitability of UTI.
In 1991( Barua, et al ) studies of 7 years close- end equity mutual funds and master share in India. They find out that mutual funds perform well and it provides satisfaction to its investors.
In 1994 mutual funds in India, according to her (Vaid) view mutual fund is more famous if it pays high return to its investors and concluded that investment is more in fixed income securities rather than in equity.
In 1995 (Sarkar) studied about mutual funds on the basis of performance. It includes 5 close end growth funds during Feb 1991 to Aug 993. Sarkar finds out that performance of these funds is below expected line compare to risks.
In 1996 (Sahadevan and Raju), studied about the performance of mutual funds for the periods of 1992 to 1996. They conclude with their view that Indian mutual funds are playing well on the basis of their benchmark.
In 1998 (S. A. Dave), for the individual funds performance studies were carried out. Susan Thomas Mastershare and SGF for the duration of 1994-95 by using NAV and market price by using methodology performance of funds were carried out.
In 1998 (Vivek Kulkarni), In his article he mentions methodology for evaluating performance of mutual funds, and criterion for selection of benchmark, method of CRISIL's in calculating risks in evaluating portfolio performance and influence of fund management fees in a performance evaluation etc.
In 1996 (Jayadev) carried about a study of 62 mutual funds in India by using the NAV for the period between 1987 and 1999. The result was 30 out of 44 fund schemes (68%) were superior permors and 24 out of 44 fund schemes (55%) were out performing the benchmark portfolio. But four out those mutual funds was not diversified properly in India. But now the stock selection ability of fund managers are very good.
In 1998 (Julie Hudson), he evaluated performance and selecting a benchmark and it is very important in order to have progress of the mutual fund industry in India.
Chakrabarti, et al. (2000) studied and focuses on private sector equity funds to identify and evaluate the performance of mutual funds. This study was focussed the risk-return characteristics of selected most important equity-based private mutual funds companies. This study ended with the result that there is no one-to-one correspondence between performance by return and performance by risk-adjusted returns
In 2001 (Amitab Gupta) he carried out schemes, in order to evaluate BSE National Index to find out whether the schemes were able to beat the market. He examined whether the returns were matching with the risk undertaken by the fund managers.
In 2001 (Singh and Meera) evaluated the performance of mutual funds in the India. The study was critically reviewed the Performance of UTI, private and money market mutual funds.
In 2001 (M S Narasimhan), tested the 76 mutual fund schemes of around 25 fund houses by evaluating the performance of mutual funds in terms of this diversification and timing performance. He used two alternative methods to examine this issue. Firstly, the portfolio return and risk and correlation between the stocks in the portfolio of each scheme can be computed and compared with each other. Latter on methodology is to examine the correlation between the frequently appearing stocks in the portfolio. Was compared average returns, standard deviation and co-efficient of variation of these stocks, in all case he ended with the view that risk is always compared to returns. He found out that fund manager are able to invest in stocks that are expected to perform now as well as future.” These studies were carried out with the top 100 performers of the relevant period to find out fund performance.
In 2001 (Mishra), carried out performance of mutual funds during April 1992 to Dec 1996. He took 24 public sector mutual funds as example. He found out performance of mutual funds by following rate of return methodologies. The study also shows instability of bet. In last this study concludes that performance of public sector mutual fund in India having poor performance during 1992-96.
In 2002 (Ramesh Chander) most recently studied the performance of mutual funds in India according to Sharpe, Treynor and Jensen. With respect of portfolio management, portfolio evaluation and portfolio construction he examined the portfolio management practices of mutual fund mangers.
In 2002 (Biswadeep Mishra), studied about the non-stationary of mutual find betas and finds out the causes of non-stationary betas in order to find out skills of fund managers. As the model overcomes the limitations of traditionally utilized Jensen's measure, also find out beta instability and their selectively and timing skills. Some individual level some of the timing skills and some had no ability of timing. The studied by generalized varying parameter shows that systematic risk of Indian mutual funds did not remain stable over time.
