PERSISTENCE IN MUTUAL FUND PERFORMANCE-EVIDENCE FROM INDIA

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1 International Journal of Business Management & Research (IJBMR) ISSN Vol. 3, Issue 3, Aug 2013, TJPRC Pvt. Ltd. PERSISTENCE IN MUTUAL FUND PERFORMANCE-EVIDENCE FROM INDIA HANISH RAJPAL Institute of Management Technology, Nagpur, Maharashtra, India ABSTRACT Mutual fund performance has been a subject of interest for researchers as well as practitioners for long. The objective of this paper is to study the persistence in performance of equity-oriented mutual funds in India over the period This study utilizes a sample of 103 equity-oriented mutual funds with growth objective for this purpose. The broad based S&P CNX Nifty and 91-day Treasury bill yields are taken as proxy for market returns and risk free rate respectively. Weekly, monthly, and quarterly measures of Jensen s alpha are computed to estimate the performance of mutual funds. By applying parametric as well as non-parametric approach, the persistence in performance (Jensen s alpha) is tested. The results do not provide any significant evidence of persistence in performance of mutual funds over time. KEYWORDS: Mutual Fund Performance, Persistence, Jensen s Alpha, Contingency Tables INTRODUCTION Persistence in mutual fund returns has been a keen area of interest for researchers, market participants, and investors particularly in last two decades. A large amount of research has been conducted on the questions such as whether mutual funds exhibit a persistent performance over time, factors that contribute to the persistent performance and the ability of prior results to forecast future returns. However, research on this area in Indian context has been very limited, possibly owing to the fact that mutual fund market developed in India only in the last two decades. The objective of this paper is to examine the phenomenon of persistence in performance of equity mutual funds in India. The study takes a sample of 103 active equity oriented mutual funds in India and employs both parametric and nonparametric techniques to assess the characteristic of persistence. The results do not provide any evidence to suggest that performance of equity mutual funds in India is persistent. The study has implications for investors, particularly retail investors, whose investment in mutual funds are generally based on past performance. The rest of the paper is organized as follows. Section II reviews the related literature. Section III provides the sample data description and research methodology. Section IV discusses the results and section V concludes the paper. REVIEW OF LITERATURE Investors very often rely on the past performance of mutual fund while selecting the fund to invest. On the other hand, mutual funds use large amount of advertisement space to boast about their past performance. Although many funds would give the disclaimer that returns in mutual funds are subject to market risk and that past performance is no guarantee of future performance, the prior performance remains a significant factor for investors and mutual funds. Many researchers find that the most significant determinants of money flows into mutual funds are the prior period returns (see Cahart, 1997; Gruber, 1996 and Lakonishok et al., 1992). Jain and Wu (2000) found a direct relationship between advertisement activity and fund flow.

