Academic journal article IUP Journal of Applied Finance

The Relationship between Fund Performance and Fund Characteristics: Evidence from India

Academic journal article IUP Journal of Applied Finance

The Relationship between Fund Performance and Fund Characteristics: Evidence from India

Article excerpt

(ProQuest: ... denotes formulae omitted.)

Introduction

Over a decade, mutual funds have gained popularity among the investors seeking investment opportunities in financial markets. Generally, mutual funds facilitate greater diversification through professional management at substantially lower cost. In recent years, numerous schemes of funds were made available to meet the needs of various investors. However, it is difficult for the investors to measure and identify superior performing funds and the quality of the management of the investment company. Generally, the investors do not have sufficient knowledge, time, cost and information about mutual funds. In order to overcome these problems, a new category of mutual funds is being introduced, i.e., Fund of Funds (FoF). The issue of identifiying the superior performing funds remains unresolved; however, FoF is an investment strategy of holding a portfolio of other investment funds rather than investing directly in shares, bonds and other securities. FoF are being traded in American market since the 1980s. In India, Securities and Exchange Board of India (SEBI) has permitted fund houses to launch FoF in mid-2003 by amending SEBI (Mutual Funds) Regulations Act, 1996. The first Fund of Mutual Funds is 'FT India Dynamic PE Ratio FoFs' launched by Franklin Templeton Mutual Fund during October 2003. Thereafter, many other asset management companies launched fund of mutual funds, and at present there are 33 funds of mutual fund schemes with a capitalization of more than 150 mn.

For a decade now, mutual funds, as a special investment vehicle, have captured the attention of investors, business analysts and academicians. This paper intends to contribute to the growing literature on mutual funds with an empirical examination of the determinants of fund of mutual funds. Internationally, the research examining performance of funds begins with the early works of Treynor (1965), Sharpe (1966) and Jensen (1968), and they observe that the markets are active to create returns to the investors. In contrast, Ippolito (1993), Gruber (1996), Sirri and Tufano (1998), and Del Guercio and Tkac (2002) identified the interesting result that fund managers perform better than the market. A few studies found that fund managers fail to beat the market or stay even with the market before management fees (Grinblatt and Titman, 1989; Grinblatt et al., 1995; and Daniel et al., 1997). Then, it is observed that mutual fund investors apparently wish to pay a lot on fees for limited stockpicking ability, which ultimately resulted in negative returns (Jensen, 1968; Malkiel, 1995; and Gruber, 1996).

Thus, the performance of funds challenges the skills of the fund managers in ensuring extreme returns to the given size, management fees, fund age, etc. A common approach to test this issue is to examine the persistence of fund returns, i.e., whether the past winners continue to produce high returns or losers continue to underperform (Grinblatt and Titman, 1992; Hendricks et al., 1993; Goetzmann and Ibbotson, 1994; and Carhart, 1997). If the past performance is due to chance, then it will be risky or unfair to predict the future performance. In case the managers are skilled in stock selection, then the persistence test will assist to infer their existence. The persistence tests also have a downside because they typically rank the funds based on short-term past performance. One may find little evidence of persistence of fund return because the allocation of funds to winners' and losers' portfolios is largely based on noise. In this context, Bollen and Busse (2004) and Barras et al. (2008) found no evidence of persistence when funds were ranked on past average return and became weaker in short period. Grinblatt and Titman (1994) highlighted the sensitiveness of fund performance in relation to benchmark portfolios and found that the fund performance is highly influenced by the selected benchmark. Leong and Aw (1997) examined the sensitiveness of fund performance to different benchmark portfolios. …

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