In 2003 (Kshema Fernandes), study of implementation of index funds in India. It includes tracking error of index funds. Not only tracking errors but also consistency by index funds and he suggested that it s possible to have low levels of tracking error under Indian conditions.
In 2004) Sondhi tested the financial performance evaluation of equity oriented mutual funds on the basis of type, size and ownership of mutual funds by using the methodology as the absolute rate of return of each funds were compared with benchmarks (BSE100) and the return on 364 days T-bills used as a risk free asset and he used the risk adjusted performance measures such as Sharpe, Treynor, Jensen's Alpha and Fama.
Madumathi, et al. (2005) studied the performance of Indian mutual funds for 3 year period starting from May 2002 to May 2005. They evaluated 18 mutual funds in India is separated in to 3 divisions as public fund managers, Indian sponsored private funds and foreign managed private funds. The study compared their performance by using different traditional performance evaluation measures and to find out the extent of diversification of portfolios each funds. They used bunch mark as S&P CNX NIFTY and CRISIL Balanced Fund Index. Her hypothesis is that private funds outperform public funds because of its manager's dedication and efficiency.
D N Rao (2006) tried to evaluate the open-ended equity mutual fund schemes divided into six distinct investment styles, studied the financial performance of select open-ended equity mutual fund schemes for the period 2005-2006. The comparison of Growth plans and the corresponding Dividend plans Sharpe ratios showed that almost 90% Growth plans had better risk adjusted excess returns highlighting the fact that Growth plans are likely to reward the investors more for the extra risk they are assuming.The analysis indicated that Growth plans have generated higher returns than that of Dividend plans but at a higher risk.
“Sanjay seghal, et al. (2008) carried out an investigation of 59 mutual funds in India for the period January 2004 to December 2007. The result was the performance of short term persistence in equity mutual funds are does not necessarily imply the well stock selection ability of fund manager. It also resulted the short term persistence results are much better when we using the daily data than monthly data. Their findings were only consistent with those for the mature market, thus he found that there is no evidence that supports is in conformity with the efficient market hypothesis.”
III. MUTUAL FUNDS
Processes of Mutual Fund:
In the diagram we can see that investors pool their money into a Mutual fund where the Fund Managers invest those money in securities both equity and debt as per the objective of the fund. The return out of that fund is then passed to the investors.
What are the factors Encourage and Discourage Mutual fund Owners
The attracting factors of mutual fund ownership are numerous. The most significant desirability is its diversification in their portfolio. It benefits fund holders by spreading out holdings over a wide variety of industries and companies, thus reducing risk. Another attraction of mutual funds is well established and organised professional management, which ease investors of many day to day management and record keeping responsibilities. What's more, the fund is probably able to offer better investment expertise than individual investors can provide. Still another advantage is that most mutual fund investments can be started with a humble capital outlay. Sometimes, there is no minimum investments are required, and after the initial investment, additional shares can usually be purchased in small amounts.
The services that mutual funds offer also make them appealing to many investors: these include automatic reinvestment of dividends, withdrawal plans and exchange privileges. Finally, mutual funds offer convenience. They are relatively easy to acquire; the funds handle the paperwork and record keeping; their prices are widely quoted; and it is possible to deal in fractional shares. Another advantage is a direct investor bears all the costs of investing such as brokerage or custody of securities. When going through a fund, he has the benefit of economies of scale: the funds pay lesser costs because of larger volumes.
There are some negative points to mutual fund ownership. One of the biggest disadvantages is that mutual funds in general can be costly and involve substantial transaction costs. Many funds carry sizable commission fees (load charge). In addition, a management fee is levied annually for the professional services provided. It deducted right off the top, regardless of whether the fund has had a good or bad year. And, even in spite of all the professional management and advice, it seems that mutual fund performance over the long haul is at best about equal to what you would expect from the market as a whole. There are some notable exceptions, of course, but most funds do little more than keep up with the market. However, there were some initial charges levied by the commission agents are removed by the AMFI on 1st January 2008 in India.