2 130 Hanish Rajpal Brown and Goetzmann (1995) also concluded that historical information can be used to beat the market. Jagdeesh and Titman (1993) contended that investors can earn abnormal return by selling recent losers and buying recent winners. Using data envelopment analysis, Soongswang and Sanohdontree (2011) analysed 138 open-ended equity mutual funds in Thailand over the period Their results suggest that on average the performance of Thai open-ended equity mutual funds is significantly higher than that of market in all time periods of examined. However, researchers also find that past performance does not indicate future performance of mutual funds. Benos and Jochec (2010) examined persistence in stock selection and market timing abilities of mutual fund managers using a sample of 448 mutual funds over a nine year period. They find that only the well performing funds exhibit a persistent market timing ability and the very best and worst performers display stock selection ability. Daniel et al. (1997) on the other hand find that actively managed funds provide excess return that is equal to average management fee. Detzel and Weigand (1998) argue that instead of relying only on the past performance, investors should identify the size and style characteristics of funds and investigate current market trends. Chevalier and Ellison (1999) argue that in presence of managerial turnover, the superior performance will be short-lived. Grinblatt and Titman (1992) examined a sample of 279 mutual funds over a ten-year horizon. They used Jensen alpha as a measure of superior performance and compared that with eight portfolios (P8). Their results suggested presence of persistence but they also concluded that persistence couldn t be attributed to fund manager s skills. Papadamou and Siriopoulos (2003) using a monthly data from 1996 to 2001 of 31 U.S.mutual funds that invested in Europe concluded that active management cannot beat benchmark index over the specified period. Fan and Addams (2012) examined a sample of 117 equity funds that invest outside U.S. in the period of 2005 to They do not find significant persistence in performance of U.S. based international mutual fund and report that relative performance of one international fund to another seems to be more like random walk than a persistent trend. As observed from the above review, there stand differences of opinion about the persistence in mutual fund performance. These differences arise due to many factors such as different definitions of performance, different sample sizes and sample periods, distinct methodologies etc. Based on the above literature, the null hypothesis for this study is as below: H 0 : There is no significant association between past performance and future performance of equity-oriented mutual funds in India. DATA AND METHODOLOGY Data Source The data for this study is obtained from Bloomberg, one of the most used databases by market participants as well as researchers. The sample pertains to four years from January 2009 to December The data contains daily NAVs of the funds under the sample. S&P CNX Nifty and the yield on 91-day Treasury bill is taken as the proxy for market portfolio and risk free rate of return respectively. Data on both these variable is also extracted from Bloomberg. Data Sample The sample consists of 103 active equity mutual funds. The universe of mutual funds available on Bloomberg has funds out of which only are active. Only 4685 funds are Indian funds. For the purposes of this study, only equity oriented mutual funds are considered. The threshold of at least 75% asset class allocation is taken to select any fund for

3 Persistence in Mutual Fund Performance-Evidence from India 131 the sample. This reduced the sample size to 329 funds. Further, the study considers funds only with growth objective. Hence, 226 funds are further removed from the sample to obtain the final sample of 103 funds. Methodology The objective of this paper is to study whether equity oriented mutual funds in India display a persistent performance overtime. In other words, does the performance of a fund in one period provide any indication of its performance in subsequent periods? To test this, Jensen s Alpha is considered as a proxy for performance of the fund. Jensen (1968) suggested adding an intercept to CAPM in order to estimate the excess return the fund earns due to superior forecasting abilities of the fund manager. This intercept is known as Jensen s Alpha and can be represented as below: Rpt Rft p p( Rm, t Rft) (1) Where, R pt is the portfolio return; R ft is the risk free rate of return; Β p is the beta of the portfolio representing systematic risk; R mt is the market return and α p if Jensen s Alpha Given the return on the portfolio and other parameters of the above equation, Jensen s Alpha can be computed by solving the below equation: R R R, R p pt ft p m t ft (2) The above equation translates into excess return on mutual fund in time t minus the beta times excess return on market portfolio. A positive value of Jensen s alpha can be attributed to fund manager s forecasting ability. The study compute Jensen s alpha on a weekly, monthly, and quarterly basis. The first step in this process is to compute the returns earned by mutual funds in the sample. The continuously compounded returns R pt are calculated as follows: R pt NAVpt ln NAV pt 1 The broad based index S&P CNX Nifty has been used as a proxy for market portfolio. The weekly, monthly, and quarterly closing values were used to compute the respective market return as follows: R m, t ln Pt Pt 1 Where, P is the closing value of Nifty at time t and t-1. As a next step, the Jensen s alpha was computed across all 103 funds on a weekly, monthly and quarterly basis for a period of four years i.e. from 2009 to In order to compute Jensen s alpha, information on two more factors is required viz. the risk free rate of return and an estimate of the systematic risk or beta of the portfolio. The yield on 91-day Treasury bill has been used as a proxy for risk free rate of return. The yields on these bonds are quoted on annualized basis. The annualized yields were converted on weekly, monthly, or quarterly yields by using the following equation:

