Are Philippine Fixed Income Fund Managers Generating Alpha for Their Clients?

Article excerpt

ABSTRACT

The Sharpe, Treynor, Jensen's alpha, and information ratio portfolio performance measures are widely-used in the asset management industry to appraise investment performance due to their strong foundations in Modern Portfolio Theory, their practical uses in the ranking of investment funds, and their ability to quantify an investment 's realized alpha or degree of investment outperformance relative to a specific benchmark return. This paper is an application of these portfolio performance measures on fixed income investment companies (mutual funds) in the Philippines over a 1-, 3-, and 5-year returns computation horizon, aimed at identifying which portfolio managers are superior in market-timing, securities selection, and in the use of new information to generate excess or abnormal returns on their fixed income funds after having accounted for risk.

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INTRODUCTION

Mutual funds, also known as investment companies, are pooled investment vehicles managed by an asset management firm that seeks to create value for shareholders through tactical allocation of investor funds in various asset classes or in securities within a particular asset category. Typically, mutual funds are classified based on investment style, and can be broadly identified as either a fixed income fund, an equity fund, or a balanced fund (combination of fixed income and equity instruments), depending on the specific assets the fund is allowed to invest in (as stated in the fund's prospectus). Investors consider mutual funds to be a viable alternative to direct investments in equity and debt securities due to a number of benefits that can be derived from pooled fund-investing, which include, but are not limited to, easy liquidity, economies-of-scale, access to otherwise inaccessible markets, diversification, and management of funds by a skilled and knowledgeable investments practitioner.

For an asset management firm to act as fund manager and administrator of an investment company, it must be awarded a management and distribution mandate by fund participants (owners). Mandated asset managers are expected to perform the following basic duties in exchange for a periodic management fee: distribute shares in the fund to potential investors, provide ready liquidity to clients who wish to divest their existing mutual fund holdings, act as investment advisor and administrator to the investment company, and manage the fund's securities portfolio for the collective benefit of all fund shareholders. However, asset managers are scrutinized by the investing community on the basis of their ability to generate returns not just relative to competitors but vis-à-vis a chosen benchmark portfolio as well. Since ownership in a mutual fund is dispersed given its pooled nature, the interests of the majority shareholders of the fund, just like in any registered corporation, are represented by a board of directors. And one of the key responsibilities of the board of directors is to prudently select a fund manager and periodically evaluate its performance in all of the five aforementioned aspects, with returns relative to peers and benchmark being one of the more critical aspects in determining investment success for the client. Asset managers that exhibit more than just modest performance are likely to have their mandate as fund manager renewed during each periodic review by the board of directors. This process of performance measurement and evaluation ensures that fund managers remain competitive in the pooled fund investments industry.

Mutual Fund Industry Growth in the Philippines

To put the competitive landscape of mutual fund investments in proper perspective, assets under management (AUM) in the Philippine mutual fund industry reached a historic high of PHP 95.7-billion as of the end of 2010. This is a dramatic increase from the PHP 1.35-billion AUM of managers of local mutual funds back in 1997 (Valderrama & Bautista, 2003). …