Investors who invest their own can build their own portfolio of shares, bonds and other securities. In case of mutual funds, it is hard to get tailor made portfolio. In an advanced mutual fund industry especially in India, the vast and wide options of mutual funds and enormous number of schemes provided by each funds and are become a great dilemma for the investors to select a good fund from them. Moreover, the mutual funds are basically tended for the small investors; however, it's hard to enter in to the mutual fund investment for the small investors
Characteristics of mutual fund:
An open-ended mutual fund
The term mutual fund is commonly used to describe as an open-ended investment company. Investors buy their shares in open ended fund and sell them back to, the mutual fund itself. When an investor buys shares in an open ended fund, the fund issues new shares of stocks and fills the purchase order with those new shares. There is no boundary or limit other than the investors demand to the number of shares the fund can issue. All open ended mutual funds stand behind their shares and buy them back when investors choose to sell. Both buy and sell transactions in these open ended funds are agreed at a price based on the current market value of all the securities held in the fund's portfolio. Technically, this value is known as Net Asset Value (NAV), is calculated by dividing the total market value of all asset held fund held less any liability by the number of fund shares outstanding. This current market value is calculated at least once in a day.
A closed-ended mutual fund
A mutual fund that has fixed duration opens for subscription only during a specified period, and closes after the initial offering. Close ended investment companies operate with a fixed number of shares outstanding and do not regularly issue new shares of stock. Take in to account all the above factors, this study is all about the open ended funds rather this close ended as it may represent the characteristics of mutual funds very clearly and precisely.
Types of Mutual Fund:
Every Mutual fund has a particular investment objective, and each fund is expected to do its best to confirm to its stated investment policy and objectives. Subdividing funds according to their investment policies and objectives is a common practice in the mutual fund industry. The categories are similarities in how the funds manage their money and their risk and risk characteristics. Various types of mutual funds are as follows.
* Growth funds: The objective of this fund is capital appreciation. Primary goals of this fund are long term growth and capital gain. These funds invest mostly in well established, large or mid-cap companies that have above-average growth potential.
* Aggressive Growth funds: This fund is also called performance fund that tend to increase in popularity when market. These funds are highly speculative investment vehicles that seek large profit from capital gains.
* Value Funds: This fund confines their investing to stocks considered to be undervalued by the market. That is, the funds look for the stocks that are fundamentally sound but they have yet to be discovered. These funds hold stocks as much for their underlying intrinsic value as for their growth potential.
* Equity-Income Funds: These funds emphasise current income by investing primarily in high-yielding common stocks. Its primary emphasise is on dividend and current income, these funds tend to hold higher security that are less price volatility than the market as a whole.
* Balanced Funds: These funds tend to hold a balanced portfolio of both stocks and bonds for the purpose of generating a well balanced return of both current income and long term capital gain. These funds are relatively safer form of investing which can earn a competitive rate of return without price volatility.
* Growth and Income Funds: These funds are also seek a balanced return made up of both current income and long term capital gains, but they place a greater emphasis on growth of capital. This is suitable for investors who can tolerate the risk and price volatility.
* Bond Funds: As the name implies, these funds are invest exclusively in various types and grades of bonds. Its primary aim is income although capital appreciations are not ignored completely. These funds are generally more liquid than direct investment in bonds.
* Money Market Funds: The first money market was set up in November 1972. It was a new idea that applied to the mutual fund concept to buying and selling of short term money market instruments- bank certificates of deposit, U.S. Treasury bills, and the like.
* Index Funds: This fund is a type of mutual fund that buys and holds a portfolio of stocks equivalent to those in a market index like the BSE SENSEX. These funds are sought to match the performance of the index market. And the approach of index fund is strictly buy and hold.
* Sector Funds: This is one of the hottest products on Wall Street that restricts its investments to a particular sector or segment of the market. These are concentrating their investment holdings in one or more industries that make up the sector being aimed at.