4 132 Hanish Rajpal j r 1 R 1 Where, r is weekly/monthly/quarterly risk free rate of return; R is annualized yield on 91-day treasury bill and j is 52 or 12 or 4 for weekly/monthly/quarterly risk free rate of return respectively. The beta of the portfolio (β p ) was computed using historical data for three years on a rolling basis. For example, in order to estimate Jensen s Alpha for the first week of the year 2009, the beta is computed by regressing excess return of mutual fund on the excess return of the market portfolio (Nifty) from the first week of 2006 to last week of For computing Jensen s alpha in subsequent weeks, the beta is computed from the three years return data on rolling basis. After this, equation (2) is applied to compute Jensen s alpha. The same process is applied to compute Jensen s alpha on monthly and quarterly basis. To evaluate persistence, this study adopts the empirical methodology of Grinblatt and Titman (1992). Specifically, the following regression equation is used: i, t 0, i 1, i i, t 1 it, (3) Where, α i,t is Jensen s alpha of fund i in period t; α i,t-1 is Jensen s alpha of fund i in period t-1; γ 0,i is the intercept term; γ 1,i is the slope coefficient and ε i,t is the error term. The variable of interest here is the slope coefficient (γ 1,i ). The slope coefficient represents the relation of past performance and future performance. A significant positive t-statistic for γ 1,i would indicate the presence of persistence in mutual fund performance. The above regression equation is used on weekly, monthly, and quarterly estimates of Jensen s alpha of 103 mutual funds. Further, robustness check is conducted for monthly and quarterly data using non-parametric approach as adopted by Ferruz et al. (2007). Ferruz et al. (2007) examines the performance persistence of fixed-income and equity pension plans in Spanish pension market over the period For this purpose, they form 4x4 contingency tables using quartiles and perform chi-square test and Haberman s analysis of residuals to test the significance. Haberman s analysis of residual is applied in order to identify the categories leading to significant chi-square value. For this purpose, adjusted standardized residuals d are calculated as below: e d d N(0,1) (4) v Where, e is the standardized residual and can be calculated as below: e n E E V is the variance of e and can be calculated as below: v ni nj 1 1 N N (5)

5 Persistence in Mutual Fund Performance-Evidence from India 133 RESULTS Any significant positive values of adjusted standardized residual would indicate persistence in the performance. Descriptive Statistics The table 1 below presents the descriptive statistics of mutual fund returns and return on the market portfolio (Nifty). Table 1: Descriptive Statistics No. of Observations Mean Minimum Maximum Annual return on Nifty Annual return on Mutual funds Quarterly return on Nifty Quarterly return on Mutual funds Monthly return on Nifty Monthly return on Mutual funds Weekly return on Nifty Weekly return on Mutual funds The mean returns on mutual funds are higher than that of Nifty on all frequencies. However, there is a large variation in returns of mutual funds as compared to that of Nifty as evident from the difference between the minimum and maximum values. Thus, the sample represents a diversified pool of high and low performing mutual funds. Empirical Findings Firstly, the regression analysis based on eq. (3) for weekly, monthly, and quarterly frequencies is applied. The alpha of mutual fund in period t is regressed on alpha of period t-1. A significant positive value of the slope coefficient ( 1 ) represents the persistence in performance. Null hypothesis can be stated as below: H 0 : 1 0 Table 2 presents the results of regression and testing of slope coefficient. The results are not significant for any frequency. This suggests that there is no persistence in the performance of equity oriented mutual funds in India. As a next step in order to validate the results obtained in the first model, non-parametric approach is used. As explained earlier, a 4x4 contingency table is formed for quarterly and monthly frequency. The results of quarterly frequency are presented in Table 3. Here, the variables of interest are the values appearing in the diagonal representing the funds maintaining their quartile position. Any cell that has significant positive adjusted error represents persistence. Table 2: Results of Persistence Using Eq. (3) Frequency N Mean Standard t- Deviation Statistics Weekly Monthly Quarterly ***' Significant at 1% level; '**' Significant at 5% level

6 134 Hanish Rajpal Table 3: Analysis of Equity Mutual Funds in India on Quarterly Basis through 4x4 Contingency Table ***' Significant at 1% level; '**' Significant at 5% level Table 4 presents the number of times the funds show persistence in quarterly performance. Here also, the diagonal values are of interest. Total number of observations across the diagonal is 60 (4 x 15 quarters). Out of these 60 observations, funds are able to maintain the top 25% position for two consecutive quarters only five times. Similarly, three times the funds have maintained their position in bottom 25% for two consecutive quarters. Similar results for the monthly frequency are presented in table 5. Table 4: Number of Times Funds Display Persistence in Quarterly Performance Quartile Position in Quarter t Quartile Position in Quarter t-1 Q1 Q2 Q3 Q4 Q Q Q Q Table 5: Number of Times Funds Display Persistence in Monthly Performance Quartile Position in Month t Quartile Position in Month t-1 Q1 Q2 Q3 Q4 Q Q Q Q Table 6: Regression of Top 25% Funds N Mean Std. Deviation t-statistic

