Performance of the Mutual Funds Industry in India Literature Review1.
Introductionto the Subject A mutual fund, according to the Economic Times,is a professionally-managed investment scheme, usually run by an assetmanagement company that brings together a group of people and invests theirmoney in stocks, bonds and other securities. It has various benefits as well asdrawbacks as compared to the conventional method of direct investment inindividual securities. On one hand, an investment in mutual funds providesreturns on a certain scale, has higher levels of diversification, providesliquidity to the investor, and is managed by professional investors, whoconstantly study and analyse the investment market for optimum results; on theother, mutual funds are accompanied with economic risks, determined by theever-fluctuating market, as well as the various expenses and fees attached withthe managers of the investor’s funds.
Mutualfunds have remained a lucrative front for investments since their inceptionduring the financial crisis of 1772-73, by Abraham van Ketwich. Present in theinvestment markets of the United States from 1890s, mutual funds were formallyregulated after the Wall Street Crash of 1829 by the US Congress. The currentmarket has since grown to a global estimate of $ 40.4 trillion at the end of2016, according to the Investment Company Institute. Mutualfunds emerged in 1963 in India, with the establishment of the Unit Trust ofIndia (UTI), an initiative undertaken by the Government of India alongside theReserve Bank of India. SBI Mutual Fund, by the State Bank of India, was thefirst non-UTI mutual fund to be introduced in the subcontinent. The Securitiesand Exchange Board of India (SEBI) Act, passed in 1992, permitted the entry ofprivate companies into the investment market.
The current Indian market valuesat $ 2.2 trillion, according to the Association of Mutual Funds in India. 2. Introductionto the ResearchA researcher should have preliminary orientationand background knowledge about the subject under discussion, and should collectthe basic concepts and information regarding the same.
Due to these reasons thereview of the literature has an important role in research study. Consideringthe importance of mutual funds, several academicians have tried to study theperformance of various funds. Initially, their studies have focused on timingand investment abilities of fund managers. Later, several researchers havetried to study the various factors and their impact on fund performance. Thesefactors include potential measurement errors from survivorship bias andmisspecification of the benchmark, the impact of fund expenses and economies ofscale, to the personal characteristics of fund managers.
Various studies thatfocused on factors such as the ability of fund managers to consistentlyoutperform the market and the fund specific organizational and managerial aspectscame out with contradictory conclusions. 2.1. Mutual Fund Performance and the Effects on the MarketMichael C.
Jensen’s “The Performance of MutualFunds in the Period 1945-64” (1968) analysed the mutual fund performance of 115funds over a period spanning from 1945 to 1964, confirmed the efficient markethypothesis. His analysis has shown that the performance of expense-adjustedfund returns was markedly lower than those randomly chosen portfolios of asimilar risk category. These results were in sync with the findings of Jack L.Treynor and William F.
Sharpe, in the Capital Asset Pricing Model (CAPM), amodel used to determine the theoretically-appropriate required rate of returnof an asset. Sharpe also looked at the performance of open-end mutual funds andfound that to a major extent the capital market is highly efficient, but thereis some evidence of persistence in performance. Performance of professionallymanaged funds also was not any better than the performance of risk-adjusted indexportfolio, which also indicated that managers of these funds did not appear topossess private information.
Thus, the results of the early studies prevailedas general conclusions in the erstwhile literature. However, anumber of later studies on the subject, nonetheless, went against the earlyfindings. For instance, a study by Richard A.
Ippolito, in The QuarterlyJournal of Economics (1989), found mutual fund returns after expenses(before loads) to be superior than the returns offered by risk-adjusted marketindices, which indicated that mutual fund managers may have access to theuseful private information. He concluded that risk-adjusted returns in themutual fund industry, net of fees and expenses, are comparable to returnsavailable in index funds. Thus, themutual fund managers may produce such excess returns that can offset theexpenses of the fund. Furtherstudies by Grinblatt and Titman (1992), Hendricks, Patel and Zeckhauser (1993),Goetzn-iann and Ibbotson (1994), and Voikman and Wohar (1995), were in supportof market efficiency as they discovered instances of repeated winners amongstfund managers. Recently, Russ Wermers’s “Mutual fund performance: An empiricaldecomposition into stock-picking talent, style, transactions costs, and expenses”(2000) decomposed mutual fund returns into a stock picking talent; features ofstockholding and trading costs and expenses. The decomposition helped Wermershow that stock picking of funds, in fact, enabled the managers to cover theircosts.