* Socially Responsible Funds: These are actively and directly incorporate ethics and morality into the investment decisions. Fund manager's decisions revolve around both morality and profitability.
* Asset Allocation Funds: These funds spread investor's money across different types of markets. However, most funds concentrate on one type of investment whether stocks, bonds or money market securities to put all money into all these market.
* International Funds: This is type of mutual fund does all or most of its investing in foreign securities. These funds have widely diversified and they are investing exclusively in foreign securities.
(Source: Fundamentals of Investing, Gitman &Joehnic)
(Amitabh Gupta 2002)
Mutual fund industry in India
Mutual fund has been a part of the investment landscape for over 75 years. The first mutual fund (MFS) was started in Boston in 1924 and is in business today. The mutual fund industry has grown so much, in fact, that it is now one of the largest financial intermediaries of this world. The starting point of Mutual Fund industry in India is with the introduction of the concept of Mutual Fund by UTI in the year 1964 by the government of India. Unit Trust of India (UTI) was established on 1963 by an Act of Parliament. It was set up by the Reserve Bank of India and functioned under the Regulatory and administrative control of the Reserve Bank of India. In 1978 UTI was de-linked from the RBI and the Industrial Development Bank of India (IDBI) took over the regulatory and administrative control in place of RBI. The first scheme launched by UTI was Unit Scheme 1964. In the past decades, Indian mutual fund industry had seen a dramatic improvement, both qualities wise as well as quantity wise. During the last 45 years, UTI has developed to be a key player in the mutual fund industry. Indian capital market has witnessed unprecedented developments and innovations particularly during the decades of 80s and 90s. These innovations, inter-alia, relate to new financial instruments such as mutual funds and variety of financial services like merchant banking etc. In changed environment the mutual funds are playing a vital role in financial intermediation, development of capital markets and the growth of corporate sector (Amitabh Gupta 2002). At the end of 1980s, public sector banks and Insurance companies (Life Insurance Company and General Insurance Company) were permitted to launch Mutual funds in the market. Though the growth was slow, but it accelerated from the year 1987 when non-UTI players entered the Industry. In 1993, Security and Exchange Board of India (SEBI), regulatory body for the Indian Capital and money market were amended some regulatory frame woks within the mutual fund industry and allowed private fund managers to issue mutual fund scheme in India. As of April 2007, the industry comprising 39 asset management companies offering 1543 mutual fund schemes, owning financial assets of Rs.4000 billions (equivalent of £45 billions) as per the information of AMFI. The asset capacity has grown for last 4 decades and the impressive growth was happened by this industry because of the entrant of private players and commercial banks for last couple of years.
IV. Research Methodology
“A research methodology is the activity that how research is, how data are producing, how to measure the progress of it and what constitutes success. It is important that for data to be credible, convincing or realistic and it must be timely, reliable, relevant, accurate and specific. Use this methodology, here trying to evaluate the performance of mutual funds in India. This is the chapter that explains the methods used in this study, giving extraordinary significance to the analysis of data. Here I am explains about the style of research used, source of data, Objectives of the study, hypothesis of study and its limitations.”
Styles of Research:
There are mainly two styles of Research are used for the business oriented topics. They are Positivism and Phenomenology. Positivism is a philosophical system developed by Auguste Comte. “This system mainly consider about the knowledge rather than questioning. This system recognises only positive facts and observable events like those things that can be measured, seen and be assumed as facts. This system compares the traditional views with the scientific views of the world. In fact, he illustrated his ideas from the scientific world view and applied to them to the sociological world of thought. This style of study is not taking the beliefs and feeling of the researchers and taking large number of samples.” “www.londonexternal.ac.uk”
Another style of research is named as Phenomenology, begun by Edmund Husserl in the 1890s. This is entirely different way of viewing the world in comparison to Positivism style of research. “Phenomenology is the qualitative method that endeavour to participant's perspectives and visions of social realities and therefore investigating small number of samples for a long period or in-depth. Researchers using Phenomenology are concerned with what things mean, rather than with identifying and measuring phenomena” (D Moran 2000).These researchers are predominantly interested in the central idea that human experience and expertise is a valuable source of data, as opposed to the idea that true research or discovery lies in simply measuring the existence of physical phenomena.