7 Persistence in Mutual Fund Performance-Evidence from India 135 In case of monthly performance, there are total 188 observations (47 months x4) across the diagonal. Out of these 188 observations, only 12 times the funds maintain top 25% position in two consecutive months. Similarly, 10 times the funds maintain bottom 25% position in two consecutive months. Results of non-parametric test, both on monthly and quarterly basis, show only a little evidence of persistence in performance of mutual funds. Relatively, only funds ranking in top 25% exhibit some amount of persistence. In order to test whether there is any significant amount of persistence in top 25% ranked funds, regression analysis using eq.(3) is again conducted on these funds. For this purpose, the average alpha was computed for all 103 funds and the funds were categorized in four quartiles based on the average alpha. The funds appearing in quartile 1 (top 25%) were selected and regression analysis was conducted. The null hypothesis is as below: H 0 : 1 0 The results of the regression are presented in table 6. Based on the results, the null hypothesis is not rejected. The funds do not show any significant persistence in performance over time. CONCLUSIONS This paper examines the persistence in performance of equity-oriented mutual funds in India over the period Past performance of mutual funds often remain a significant factor for investments while making a selecting a fund to invest. Mutual funds also pay a large attention on their past performance while soliciting new investments. The question then is whether past performance can predict the future performance of mutual funds. The objective, thus, is to analyze whether mutual funds performance remain consistent over time. The study takes a sample of 103 equity-oriented mutual funds and employs both parametric as well as non-parametric techniques in order to test and substantiate the findings. No evidence was found in the study through which it can be inferred that funds perform consistently over time. The findings have implication for investors, particularly for retail investors, who tend to invest in a specific mutual fund based on past performance of the fund. REFERENCES 1. Benos, E. and Jochec, M. (2011), Short term persistence in mutual fund market timing and stock selection abilities. Annals of Finance, 7, Brown, S., & Goetzmann, W. (1995). Performance persistence. Journal of Finance, 50, Carhart, M. (1997). On persistence in mutual fund performance. Journal of finance, 52, Chevalier, J. and Ellison, G. (1999). Career concerns of mutual fund managers. Quarterly Journal of Economics, 114, Daniel, K., Grinblatt, M., Titman, S. & Werrners, R. (1997). Measuring mutual fund performance with characteristicsbased benchmarks. Journal of Finance, 52,

8 136 Hanish Rajpal 6. Detzel, F.L. & Weigand, R.A. (1998). Explaining persistence in mutual fund performance. Financial Services Review, 7(1): Fan, Y. and Addams, H.L. (2012) United States-based international mutual funds: Performance and persistence. Financial Services Review, 21(1), Ferruz, L., Vicente, L.A., and Andreu, L. (2007). Identifying differences in the performance persistence of pension plans. Pension, 12(3), Grinblatt, M. and Titman, S. (1992). The persistence of mutual fund performance. Journal of Finance, 47(5), Gruber, M.(1996). Another puzzle: The growth in actively managed mutual funds. Journal of Finance 51, Jain, P.C. and Wu, J.S. (2000). Truth in mutual fund advertising: Evidence on future performance and fund flows. Journal of Finance 55, Lakonishok, J., Shleifer, A., & Vishny, R. (1992). The structure and performance of the money management industry. Brooking Papers on Economic Activity: Microeconomics, Papadamou, S. and Siriopoulos, C. (2003). Hot hand of U.S.equity fund managers in European market: Performance and style analysis. American Business Review, 21(2), Soonswang, A. and Sanohdontree, Y. (2011) Open-ended equity mutual funds. International Journal of Business and Social Sciences, 2(17),

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