Other studies by Elton, Gruber. Das and Hlavka(1993), Malkiel (1995) and Carhart (1997) reinforced the early conclusion ofJensen (1968). While doing away with survivorship bias, Mark M. Carhart, in his”On persistence in mutual fund performance” (1997), has shown that the commonfactors that drive stock returns are responsible for consistency in mutual fundperformance. On theother hand Burton Malkiel’s studies consider both benchmark errors andsurvivorship bias, and conclude that the previous results indicating marketinefficiency were affected by these factors. 2.2. Performance Measurement and Global ReturnsPerformance Measurement plays an important rolefor investors when deciding to invest in mutual funds.
Since Harry Markowitz’sstudy on Portfolio Selection, in The Journal of Finance (1952), severalindicators have been developed to assess fund performance. Traditionalindicators are accompanied by the measures that evaluate conditions such asasset allocation and performance persistence. The rising number of indicatorsmight lead to a more confused performance evaluation as the use of theinnumerable indicators can lead to wavering results and varying fund rankings.Hery Razafitombo, in “A Statistical Analysis ofMutual Fund Performance Measures: The Relevance of IR, Betas and Sharpe Ratios”(2011), noted that there was ample academic literature on performancemeasurement, though few studies contrasted between the various measures.
In the study, the author chose 15 performance measures:Jensen’s ‘alpha’, ‘beta’, ‘bull-beta’, ‘bear-beta’, ‘absolute performance’,’relative performance’, ‘number of negative periods’, ‘number of positiveperiods’, ‘standard deviation’, ‘maximum drawdown’, ‘tracking error’,’information ratio’, ‘Sharpe ratio’, ‘Treynor ratio’ and ‘Sortino ratio’; and,tried to recognize which ones were the most relevant ones for evaluating mutualfunds. Using a sample of 210 equity mutual funds from the Reuters-Lipperdatabase, he examined their statistical properties, over the phase from 2000 to2006, and noted that his investigations were clearly comprehensive, associatedto other studies, as he conducted the three-step tests.These results showed that correlations betweenthe various measures are changing over time and are rather weak. From this, aninference could be made that all these performance indicators are worthconsidering as they bring complementary information to the investors. Amongstthe performance measurement indicators considered in this study, the ‘performanceanalysis’, i.
e., the market exposure, the relative performance, and themanager’s skilfulness and quality of tracking, especially highlights thesignificance of ‘information ratios’, ‘betas’ and ‘Sharpe ratios’ to evaluatethese three dimensions. Above all, the main conclusion of the author was that’performance analysis’ should be usefully performed with a multi-criteriaapproach integrating all its various aspects, i.e., including calculations overdifferent time periods (short term, medium term and long term), and includingthe three dimensions of performance evaluation (relative performance, betaexposure and manager skill).The results found in the literature werecontroversial: certain studies found no convergence amid funds’ rankings obtainedwith numerous measures (Plantinga and De Groot, (2001)); others reached unlikelyconclusions, such as convergence amongst a group of measures, nonetheless withthe Sharpe ratio, which measures the relationship between the risk premium andthe standard deviation of the returns generated by a fund, standing apart(Hwang and Salmon (2002)).