In this important time, considering the factors describing to this study, I prefer Positivist style of research. This is relating to the mutual fund industry in India by reviewing the performance evaluation methods of mutual funds and here only takes the facts and s published by each fund managers in their websites. Like positive style of research, this study will take only the quantitative or measurable data and ignoring the qualitative data.The study is trying to evaluate the performance of fund managers in India by using various evaluation techniques.
Sampling is very important in here like any study, because of limited period of time and insufficient data. This study is relates to the mutual funds in India, this is really difficult to study the characteristics of all mutual fund in India. There are more than 1500 fund schemes on market in India. Therefore, I have to select the sample from this schemes to represents the whole population without much bias. So I like to prefer the cluster sampling to select randomly some fund schemes to represent the total characteristics of whole population.
“Cluster sampling means that it is dividing whole population into discrete groups prior to sampling. The groups are termed as Clusters in this form of sampling and can be based on any naturally occurring grouping. For example, it can group data by type of manufacturing firm or geographical area. For cluster sampling, sampling frame is the complete list of clusters rather than a complete list of individual cases within a population. Then we need to select a few clusters, normally using simple random sampling. Data are then collected from every case within the selected clusters.”(Risto Lehtonen 2004)
Here the study trying to follow cluster sampling design in its methodology, because of limited time availability, here I consider only 10 sample mutual fund schemes. So this study considering only income fund schemes with growth option. These fund schemes are emphasise the objectives of investing its income in high-yielding mutual funds to earn mainly current income and in capital appreciation. The fund schemes invest in highly grade common stocks, some convertible securities and preferred stocks. Hence, cluster for this study is growth option within the income fund scheme and used to represent the characteristic of all mutual fund performance. I selected this cluster (growth option in income fund scheme) as it is most potential and prospective scheme.
Hypothesis of this study
This study divides the mutual funds on the basis of sponsors into two categories as public sector managed Indian mutual funds and private sector managed Indian mutual funds. Mutual funds could be defined in terms of its Net Asset Value (NAV), used to represents the current market value a share of stocks in a particular. This NAV's are in crores of Indian Rupees.
As far as I am concerned, private sector sponsored mutual funds would outperform in India. The forces behind this idea are they are more committed, responsible, well trained professionals and they can exploit and diversify their global persistence than public sector sponsored funds. It is understood that private sector fund managers are more educated and expert in the field of investment and they are making more income by invest in the wide and vast global finance markets. Last but not least, it is clear that public sector management is more corrupted. These factors are forced me to assume that private managed funds would outperform in Indian mutual fund industry. I choose SBI Mutual Fund as far as considering an individual fund, as it is one of the leading mutual funds in the country with a massive investor support. SBI mutual fund originated from State Bank of India and SGAM (Societe Generale Asset Management), France. More over, SBI mutual fund has very wealthy knowledge in the ground of fund management, and they produce its expertise in constantly delivering and given that worth to its investors.
At the end of this study, it delivers the results used to test the hypothesis mentioned above. So, by finding the average performance of both public sector and private sector managed funds help to test the first hypothesis that the private managed funds outperform Indian managed funds. By ranking performance of every sample funds help to solve the second hypothesis related to an individual fund.
Objectives of this study
Identify and assess the performance of both private sector managed and public sector managed funds based on the composite performance indices.
Find out the best performing mutual fund from sample based on various performance measures.
Ranking the performance of each fund.