A. Plantinga and S. De Groot, in their “Risk-AdjustedPerformance Measures and Implied Risk-Attitudes” (2001), examine to what extentperformance measures can be used as alternatives for preference functions. Thestudy consisted of ‘Sharpe ratio, ‘Sharpe’s alpha’, ‘the expected returnmeasure’, ‘the Fouse index’, ‘the Sortino ratio’ and ‘the upside potentialratio’. It was found that the first three measures corresponded to theinclinations of investors with a low degree of risk aversion, while the latterthree measures matched the preferences of investors with medium and higherdegrees of risk aversion. Therefore, the choice of the suitable performancemeasure should be determined by the preference function of the investor.C.S.
Pedersen and T. Rudholm-Alfvin, in “Selectinga risk-adjusted shareholder performance measure” (2003), and Martin Eling andFrank Schuhmacher, in “Does the choice of performance measure influence theevaluation of hedge funds?” (2007), also accomplished the convergence betweenthe ranks produced by numerous measures, and recognize the Sharpe ratio asexhibiting dominance to establish the ranking. The choice of a ‘performance measure’ may alsobe justified by other considerations.
A frequently used justification of aperformance measure is its ability to identify the investment skills ofportfolio managers. An interesting contribution to this discussion is byKothari and Warner (2001), which focused on the capability of numerousrisk-adjusted performance measures, such as the ‘Sharpe ratio’ and the ‘Jensen’salpha’, to identify investment skills, and concluded that the performancemeasures have important difficulties in detecting investment skills.Redman, Gullett and Manakyan, in “Theperformance of global and international mutual fund” (2000), evaluated therisk-adjusted returns using ‘Treynor ratio’, ‘Sharpe ratio’, and ‘Jensen’s alpha’,for 5 portfolios of global mutual funds and for three time periods of nine andfour years (1985-1994, 1985-1989, and 1990-1994), with the benchmark of theVanguard Index 500. During the first and second time frame, the portfoliosperformed better than the U.S. markets; however, during the third time frame,the earnings fell below the U.S.
index.A study by Noulas and John (2005) surveyed theperformance of 23 Greek equity funds amid the years 1997-2000 on a weeklybasis. The performance was evaluated and ranked using the ratios of Treynor,Sharpe and Jensen. The results showed that the beta of all funds was less thanone for four-year period establishing that the equity funds had neither likerisks nor the same return.
On a global front, “Empirical Analysis ofInternational Mutual Fund performance”, a study by Suzanne and Boudreaux (2007),analysed ten sample portfolios of global mutual funds and examined the returnsby using ‘Sharpe’s ratio’ for the time frame of 2000-2006. Nine out of ten ofthe sample mutual funds under study performed better than the benchmarked U.S.
market. The portfolios which comprised of all global mutual funds did betterthan the portfolio which had only U.S. stock mutual funds. 2.3. Performance Measurement and the Indian PerspectivesUsing the ‘Modigliani and Modigliani (m-squared)’performance measure, Onur Arugaslan and Ajay Samant evaluated 50 extensive U.S.
global equity funds a ten-year period of 1994-2003, in their study “Evaluatinglarge US?based equity mutual funds using risk?adjusted performance measures” (2008). Theresults showed that risk effected the attractiveness of the fund as even thoughthe funds had greater returns funds, they did lose attractiveness amongst theinvestors due to superior risk whereas the lesser return funds were attractivedue to the minority of the risk.Sathya Swaroop Debashish measured theperformance of equity based mutual funds in India, in his study “InvestigatingPerformance of Equity-based Mutual Fund Schemes in Indian Scenario”, publishedin the KCA Journal of Business Management (2009).
He perused 23 schemesover a period of 13 years, from April 1996 to March 2009, using various riskadjusted measures. The results show that ‘UTI’, ‘Franklin Templeton’, ‘PrudentialICICI’ (in the private sector) and ‘SBI’, have all out-performed the market portfoliowith positive values, while the ‘Birla Sunlife’, ‘HDFC’ and ‘LIC’ mutual fundsshowed a poor below-average performance, when amounted against the risk-returnrelationship models and measures. “Performance analysis of Indian mutual fundswith a special reference to sector funds” (2011), a study by B. Ramesh and P.S.S.Dhume, analysed the performance of sector funds which were located within thedomains of banking, infrastructure, ‘FMCG’, technology and pharmaceuticals. Thestudy focused on different performance measures, the findings of whichdiscovered that, except the infrastructure sector funds, all the other fundshad outpaced the market.
R. Anitha (2011) assessed the performance ofprivate and public sector mutual funds for a period of two years (2005-2007),along with C. Radhapriya and T.
Devasenathipathi. Selected funds were studiedusing statistical measures like ‘mean’, ‘variance’, ‘co-variance’ and ‘standarddeviation’. The performance of all the selected funds has exhibited volatilityduring period of study, leading to the difficult situation of assigning oneparticular fund that would outperform the others consistently. M.K. Patel and K.
P.Prajapati (2012) estimated the performance of mutual funds in India using’relative performance indices’, ‘Treynor’s and Sharpe’s ratios’, ‘risk-returnanalysis’, ‘Jensen’s measure’, and ‘Fama’s measure’, and concluded that most ofthe mutual funds had given positive returns during the period of study. Jain(2012) investigated the performance of equity mutual funds in India using’CAPM’. The results show that, in the long run, the performance of privatesector companies’ MFs have been far better than the public sector ones. Out ofthe pool of sample companies, HDFC and ICICI were the best performers whereasLIC did not perform well. Thus, the overall analysis discovered that the privatesector mutual fund schemes were less risky but more rewarding when compared tothe public sector ones. M.S.
Annapoorna and P.K. Gupta (2013) assessed themutual fund schemes performances which had been ranked ‘1’ by CRISIL andcompare these returns with SBI’s domestic term deposit rates. For the purposesof calculation, simple statistical methods of ‘averages’ and ‘rate of returns’were used.
The results obtained clearly depicted that, in most cases, the mutualfund schemes have been unsuccessful in providing benefits akin to the SBIdomestic term deposits.Dr.R.
Karrupasamy and V. Vanaja (2013) studiedand evaluated the performance of large-cap, mid-cap and small-cap equity mutualfunds on a risk-adjusted basis, using ‘Sharpe’s’, ‘Jensen’s’ and ‘Treynor’s’measures, for a period of three years. The findings suggested that most of the selectedschemes had outperformed the category average as well as the benchmark indices.
They also proposed that investors looking for an investment below 2 years couldgo for large-cap schemes, whereas those having investment beyond 3 years shouldinvest in small and mid-cap schemes.A.C. Bhavsar, Akshay Damani and Anvesha (2014)contributed by giving a comparative exploration of the performance of selectprivate and public sector mutual funds, in their study “A Comparative Study ofthe Performance of Selected Mutual Fund Growth Schemes from the Private Sectorand Public Sector Schemes in India”, concluding that mutual funds with publicsector holdings had been greater performers when compared to their privatesector complements.
Also, with ‘Jensen’s alpha’, private sector funds had beenranked better, but a higher rank was given to public sector funds under the ‘Treynor’and ‘Sharpe’ ratios. Kavita Arora (2015) studied the risk- adjusted performanceof 100 mutual funds from the period April 1, 2000 to March 31, 2008, where theresults for overall performance was mixed: ‘Sharpe’s ratios’ of 52 mutual fundschemes were better than that their benchmark indices; and, ‘Treynor ratios’ of70 per cent of mutual fund schemes were higher than their respective indices.Thus, almost half of the mutual funds have performed better than their indices,in a broader perspective. References:· https://timesofindia.indiatimes.com/articles/Different-Types-and-Kinds-of-Mutual-Funds/articleshowhsbc/22624820.cms· https://www.amfiindia.com/research-information/aum-data/average-aum· http://www.amfiindia.com/research-information/mf-history· https://papers.ssrn.com/sol3/papers.cfm?abstract_id=636146· http://www.icifactbook.org/· https://economictimes.indiatimes.com/definition/mutual-fund· http://finance.martinsewell.com/fund-performance/fund-performance.pdf