“To assess and evaluate the performance of the selected funds, there are number of data used. This is the section that clearly explains about the methodology and performance measures which are used to solve the questions of this study. This work uses the monthly close values of BSE and the NAV of 10 selected mutual funds for the period starting from 1st September 2006 to 31st July 2009. Different measures for methodologies are explained as follows.“
“By using the monthly close values of market index and the selected funds, can find out the return for the market index and mutual funds for the particular periods. This is the logarithmic mean monthly return of both market and the selected funds and used through out the studies for applying in various performance measures.” This can be calculated by using the following formula:
RM (BSE) = LN [Close value of sensex (t) /Close value of sensex (t-1)]
RP (Selected funds) = LN [Close value of NAV (t)/ close value of NAV (t-1)]
Risk Free Rate (RF):
“By the term it self explaining that these assets are risk less as there is no variability of return. In this study I am using 364 days Treasury Bills for the respective period as risk free asset has it does not carry any risk at all and ensure a fixed rate of return for holding these assets.It is carried out from the official site of reserve bank of India (http://www.rbi.org.in).”
Risk (Standard Deviation):
“Standard deviation (σ) is the term which measures the total risk for a particular index or portfolio. This can be calculated from the logarithmic monthly return as discussed above. By applying the standard deviation formula in excel sheet, can easily calculate the standard deviation.”
“Beta (β) is also known as systematic risk or non-diversifiable risk, used to represents the individual risks for the funds. Higher the beta indicates the high sensitivity of fund return to market return and vice versa. And here the betas are obtained from various company websites.”
“α is the term alpha is representing a manager's abnormal rate of return, which is the difference between the return the portfolio actually produced and the expected return given its risk level. A positive alpha indicates manager's ability to diversify their portfolio properly and vice versa.”
By using the above facts like returns, standard deviation, beta, alpha,risk free rate etc, I can apply these into various performance evaluation measures to assess and evaluate the selected fund schemes.
1. Sharpe measure: (RP- RF)/ σP
2. Treynor measure: ( RP-RF) /βp
3. Jensen Alpha: RP- [RF- (RM-RF) βp
Appraisal ratio: α / σP
Source of Data
“The Net Asset Value (NAV) for the period 1st September 2006 to 31st July 2009 of selected mutual funds is taken from the websites of individual mutual fund. These values are matched with the website of Mutual funds India and Association of Mutual Fund of India (AMFI) for the integrity and reliability. The following websites are used as follows.”
1. http://www.amfiindia.com 2. http://www.mutualfundsindia.com
“The market index is used by funds to benchmark their fund performance. In this study, I am taking S & P CNX NIFTY as it is Indian national stock market representing the characteristics of total Indian financial market. This market index to use to compare and regressed its close value with the NAV's of above selected mutual funds. And these values are taken from the website of Bombay stock exchange (http://www.bseindia.com/) matched with the website of Yahoo Finance to increase the integrity.”
“Risk free rate in the market is used in various methods to assess the performance of selected funds. In this particular study, I am using 364 days Treasury Bills as risk free asset. Because, this Treasury bill does not carry any risk at all as the Government of India ensures the repayments and carry fixed rate of return after 1 year issued by Reserve Bank of India.”
Selected funds for the study
Birla Sun Life Income Fund-Plan Growth
ICICI Prudential Income Plan Growth Option
Kotak Income plus Growth
Sahara Income Fund Growth
Tata Income Fund - Growth
Canara Robako Income Growth
HDFC Floating Rate Income Fund Long Term Plan Growth plan
HSBC Income Fund Investment Regular Growth
LIC Monthly Income Plan Growth Option
SBI Magnum Income Fund Growth
V. Analysis, Findings and Discussions
“This chapter clearly explains about the actual analysis and test results that occurred from this analysis. Comparison study between Indian and foreign managed funds are the main issue in this study. However, I have to verify my hypothesis I mentioned earlier. By using relevant fund performance evaluation criteria or methodologies such as NAV, Sharpe measure, Treynor measure, Jensen Alpha, Appraisal ratio and Residual Variance. Later I have to verify and test the stock selection and market timing ability of fund managers. The results for the selected fund data for the respective periods are showing in this section as follows.”
Results of various methods
Average return for 3 year for 10 funds